AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 16, 2002
REGISTRATION NO. 333-90938
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM N-14
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933 [X]
---------------------
PRE-EFFECTIVE AMENDMENT NO. 1 [X]
POST-EFFECTIVE AMENDMENT NO. [ ]
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MORGAN STANLEY LIMITED DURATION FUND
A Massachusetts business trust
Formerly named Morgan Stanley Short Term Bond Fund
(Exact Name of Registrant as Specified in Charter)
1221 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10020
(Address of Principal Executive Offices)
(800) 869-6397
(Registrant's Telephone Number)
BARRY FINK, ESQ.
1221 Avenue of the Americas
New York, New York 10020
(Name and Address of Agent for Service)
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COPY TO:
STUART M. STRAUSS, ESQ.
Mayer, Brown, Rowe & Maw
1675 Broadway
New York, New York 10019
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THE REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
The Exhibit Index is located on page [ ].
PURSUANT TO RULE 429, THIS REGISTRATION STATEMENT RELATES TO SHARES
PREVIOUSLY REGISTERED BY THE REGISTRANT ON FORM N-1A (REGISTRATION NOS.
33-50857; 811-7117).
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FORM N-14
MORGAN STANLEY LIMITED DURATION FUND
CROSS REFERENCE SHEET
PURSUANT TO RULE 481(A) UNDER THE SECURITIES ACT OF 1933
PART A OF FORM N-14 ITEM NO. PROXY STATEMENT AND PROSPECTUS HEADING
- ------------------------------ ---------------------------------------------------------
1 (a) ........................ Cross Reference Sheet
(b) ........................ Front Cover Page
(c) ........................ *
2 (a) ........................ *
(b) ........................ Table of Contents
3 (a) ........................ Fee Table
(b) ........................ Synopsis
(c) ........................ Principal Risk Factors
4 (a) ........................ The Reorganization
(b) ........................ The Reorganization -- Capitalization Table (Unaudited)
5 (a) ........................ Registrant's Prospectus
(b) ........................ *
(c) ........................ *
(d) ........................ *
(e) ........................ Available Information
(f) ........................ Available Information
6 (a) ........................ Prospectus of Morgan Stanley North American Government
Income Trust
(b) ........................ Available Information
(c) ........................ *
(d) ........................ *
7 (a) ........................ Introduction -- General, Record Date; Share Information,
Expenses of Solicitation, Proxies, Vote Required
(b) ........................ *
(c) ........................ Introduction; The Reorganization -- Appraisal Rights
8 (a) ........................ The Reorganization
(b) ........................ *
9 .......................... *
PART B OF FORM N-14 ITEM NO. STATEMENT OF ADDITIONAL INFORMATION HEADING
- ------------------------------ ---------------------------------------------------------------
10(a) ........................ Cover Page
(b) ........................ *
11 .......................... Table of Contents
12(a) ........................ Additional Information about Morgan Stanley Limited
Duration Fund
(b) ........................ *
(c) ........................
13(a) ........................ Additional Information about Morgan Stanley North
American Government Income Trust
(b) ........................ *
(c) ........................ *
14 ........................ Registrant's Annual Report for the fiscal year ended April 30,
2002. Morgan Stanley North American Government
Income Trust's Annual Report for the fiscal year ended
October 31, 2001 and Semi-Annual Report for the
six-month period ended April 30, 2002.
PART C OF FORM N-14 ITEM NO. OTHER INFORMATION HEADING
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15 .......................... Indemnification
16 .......................... Exhibits
17 .......................... Undertakings
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* Not Applicable or negative answer
MORGAN STANLEY NORTH AMERICAN GOVERNMENT INCOME TRUST
1221 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10020
(800) 869-6397
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD SEPTEMBER 24, 2002
TO THE SHAREHOLDERS OF MORGAN STANLEY NORTH AMERICAN GOVERNMENT INCOME TRUST,
Notice is hereby given of a Special Meeting of the Shareholders of Morgan
Stanley North American Government Income Trust ("North American") to be held in
the Conference Room, at Harborside Financial Center, Plaza Two, 2nd Floor,
Jersey City, New Jersey 07311, at 9:00 a.m., Eastern time, on September 24,
2002, and any adjournments thereof (the "Meeting"), for the following purposes:
1. To consider and vote upon an Agreement and Plan of Reorganization, dated
April 25, 2002 (the "Reorganization Agreement"), between North American
and Morgan Stanley Limited Duration Fund ("Limited Duration"), pursuant to
which substantially all of the assets of North American would be combined
with those of Limited Duration and shareholders of North American would
become shareholders of Limited Duration receiving shares of Limited
Duration with a value equal to the value of their holdings in North
American (the "Reorganization"); and
2. To act upon such other matters as may properly come before the Meeting.
The Reorganization is more fully described in the accompanying Proxy
Statement and Prospectus and a copy of the Reorganization Agreement is attached
as Exhibit A thereto. Shareholders of record at the close of business on July
5, 2002 are entitled to notice of, and to vote at, the Meeting. Please read the
Proxy Statement and Prospectus carefully before telling us, through your proxy
or in person, how you wish your shares to be voted. Alternatively, if you are
eligible to vote telephonically by touchtone telephone or electronically on the
Internet (as discussed in the enclosed Proxy Statement) you may do so in lieu
of attending the Meeting in person. THE BOARD OF TRUSTEES OF NORTH AMERICAN
RECOMMENDS YOU VOTE IN FAVOR OF THE REORGANIZATION. WE URGE YOU TO SIGN, DATE
AND MAIL THE ENCLOSED PROXY PROMPTLY.
By Order of the Board of Trustees,
BARRY FINK,
Secretary
July , 2002
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YOU CAN HELP AVOID THE NECESSITY AND EXPENSE OF SENDING FOLLOW-UP LETTERS TO
ENSURE A QUORUM BY PROMPTLY RETURNING THE ENCLOSED PROXY. IF YOU ARE UNABLE
TO BE PRESENT IN PERSON, PLEASE FILL IN, SIGN AND RETURN THE ENCLOSED PROXY
IN ORDER THAT THE NECESSARY QUORUM BE REPRESENTED AT THE MEETING. THE
ENCLOSED ENVELOPE REQUIRES NO POSTAGE IF MAILED IN THE UNITED STATES.
SHAREHOLDERS WILL BE ABLE TO VOTE TELEPHONICALLY BY TOUCHTONE TELEPHONE OR
ELECTRONICALLY ON THE INTERNET BY FOLLOWING INSTRUCTIONS ON THEIR PROXY
CARDS OR ON THE ENCLOSED VOTING INFORMATION CARD.
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MORGAN STANLEY LIMITED DURATION FUND
1221 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10020
(800) 869-6397
ACQUISITION OF THE ASSETS OF
MORGAN STANLEY NORTH AMERICAN GOVERNMENT INCOME TRUST
BY AND IN EXCHANGE FOR SHARES OF
MORGAN STANLEY LIMITED DURATION FUND
This Proxy Statement and Prospectus is being furnished to shareholders of
Morgan Stanley North American Government Income Trust ("North American") in
connection with an Agreement and Plan of Reorganization, dated April 25, 2002
(the "Reorganization Agreement"), pursuant to which substantially all the
assets of North American will be combined with those of Morgan Stanley Limited
Duration Fund ("Limited Duration") in exchange for shares of Limited Duration
(the "Reorganization"). As a result of this transaction, shareholders of North
American will become shareholders of Limited Duration and will receive shares
of Limited Duration with a value equal to the value of their holdings in North
American. The terms and conditions of this transaction are more fully described
in this Proxy Statement and Prospectus and in the Reorganization Agreement
between North American and Limited Duration, attached hereto as Exhibit A. The
address and telephone number of North American is that of Limited Duration set
forth above. This Proxy Statement also constitutes a Prospectus of Limited
Duration, which is dated June 28, 2002, filed by Limited Duration with the
Securities and Exchange Commission (the "Commission") as part of its
Registration Statement on Form N-14 (the "Registration Statement").
Limited Duration is an open-end diversified management investment company
whose investment objective is to seek to provide investors with a high level of
current income, consistent with the preservation of capital. The fund normally
invests at least 65% of its assets in securities issued or guaranteed as to the
principal and interest by the U.S. government, its agencies or
instrumentalities, investment grade mortgage-backed securities, including
collateralized mortgage obligations, and investment grade corporate and other
types of bonds. In selecting portfolio investments, the fund's Investment
Manager, Morgan Stanley Investment Advisors Inc, considers both domestic and
international economic developments, interest rate levels, the steepness of the
yield curve and other factors, and seeks to maintain an overall average
duration for the fund's portfolio of three years or less.
This Proxy Statement and Prospectus set forth concisely information about
Limited Duration that shareholders of North American should know before voting
on the Reorganization Agreement. A copy of the Prospectus for Limited Duration
dated June 28, 2002, is attached as Exhibit B and incorporated herein by
reference. Also enclosed and incorporated herein by reference is Limited
Duration's Annual Report for the fiscal year ended April 30, 2002. A Statement
of Additional Information relating to the Reorganization, described in this
Proxy Statement and Prospectus, dated July , 2002, has been filed with the
Commission and is also incorporated herein by reference. Also incorporated
herein by reference are North American's Prospectus, dated December 31, 2001,
and Annual Report for its fiscal year ended October 31, 2001 and Semi-Annual
Report for the six-month period ended April 30, 2002. Such documents are
available without charge by calling (800) 869-6397 (toll free).
Investors are advised to read and retain this Proxy Statement and Prospectus
for future reference.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED ON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
THIS PROXY STATEMENT AND PROSPECTUS IS DATED JULY , 2002.
TABLE OF CONTENTS
PROXY STATEMENT AND PROSPECTUS
PAGE
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INTRODUCTION ........................................................................... 1
General .............................................................................. 1
Record Date; Share Information ....................................................... 1
Proxies .............................................................................. 2
Expenses of Solicitation ............................................................. 2
Vote Required ........................................................................ 3
SYNOPSIS ............................................................................... 4
The Reorganization ................................................................... 4
Fee Table ............................................................................ 4
Tax Consequences of the Reorganization ............................................... 6
Comparison of North American and Limited Duration .................................... 6
PRINCIPAL RISK FACTORS ................................................................. 8
THE REORGANIZATION ..................................................................... 11
The Proposal ......................................................................... 11
The Board's Consideration ............................................................ 11
The Reorganization Agreement ......................................................... 12
Tax Aspects of the Reorganization .................................................... 13
Description of Shares ................................................................ 15
Capitalization Table (unaudited) ..................................................... 15
Appraisal Rights ..................................................................... 15
COMPARISON OF INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS ......................... 15
Investment Objectives and Policies ................................................... 15
Investment Restrictions .............................................................. 16
ADDITIONAL INFORMATION ABOUT NORTH AMERICAN AND
LIMITED DURATION ...................................................................... 16
General .............................................................................. 16
Financial Information ................................................................ 17
Management ........................................................................... 17
Description of Securities and Shareholder Inquiries .................................. 17
Dividends, Distributions and Taxes ................................................... 17
Purchases, Repurchases and Redemptions ............................................... 17
MANAGEMENT'S DISCUSSION OF FUND PERFORMANCE ............................................ 17
FINANCIAL STATEMENTS AND EXPERTS ....................................................... 17
LEGAL MATTERS .......................................................................... 17
AVAILABLE INFORMATION .................................................................. 18
OTHER BUSINESS ......................................................................... 18
Exhibit A - Agreement and Plan of Reorganization, dated April 25, 2002, by and between
North American and Limited Duration
Exhibit B - Prospectus of Limited Duration dated June 28, 2002
MORGAN STANLEY
NORTH AMERICAN GOVERNMENT INCOME TRUST
1221 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10020
(800) 869-6397
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PROXY STATEMENT AND PROSPECTUS
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SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD SEPTEMBER 24, 2002
INTRODUCTION
GENERAL
This Proxy Statement and Prospectus is being furnished to the shareholders
of Morgan Stanley North American Government Income Trust ("North American"), an
open-end diversified management investment company, in connection with the
solicitation by the Board of Trustees of North American (the "Board") of
proxies to be used at the Special Meeting of Shareholders of North American to
be held in the Conference Room at Harborside Financial Center, Plaza Two, 2nd
Floor, Jersey City, New Jersey 07311 at 9:00 A.M., Eastern time, on September
24, 2002 and any adjournments thereof (the "Meeting"). It is expected that the
mailing of this Proxy Statement and Prospectus will be made on or about July
, 2002.
At the Meeting, North American shareholders (the "Shareholders") will
consider and vote upon an Agreement and Plan of Reorganization, dated April 25,
2002 (the "Reorganization Agreement"), between North American and Morgan
Stanley Limited Duration Fund ("Limited Duration") pursuant to which
substantially all of the assets of North American will be combined with those
of Limited Duration in exchange for shares of Limited Duration. As a result of
this transaction, Shareholders will become shareholders of Limited Duration and
will receive shares of Limited Duration equal to the value of their holdings in
North American on the date of such transaction (the "Reorganization"). The
shares to be issued by Limited Duration pursuant to the Reorganization (the
"Limited Duration Shares") will be issued at net asset value without an initial
sales charge. Further information relating to Limited Duration is set forth
herein and in Limited Duration's current Prospectus, dated June 28, 2002
("Limited Duration's Prospectus"), attached to this Proxy Statement and
Prospectus and incorporated herein by reference.
The information concerning North American contained herein has been
supplied by North American and the information concerning Limited Duration
contained herein has been supplied by Limited Duration.
RECORD DATE; SHARE INFORMATION
The Board has fixed the close of business on July 5, 2002 as the record
date (the "Record Date") for the determination of the Shareholders entitled to
notice of, and to vote at, the Meeting. As of the Record Date, there were
[ ] shares of North American issued and outstanding. Shareholders
on the Record Date are entitled to one vote per share on each matter submitted
to a vote at the Meeting. A majority of the outstanding shares entitled to
vote, represented in person or by proxy, will constitute a quorum at the
Meeting.
1
The following persons were known to own, of record or beneficially, 5% or
more of the outstanding shares of North American as of the Record Date: [Insert
5% ownership information.] As of the Record Date, the trustees and officers of
North American, as a group, owned less than 1% of the outstanding shares of
North American.
The following persons were known to own, of record or beneficially, 5% or
more of the outstanding shares of Limited Duration as of the Record Date:
[INSERT 5% OWNERSHIP INFORMATION.] As of the Record Date, the trustees and
officers of Limited Duration, as a group, owned less than 1% of the outstanding
shares of Limited Duration.
PROXIES
The enclosed form of proxy, if properly executed and returned, will be
voted in accordance with the choice specified thereon. The proxy will be voted
in favor of the Reorganization Agreement unless a choice is indicated to vote
against or to abstain from voting on the Reorganization Agreement. The Board
knows of no business, other than that set forth in the Notice of Special
Meeting of Shareholders, to be presented for consideration at the Meeting.
However, the proxy confers discretionary authority upon the persons named
therein to vote as they determine on other business, not currently
contemplated, which may come before the Meeting. Abstentions and, if
applicable, broker "non-votes" will not count as votes in favor of the
Reorganization Agreement, and broker "non-votes" will not be deemed to be
present at the meeting for purposes of determining whether the Reorganization
Agreement has been approved. Broker "non-votes" are shares held in street name
for which the broker indicates that instructions have not been received from
the beneficial owners or other persons entitled to vote and for which the
broker does not have discretionary voting authority. If a Shareholder executes
and returns a proxy but fails to indicate how the votes should be cast, the
proxy will be voted in favor of the Reorganization Agreement. The proxy may be
revoked at any time prior to the voting thereof by: (i) delivering written
notice of revocation to the Secretary of North American, c/o Morgan Stanley
Trust, Harborside Financial Center, Plaza Two, Jersey City, NJ 07311; (ii)
attending the Meeting and voting in person; or (iii) completing and returning a
new proxy (whether by mail or, as discussed below, by touchtone telephone or
the Internet) (if returned and received in time to be voted). Attendance at the
Meeting will not in and of itself revoke a proxy.
In the event that the necessary quorum to transact business or the vote
required to approve or reject the Reorganization Agreement is not obtained at
the Meeting, the persons named as proxies may propose one or more adjournments
of the Meeting to permit further solicitation of proxies. Any such adjournment
will require the affirmative vote of the holders of a majority of shares of
North American present in person or by proxy at the Meeting. The persons named
as proxies will vote in favor of such adjournment those proxies which they are
entitled to vote in favor of the Reorganization Agreement and will vote against
any such adjournment those proxies required to be voted against the
Reorganization Agreement.
EXPENSES OF SOLICITATION
All expenses of this solicitation, including the cost of preparing and
mailing this Proxy Statement and Prospectus, will be borne by North American,
which expenses are expected to approximate $96,000. North American and Limited
Duration will bear all of their respective other expenses associated with the
Reorganization.
The solicitation of proxies will be by mail, which may be supplemented by
solicitation by mail, telephone or otherwise through officers of North American
or officers and regular employees of Morgan Stanley Investment Advisors Inc.
("Morgan Stanley Investment Advisors" or the "Investment Manager"), Morgan
2
Stanley Trust ("Morgan Stanley Trust" or the "Transfer Agent"), Morgan Stanley
Services Company Inc. ("Morgan Stanley Services") and/or Morgan Stanley DW Inc.
("Morgan Stanley DW"), without special compensation therefor. As described
below, North American will employ Alamo Direct Mail Services Inc. ("Alamo") to
make telephone calls to Shareholders to remind them to vote. In addition, North
American may also employ D.F. King & Co., Inc. ("D.F. King") as proxy solicitor
if it appears that the required number of votes to achieve quorum will not be
received. In the event of a solicitation by D.F. King, North American would pay
D.F. King $3,000 and the expenses outlined below.
Shareholders will be able to vote their shares by touchtone telephone or
by Internet by following the instructions on the proxy card or on the Voting
Information Card accompanying this Proxy Statement. To vote by Internet or by
telephone, Shareholders can access the website or call the toll-free number
listed on the proxy card or noted in the enclosed voting instructions. To vote
by Internet or by telephone, Shareholders will need the "control number" that
appears on the proxy card.
In certain instances, Morgan Stanley Trust, Alamo and/or D.F. King may
call Shareholders to ask if they would be willing to have their votes recorded
by telephone. The telephone voting procedure is designed to authenticate
Shareholders' identities, to allow Shareholders to authorize the voting of
their shares in accordance with their instructions and to confirm that their
instructions have been recorded properly. No recommendation will be made as to
how a Shareholder should vote on any Proposal other than to refer to the
recommendations of the Board. North American has been advised by counsel that
these procedures are consistent with the requirements of applicable law.
Shareholders voting by telephone in this manner will be asked for their social
security number or other identifying information and will be given an
opportunity to authorize proxies to vote their shares in accordance with their
instructions. To ensure that the Shareholders' instructions have been recorded
correctly, they will receive a confirmation of their instructions in the mail.
A special toll-free number set forth in the confirmation will be available in
case the information contained in the confirmation is incorrect. Although a
Shareholder's vote may be taken by telephone, each Shareholder will receive a
copy of this Proxy Statement and may vote by mail using the enclosed proxy card
or by touchtone telephone or the Internet as set forth above. The last proxy
vote received in time to be voted, whether by proxy card, touchtone telephone
or Internet, will be the last vote that is counted and will revoke all previous
votes by the Shareholder. With respect to telephone calls by Alamo, expenses
would be approximately $1.00 per outbound telephone contact. With respect to
the solicitation of a telephonic vote by D.F. King, approximate additional
expenses may include $6.00 per telephone vote transacted, $3.25 per outbound or
inbound telephone contact, and costs relating to obtaining Shareholders'
telephone numbers and providing additional materials upon Shareholder requests,
which would be borne by North American.
VOTE REQUIRED
Approval of the Reorganization Agreement by the Shareholders requires the
affirmative vote of a majority (i.e., more than 50%) of the shares of North
American represented in person or by proxy and entitled to vote at the Meeting,
provided a quorum is present at the Meeting. If the Reorganization Agreement is
not approved by Shareholders, North American will continue in existence and the
Board will consider alternative actions.
3
SYNOPSIS
The following is a synopsis of certain information contained in or
incorporated by reference in this Proxy Statement and Prospectus. This synopsis
is only a summary and is qualified in its entirety by the more detailed
information contained or incorporated by reference in this Proxy Statement and
Prospectus and the Reorganization Agreement. Shareholders should carefully
review this Proxy Statement and Prospectus and Reorganization Agreement in
their entirety and, in particular, Limited Duration's Prospectus, which is
attached to this Proxy Statement and incorporated herein by reference.
THE REORGANIZATION
The Reorganization Agreement provides for the transfer of substantially
all the assets of North American, subject to stated liabilities, to Limited
Duration in exchange for the Limited Duration Shares. The aggregate net asset
value of the Limited Duration Shares issued in the exchange will equal the
aggregate value of the net assets of North American received by Limited
Duration. On or after the closing date scheduled for the Reorganization (the
"Closing Date"), North American will distribute the Limited Duration Shares
received by North American to Shareholders as of the Valuation Date (as defined
below under "The Reorganization -- The Reorganization Agreement") in complete
liquidation of North American, and North American will thereafter be dissolved
and deregistered under the Investment Company Act of 1940, as amended (the
"1940 Act"). As a result of the Reorganization, each Shareholder will receive
that number of full and fractional Limited Duration Shares equal in value to
such Shareholder's pro rata interest in the net assets of North American
transferred to Limited Duration. Pursuant to the Reorganization, Shareholders
holding their shares of North American in certificate form will be asked to
surrender their certificates in connection with the Reorganization.
Shareholders who do not surrender their certificates prior to the Closing Date
will still receive their shares of Limited Duration; however, such Shareholders
will not be able to redeem, transfer or exchange the Limited Duration Shares
received until the old certificates have been surrendered. The Board has
determined that the interests of Shareholders will not be diluted as a result
of the Reorganization.
At least one but not more than 20 business days prior to the Valuation
Date, North American will declare and pay a dividend or dividends which,
together with all previous such dividends, will have the effect of distributing
to Shareholders all of North American's investment company taxable income for
all periods since the inception of North American through and including the
Valuation Date (computed without regard to any dividends paid deduction), and
all of North American's net capital gain, if any, realized in such periods
(after reduction for any capital loss carryforward).
FOR THE REASONS SET FORTH BELOW UNDER "THE REORGANIZATION -- THE BOARD'S
CONSIDERATION," THE BOARD, INCLUDING THE TRUSTEES WHO ARE NOT "INTERESTED
PERSONS" OF NORTH AMERICAN ("INDEPENDENT TRUSTEES"), AS THAT TERM IS DEFINED IN
THE 1940 ACT HAS CONCLUDED THAT THE REORGANIZATION IS IN THE BEST INTERESTS OF
NORTH AMERICAN AND ITS SHAREHOLDERS AND RECOMMENDS APPROVAL OF THE
REORGANIZATION AGREEMENT.
FEE TABLE
The following table briefly describes the fees and expenses that a
shareholder of North American and Limited Duration may pay if they buy and hold
shares of each respective fund. These expenses are deducted from each
respective fund's assets and are based on expenses paid by North American for
its fiscal year ended October 31, 2001, and by Limited Duration for its fiscal
year ended April 30, 2002. North American and Limited Duration each pay
expenses for management of their assets, distribution of their shares and other
services, and those expenses are reflected in the net asset value per share of
each fund. The table also sets forth pro forma fees for the surviving combined
fund (Limited Duration) (the "Combined Fund"), reflecting what the fee schedule
would have been on April 30, 2002, if the Reorganization had been consummated
twelve (12) months prior to that date.
4
Shareholder Fees (fees paid directly from your investment)
PRO FORMA
NORTH LIMITED COMBINED FUND
AMERICAN DURATION (LIMITED DURATION)
---------- ---------- -------------------
MAXIMUM SALES CHARGE (LOAD) IMPOSED ON PURCHASES
(AS A PERCENTAGE OF OFFERING PRICE) .................. none none none
MAXIMUM SALES CHARGE (LOAD) IMPOSED ON REINVESTED
DIVIDENDS ............................................ none none none
MAXIMUM CONTINGENT DEFERRED SALES CHARGE (LOAD) (AS A
PERCENTAGE OF THE LESSER OF ORIGINAL PURCHASE PRICE OR
REDEMPTION PROCEEDS) ................................. none none none
REDEMPTION FEES ....................................... none none none
EXCHANGE FEE .......................................... none none none
Annual Fund Operating Expenses (expenses that are deducted from fund assets)
PRO FORMA
NORTH LIMITED COMBINED FUND
AMERICAN DURATION (LIMITED DURATION)
---------- ---------- -------------------
MANAGEMENT FEES(1) .............................. 0.65% 0.70% 0.70%
DISTRIBUTION AND SERVICE (12B-1) FEES ........... 0.73% 0.00% 0.00%
OTHER EXPENSES(1) ............................... 0.42% 0.22% 0.24%
TOTAL ANNUAL FUND OPERATING EXPENSES(1) ......... 1.80% 0.92% 0.94%
- ----------
(1) With respect to Limited Duration during Limited Duration's fiscal year
ended April 30, 2002, the Investment Manager waived its compensation and
assumed operating expenses (except brokerage fees) without limitation to
the extent such compensation and expenses exceeded 0.80% of Limited
Duration's daily net assets on an annualized basis (the "Undertaking").
The Investment Manager will continue to do so until December 31, 2002.
The fees and expenses for Limited Duration disclosed above do not reflect
the assumption of such expenses and waiver of compensation by the
Investment Manager for the Fund's fiscal year ended April 30, 2002. For
the fiscal year ended April 30, 2002, taking the assumption of expenses
and the waiver of compensation into account, the actual management fee
was 0.58% of Limited Duration's daily net assets and the actual other
expenses were 0.22% of daily net assets.
EXAMPLE
To attempt to show the effect of these expenses on an investment over
time, the hypotheticals shown below have been created. The example assumes that
an investor invests $10,000 in either North American or Limited Duration or the
new Combined Fund (Limited Duration), that the investment has a 5% return each
year and that the operating expenses for each fund remain the same (as set
forth in the chart above). Although a shareholder's actual costs may be higher
or lower, the tables below show a shareholder's costs at the end of each period
based on these assumptions depending upon whether or not a shareholder sold his
shares at the end of each period.
5
If a Shareholder SOLD His Shares:
1 YEAR 3 YEARS 5 YEARS 10 YEARS
-------- --------- --------- ---------
North American ................... $183 $566 $975 $2,116
Limited Duration ................. $ 94 $293 $509 $1,131
Pro Forma Combined Fund .......... $ 96 $300 $520 $1,155
If a Shareholder HELD His Shares:
1 YEAR 3 YEARS 5 YEARS 10 YEARS
-------- --------- --------- ---------
North American ................... $183 $566 $975 $2,116
Limited Duration ................. $ 94 $293 $509 $1,131
Pro Forma Combined Fund .......... $ 96 $300 $520 $1,155
The purpose of the foregoing fee table is to assist the investor or
shareholder in understanding the various costs and expenses that an investor or
shareholder in the fund will bear directly or indirectly. For a more complete
description of these costs and expenses, see "Comparison of North American and
Limited Duration -- Investment Management and Distribution Plan Fees," "Other
Significant Fees," and "Purchases, Exchanges and Redemptions" below.
TAX CONSEQUENCES OF THE REORGANIZATION
As a condition to the Reorganization, North American will receive an
opinion of Mayer, Brown, Rowe & Maw to the effect that the Reorganization will
constitute a tax-free reorganization for federal income tax purposes, and that
no gain or loss will be recognized by North American or the Shareholders of
North American for federal income tax purposes as a result of the transactions
included in the Reorganization. For further information about the tax
consequences of the Reorganization, see "The Reorganization -- Tax Aspects of
the Reorganization" below.
COMPARISON OF NORTH AMERICAN AND LIMITED DURATION
INVESTMENT OBJECTIVES AND POLICIES. The investment objective of North
American is to seek to earn a high level of current income while maintaining
relatively low volatility of principal. The investment objective of Limited
Duration is to seek to provide a high level of current income, consistent with
the preservation of capital.
North American seeks to achieve its investment objective by normally
investing at least 80% of its assets in fixed-income securities issued or
guaranteed by the United States, Canadian or Mexican governments, their
subdivisions, agencies or instrumentalities. North American normally invests at
least 50% of its net assets in U.S. government securities, and no more than 25%
each in Canadian and Mexican government securities. The fund's Sub-Advisor, TCW
Investment Management Company ("TCW"), allocates fund assets among the three
countries based on its analysis of market, economic and political conditions in
those countries. TCW expects that, under normal circumstances, the weighted
average maturity of the fund's investment securities will be no greater than 3
years. In addition, the fund purchases Mexican government securities that have
remaining maturities of one year or less.
Limited Duration seeks to achieve its investment objective by normally
investing at least 65% of its assets in securities issued or guaranteed as to
the principal and interest by the U.S. government, its agencies or
instrumentalities (including zero coupon securities), investment grade
mortgage-backed securities, including collateralized mortgage obligations, and
investment grade corporate and other types of bonds. In selecting
6
portfolio investments to purchase or sell, the fund's Investment Manager,
Morgan Stanley Investment Advisors, considers both domestic and international
economic developments, interest rate levels, the steepness of the yield curve
and other factors, and seeks to maintain an overall average duration for the
fund's portfolio of three years or less.
The principal differences between the funds' investment policies, as well
as certain similarities, are more fully described under "Comparison of
Investment Objectives, Policies and Restrictions" below.
The investment policies of both North American and Limited Duration are
not fundamental and may be changed by their respective Boards of Trustees.
INVESTMENT MANAGEMENT AND DISTRIBUTION PLAN FEES. North American and
Limited Duration obtain management services from Morgan Stanley Investment
Advisors. With respect to North American, Morgan Stanley Investment Advisors
has contracted with TCW to invest the fund's assets, including the placing of
orders for the purchase and sale of portfolio securities. North American pays
Morgan Stanley Investment Advisors monthly compensation calculated daily at an
annual rate of 0.65% of the fund's average daily net assets. Morgan Stanley
Investment Advisors pays TCW compensation equal to 40% of its compensation for
services and facilities furnished to the fund. With respect to Limited
Duration, the fund pays Morgan Stanley Investment Advisors monthly compensation
calculated daily at an annual rate of 0.70% of the fund's average daily net
assets. During the fiscal year ended April 30, 2002, Limited Duration's
Investment Manager waived its compensation and assumed operating expenses
(except brokerage fees) without limitation to the extent that such compensation
and expenses exceeded 0.80% of the fund's daily net assets, on an annualized
basis. The Investment Manager will continue to assume all operating expenses
(except brokerage fees) and waive its compensation for the Combined Fund to the
extent they exceed 0.80% of the Combined Fund's daily net assets, on an
annualized basis, until December 31, 2002.
Both North American and Limited Duration have adopted distribution plans
pursuant to Rule 12b-1 under the 1940 Act ("Rule 12b-1 Plan(s)"). North
American's Rule 12b-1 Plan provides that the fund will reimburse Morgan Stanley
Distributors Inc., the funds' distributor (the "Distributor"), and others for
the expenses of certain activities and services incurred by them in connection
with the distribution of shares of the fund. Reimbursement for these expenses
is made in monthly payments by the fund to the Distributor at the maximum
annual rate of 0.75% of the average daily net assets of the fund. With respect
to Limited Duration, the fund's 12b-1 Plan allows the Distributor to use its
own assets or those of its affiliates, including Morgan Stanley Investment
Advisors to pay distribution fees for the sale and distribution of Limited
Duration's shares. Limited Duration does not itself pay 12b-1 fees.
OTHER SIGNIFICANT FEES. Both North American and Limited Duration pay
additional fees in connection with their operations, including legal, auditing,
transfer agent, trustees fees and custodial fees. See "Synopsis -- Fee Table"
above for the percentage of average net assets represented by such "Other
Expenses."
PURCHASES, EXCHANGES AND REDEMPTIONS. Shares of each fund are sold at net
asset value. Shares of North American and Limited Duration are distributed by
the Distributor and offered by Morgan Stanley DW and other dealers who have
entered into selected dealer agreements with the Distributor.
Shares of North American and Limited Duration may be exchanged for shares
of any other continuously offered Morgan Stanley Fund provided that shares of
North American or Limited Duration were acquired in exchange for shares
initially purchased in a Morgan Stanley Multi-Class Fund or a Morgan Stanley
Fund subject to a front-end sales charge ("FSC Fund"). In that case the shares
of North American or Limited Duration so acquired may be subsequently
re-exchanged for shares of the same class of any Morgan Stanley Multi-Class
Fund or FSC Fund. Shares of North American or Limited Duration, however
acquired, may be
7
exchanged for shares of another Morgan Stanley No Load Fund, a Morgan Stanley
money market fund or Morgan Stanley Short-Term U.S. Treasury Trust. Upon
consummation of the Reorganization, the foregoing exchange privileges will
still be applicable to shareholders of the Combined Fund.
Both North American and Limited Duration provide telephone exchange
privileges to their shareholders. For greater details relating to exchange
privileges applicable to Limited Duration, see the section entitled "How to
Exchange Shares" in Limited Duration's Prospectus.
Shareholders of North American and Limited Duration may redeem their
shares for cash at any time at the net asset value per share next determined.
North American and Limited Duration may redeem involuntarily, at net asset
value, most accounts valued at less than $100.
DIVIDENDS. Each fund declares dividends separately for each of its
classes. North American pays dividends from net investment income monthly and
usually distributes net capital gains, if any, in December. Limited Duration
also pays dividends from net investment income monthly and usually distributes
net capital gains, if any, in December. Each fund, however, may determine
either to distribute or to retain all or part of any net long-term capital
gains in any year for reinvestment. With respect to each fund, dividends and
capital gains distributions are automatically reinvested in additional shares
of the fund at net asset value unless the shareholder elects to receive cash.
For more details relating to how each fund makes distributions, see the section
"Distributions" in each fund's Prospectus.
PRINCIPAL RISK FACTORS
The share price or net asset value and yield of North American and Limited
Duration will fluctuate with changes in the market value of their respective
portfolio securities. The market value of the funds' portfolio securities will
increase or decrease due to a variety of market, economic and political
factors, including movements in interest rates, which cannot be predicted.
Each fund invests in fixed-income securities. All fixed-income securities,
such as bonds, are subject to two types of risk: credit risk and interest rate
risk. Credit risk refers to the possibility that the issuer of a security will
be unable to make interest payments and repay the principal on its debt.
Interest rate risk refers to fluctuations in the value of a fixed-income
security resulting from changes in the general level of interest rates. When
the general level of interest rates goes up, the prices of most fixed-income
securities go down. When the general level of interest rates goes down, the
prices of most fixed-income securities go up. (Zero-coupon securities are
typically subject to greater price fluctuations than comparable securities that
pay interest.)
In the case of North American, a substantial portion of the fixed-income
securities in which the fund may invest will be mortgage-backed securities.
Limited Duration may also invest a substantial portion of its assets in
mortgage-backed securities. Mortgage-backed securities have different risk
characteristics than traditional debt securities. Although generally the value
of fixed-income securities increases during periods of falling interest rates
and decreases during periods of rising interest rates, this is not always the
case with mortgage-backed securities. This is due to the fact that principal on
underlying mortgages may be prepaid at any time, as well as other factors.
Prepayment risk includes the possibility that, as interest rates fall,
securities with stated interest rates may have the principal prepaid earlier
than expected, requiring either fund to invest the proceeds at generally lower
interest rates. Investments in mortgage-backed securities are made based upon,
among other things, expected rates of prepayments on underlying mortgage pools.
Rates of prepayment, faster or slower than expected at the time of investment,
could reduce the fund's yield, increase the volatility of the fund and/or cause
a decline in net asset value. Certain mortgage-backed securities, especially
privately issued mortgage-backed securities, are more volatile and less liquid
than traditional types of securities.
8
Each fund may also invest in collateralized mortgage obligations ("CMOs").
CMOs are debt obligations collateralized by mortgage loans or mortgage
pass-through securities. Payments of principal and interest on such mortgage
loans or pass-through securities are used to make payments on the CMOs. CMOs
are issued in multiple classes, each with a specific fixed or floating coupon
rate and a stated maturity date. The principal and interest on the underlying
mortgage loans or pass-through securities may be allocated among the classes in
a number of different ways and, as a result, certain classes will have more
predictable cash flows than others. The more predictable the cash flow the
lower the yield and the less predictable the cash flow, the higher the yield
and the greater the risk. Certain classes of CMOs in which the fund may invest
may increase or decrease in value substantially with changes in interest rates
and/or rates of prepayment. In addition, if the collateral securing CMOs or
third party guarantees is insufficient to make payments, the fund could sustain
a loss.
North American may invest up to 10% of its net assets in inverse floaters.
An inverse floater has a coupon rate that moves in the direction opposite to
that of a designated interest rate index. The coupon rate on inverse floaters
typically changes at a multiple of the change in the relevant index rate, and,
consequently inverse floaters are more volatile than most other fixed-income
securities. North American may also purchase stripped mortgage-backed
securities, which are structured in two classes. One class entitles the holder
to receive all or most of the interest but little or none of the principal of a
pool of mortgage assets (the "IO" Class), while the other class entitles the
holder to receive all or most of the principal but little or none of the
interest (the "PO" Class). IOs tend to decrease in value substantially if
interest rates decline and prepayment rates become more rapid. POs tend to
decrease in value substantially if interest rates increase and repayment rates
decrease.
Each fund may invest in foreign securities. With respect to North
American, the fund may invest up to 25% of its net assets each in Canadian or
Mexican government securities, and up to 20% of its net assets in U.S.,
Canadian or Mexican securities that are not government securities. Limited
Duration may invest up to 25% of its net assets in investment grade
fixed-income securities issued by foreign governments of corporations. The
funds' investments in foreign securities involve risks in addition to the risks
associated with domestic securities. One additional risk is currency risk.
While the price of fund shares is quoted in U.S. dollars, each fund generally
converts U.S. dollars to a foreign market's local currency to purchase a
security in that market. If the value of that local currency falls relative to
the U.S. dollar, the U.S. dollar value of the foreign security will decrease.
This is true even if the foreign security's local price remains unchanged.
Foreign securities also have risks related to economic and political
developments abroad, including effects of foreign social, economic or political
instability. Foreign issuers, in general, are not subject to the regulatory
requirements of U.S. issuers and, as such, there may be less publicly available
information about these issuers. Moreover, foreign accounting, auditing and
financial reporting standards generally are different from those applicable to
U.S. issuers. Finally, in the event of a default of any foreign debt
obligations, it may be more difficult for a fund to obtain or enforce a
judgment against the issuers of the securities.
Securities of foreign issuers may be less liquid than comparable
securities of U.S. issuers and, as such, their price changes may be more
volatile. Furthermore, foreign exchanges and broker-dealers are generally
subject to less government and exchange scrutiny and regulation than their U.S.
counterparts. In addition, differences in clearance and settlement procedures
in foreign markets may occasion delays in settlement of the funds' trades
effected in those markets and could result in losses to the fund due to
subsequent declines in the value of the securities subject to the trades.
With respect to North American, the fund's investment in Canadian debt
securities carries an additional risk related to the smaller size and lesser
liquidity of the Canadian debt securities market. In addition, the Mexican
securities in which the fund may invest are issued by a developing country,
and, consequently, may be especially volatile. The Mexican government has
exercised and continues to exercise a significant influence over many aspects
of the private sector in Mexico. Consequently, Mexican government actions
concerning the economy could have a significant effect on market conditions and
prices and yields of Mexican debt obligations.
9
Both funds may invest in futures, and North American may also invest in
options, with respect to financial instruments and interest rate indexes. Each
fund's participation in these markets is subject to certain risks. For example,
the Investment Manager's (in the case of Limited Duration), or the
Sub-Advisor's (in the case of North American) predictions of movements in the
direction of the stock, bond or interest rate markets may be inaccurate, and
the adverse consequences to the fund (e.g., a reduction in the fund's net asset
value or a reduction in the amount of income available for distribution) may
leave the fund in a worse position than if these strategies were not used.
Other risks inherent in the use of options and futures include, for example,
the possible imperfect correlation between the price of options and futures
contracts and movements in the prices of the securities being hedged, and the
possible absence of a liquid secondary market for any particular instrument.
Certain options may be over-the-counter options, which are options negotiated
with dealers; there is no secondary market for these investments.
North American may also invest in reverse repurchase agreements and dollar
rolls. Such investments involve the risk that the market value of the
securities the fund is obligated to repurchase under the agreement may decline
below the repurchase price. In the event the buyer of securities under a
reverse repurchase agreement or dollar roll files for bankruptcy or becomes
insolvent, the fund's use of proceeds of the agreement may be restricted
pending a determination by the other party, or its trustee or receiver, whether
to enforce the fund's obligation to repurchase the securities. Reverse
repurchase agreements and dollar rolls are speculative techniques involving
leverage, and are considered borrowings by the fund.
Limited Duration may invest in asset backed securities. Asset-backed
securities have risk characteristics similar to mortgage-backed securities.
Like mortgage-backed securities, they generally decrease in value as a result
of interest rate increases, but may benefit less than other fixed-income
securities from declining interest rates, principally because of prepayments.
Also, as in the case of mortgage-backed securities, prepayments generally
increase during a period of declining interest rates although other factors,
such as changes in credit use and payment patterns, may also influence
prepayment rates. Asset-backed securities also involve the risk that various
federal and state consumer laws and other legal and economic factors may result
in the collateral backing the securities being insufficient to support payment
on the securities.
Limited Duration may also invest up to 5% of its net assets in
fixed-income securities rated lower than investment grade, which are otherwise
known as "junk bonds," and in "Rule 144A" fixed-income securities, which are
subject to resale restrictions,
Limited Duration's investments in junk bonds pose significant risks. The
prices of junk bonds are likely to be more sensitive to adverse economic
changes or individual corporate developments than higher rated securities.
During an economic downturn or substantial period of rising interest rates,
junk bond issuers and, in particular, highly leveraged issuers may experience
financial stress that would adversely affect their ability to service their
principal and interest payment obligations, to meet their projected business
goals or to obtain additional financing. In the event of a default, the fund
may incur additional expenses to seek recovery. The secondary market for junk
bonds may be less liquid than the markets for higher quality securities and, as
such, may have an adverse effect on the market prices of certain securities.
Many junk bonds are issued as Rule 144A securities. Rule 144A securities could
have the effect of increasing the level of fund illiquidity to the extent a
fund may be unable to find qualified institutional buyers interested in
purchasing the securities. The illiquidity of the market may also adversely
affect the ability of the fund's Trustees to arrive at a fair value for certain
junk bonds at certain times and could make it difficult for the fund to sell
certain securities.
The foregoing discussion is a summary of the principal risk factors. For a
more complete discussion of the risks of each fund, see the sections entitled
"Principal Risks" and "Additional Risk Information" in each fund's Prospectus,
both of which are incorporated herein by reference.
10
THE REORGANIZATION
THE PROPOSAL
The Board of North American, including the Independent Trustees, having
reviewed the financial position of North American and the prospects for
achieving economies of scale through the Reorganization and having determined
that the Reorganization is in the best interests of North American and its
Shareholders and that the interests of Shareholders will not be diluted as a
result thereof, recommends approval of the Reorganization by Shareholders of
North American.
THE BOARD'S CONSIDERATION
At a meeting held on April 25, 2002, the Board of North American,
including the Independent Trustees, unanimously approved the Reorganization
Agreement and determined to recommend that Shareholders approve the
Reorganization Agreement. In reaching this decision, the Board made an
extensive inquiry into a number of factors, particularly the comparative
expenses currently incurred in the operations of North American and Limited
Duration. The Board also considered other factors, including, but not limited
to: the general compatibility of the investment objectives, policies and
restrictions of North American and Limited Duration; the terms and conditions
of the Reorganization which would affect the price of shares to be issued in
the Reorganization; the tax-free nature of the Reorganization; and any direct
or indirect costs to be incurred by North American and Limited Duration in
connection with the Reorganization.
In recommending the Reorganization to Shareholders, the Board of North
American considered that the Reorganization would have the following benefits
to Shareholders:
1. Once the reorganization is consummated, the expenses which would be
borne by shareholders of the Combined Fund will be appreciably lower on a
percentage basis than the expenses per share of North American. This is
attributable to the fact that, although the investment management fee rate paid
by Limited Duration for its last fiscal year (0.70%) was higher than the
investment management fee rate paid by North American for its last fiscal year
(0.65%), Limited Duration does not pay distribution (12b-1) fees, while North
American paid distribution (12b-1) fees for its last fiscal year at a rate of
0.73% of its average daily net assets. The Board also noted that Limited
Duration's "Other Expenses" for its last fiscal year (0.22%) were significantly
lower than North American's "Other Expenses" for its last fiscal year (0.42%).
In addition, the Board also noted the Undertaking by Limited Duration's
Investment Manager pursuant to which the fund's expenses (except for brokerage
and 12b-1 fees) are capped at 0.80% of its average net daily assets until
December 31, 2002.
2. The Board also noted that the Reorganization would afford Shareholders
the opportunity for continued participation in a fund that invests principally
in U.S. government securities and investment grade fixed income securities.
3. The Reorganization is intended to qualify as a tax-free reorganization
for Federal income tax purposes, pursuant to which no gain or loss will be
recognized by North American or its Shareholders for Federal income tax
purposes as a result of transactions included in the Reorganization.
The Board of Trustees of Limited Duration, including the Independent
Trustees of Limited Duration, unanimously determined that the Reorganization is
in the best interests of Limited Duration and its shareholders and that the
interests of existing shareholders of Limited Duration will not be diluted as a
result thereof. The transaction will enable Limited Duration to acquire
investment securities which are consistent with Limited Duration's investment
objectives, without the brokerage costs attendant to the purchase of such
securities in the market.
11
THE REORGANIZATION AGREEMENT
The terms and conditions under which the Reorganization would be
consummated, as summarized below, are set forth in the Reorganization
Agreement. This summary is qualified in its entirety by reference to the
Reorganization Agreement, a copy of which is attached as Exhibit A to this
Proxy Statement and Prospectus.
The Reorganization Agreement provides that (i) North American will
transfer all of its assets, including portfolio securities, cash (other than
cash amounts retained by North American as a "Cash Reserve" in the amount
sufficient to discharge its liabilities not discharged prior to the Valuation
Date (as defined below) and for expenses of the dissolution), cash equivalents
and receivables to Limited Duration on the Closing Date in exchange for the
assumption by Limited Duration of stated liabilities of North American,
including all expenses, costs, charges and reserves, as reflected on an
unaudited statement of assets and liabilities of North American prepared by the
Treasurer of North American as of the Valuation Date (as defined below) in
accordance with generally accepted accounting principles consistently applied
from the prior audited period, and the delivery of the Limited Duration Shares;
(ii) such Limited Duration Shares would be distributed to Shareholders on the
Closing Date or as soon as practicable thereafter; (iii) North American would
be dissolved; and (iv) the outstanding shares of North American would be
canceled.
The number of Limited Duration Shares to be delivered to North American
will be determined by dividing the aggregate net asset value of the shares of
North American acquired by Limited Duration by the net asset value per share of
the shares of Limited Duration. These values will be calculated as of the close
of business of the New York Stock Exchange on the third business day following
the receipt of the requisite approval by Shareholders of the Reorganization
Agreement or at such other time as North American and Limited Duration may
agree (the "Valuation Date"). As an illustration, assume that on the Valuation
Date, North American's shares had an aggregate net asset value (not including
any Cash Reserve of North American) of $100,000. If the net asset value per
share of Limited Duration were $10 per share at the close of business on the
Valuation Date, the number of shares of Limited Duration to be issued would be
10,000 ($100,000 (divided by) $10). These 10,000 shares of Limited Duration
would be distributed to the former Shareholders of North American. This example
is given for illustration purposes only and does not bear any relationship to
the dollar amounts or shares expected to be involved in the Reorganization.
On the Closing Date or as soon as practicable thereafter, North American
will distribute pro rata to its Shareholders of record as of the close of
business on the Valuation Date, the Limited Duration Shares it receives.
Limited Duration will cause its transfer agent to credit and confirm an
appropriate number of Limited Duration Shares to each Shareholder. Certificates
for Limited Duration Shares will be issued only upon written request of a
Shareholder and only for whole shares, with fractional shares credited to the
name of the Shareholder on the books of Limited Duration. Shareholders who wish
to receive certificates representing their Limited Duration Shares must, after
receipt of their confirmations, make a written request to Limited Duration's
transfer agent Morgan Stanley Trust, Harborside Financial Center, Jersey City,
New Jersey 07311. Shareholders of North American holding their shares in
certificate form will be asked to surrender such certificates in connection
with the Reorganization. Shareholders who do not surrender their certificates
prior to the Closing Date will still receive their shares of Limited Duration;
however, such Shareholders will not be able to redeem, transfer or exchange the
Limited Duration Shares received until the old certificates have been
surrendered.
The Closing Date will be the next business day following the Valuation
Date. The consummation of the Reorganization is contingent upon the approval of
the Reorganization by the Shareholders and the receipt of the other opinions
and certificates set forth in Sections 6, 7 and 8 of the Reorganization
Agreement and the occurrence of the events described in those Sections, certain
of which may be waived by North American or
12
Limited Duration. The Reorganization Agreement may be amended in any mutually
agreeable manner. All expenses of this solicitation, including the cost of
preparing and mailing this Proxy Statement and Prospectus, will be borne by
North American, which expenses are expected to approximate $96,000. North
American and Limited Duration will bear all of their respective other expenses
associated with the Reorganization.
The Reorganization Agreement may be terminated and the Reorganization
abandoned at any time, before or after approval by Shareholders or by mutual
consent of North American and Limited Duration. In addition, either party may
terminate the Reorganization Agreement upon the occurrence of a material breach
of the Reorganization Agreement by the other party or if, by December 31, 2002,
any condition set forth in the Reorganization Agreement has not been fulfilled
or waived by the party entitled to its benefits.
Under the Reorganization Agreement, within one year after the Closing
Date, North American shall: either pay or make provision for all of its
liabilities and distribute any remaining amount of the Cash Reserve (after
paying or making provision for such liabilities and the estimated cost of
making the distribution) to former Shareholders of North American that received
Limited Duration Shares. North American shall be dissolved and deregistered as
an investment company promptly following the distributions of shares of Limited
Duration to Shareholders of record of North American.
The effect of the Reorganization is that Shareholders who vote their
shares in favor of the Reorganization Agreement are electing to sell their
shares of North American (at net asset value on the Valuation Date calculated
after subtracting any Cash Reserve) and reinvest the proceeds in Limited
Duration Shares at net asset value and without recognition of taxable gain or
loss for Federal income tax purposes. See "Tax Aspects of the Reorganization"
below. As noted in "Tax Aspects of the Reorganization" below, if North American
recognizes net gain from the sale of securities prior to the Closing Date, such
gain, to the extent not offset by capital loss carryforwards, will be
distributed to Shareholders prior to the Closing Date and will be taxable to
Shareholders as capital gain.
Shareholders will continue to be able to redeem their shares of North
American at net asset value next determined after receipt of the redemption
request until the close of business on the business day next preceding the
Closing Date. Redemption requests received by North American thereafter will be
treated as requests for redemption of shares of the Combined Fund.
TAX ASPECTS OF THE REORGANIZATION
TAX CONSEQUENCES OF THE REORGANIZATION TO THE SHAREHOLDERS. The
Reorganization is intended to qualify for Federal income tax purposes as a
tax-free reorganization under Section 368(a)(1)(C) of the Internal Revenue Code
of 1986, as amended (the "Code").
As a condition to the Reorganization, North American and Limited Duration
will receive an opinion of Mayer, Brown, Rowe & Maw to the effect that, based
on certain assumptions, facts, the terms of the Reorganization Agreement and
representations set forth in the Reorganization Agreement or otherwise provided
by North American and Limited Duration (including a representation to the
effect that Limited Duration has no plan or intention to sell or otherwise
dispose of more than sixty-six percent of the assets of North American acquired
in the Reorganization except for dispositions made in the ordinary course of
business):
1. The transfer of North American's assets in exchange for the Limited
Duration Shares and the assumption by Limited Duration of certain stated
liabilities of North American followed by the distribution by North American of
the Limited Duration Shares to Shareholders in exchange for their North
American shares
13
pursuant to and in accordance with the terms of the Reorganization Agreement
will constitute a "reorganization" within the meaning of Section 368(a)(1)(C)
of the Code, and North American and Limited Duration will each be a "party to a
reorganization" within the meaning of Section 368(b) of the Code;
2. No gain or loss will be recognized by Limited Duration upon the receipt
of the assets of North American solely in exchange for the Limited Duration
Shares and the assumption by Limited Duration of the stated liabilities of
North American;
3. No gain or loss will be recognized by North American upon the transfer
of the assets of North American to Limited Duration in exchange for the Limited
Duration Shares and the assumption by Limited Duration of the stated
liabilities or upon the distribution of Limited Duration Shares to Shareholders
in exchange for their North American shares;
4. No gain or loss will be recognized by Shareholders upon the exchange of
the shares of North American for the Limited Duration Shares;
5. The aggregate tax basis for the Limited Duration Shares received by
each of the Shareholders pursuant to the Reorganization will be the same as the
aggregate tax basis of the shares in North American held by each such
Shareholder immediately prior to the Reorganization;
6. The holding period of the Limited Duration Shares to be received by
each Shareholder will include the period during which the shares in North
American surrendered in exchange therefor were held (provided such shares in
North American were held as capital assets on the date of the Reorganization);
7. The tax basis of the assets of North American acquired by Limited
Duration will be the same as the tax basis of such assets of North American
immediately prior to the Reorganization; and
8. The holding period of the assets of North American in the hands of
Limited Duration will include the period during which those assets were held by
North American.
The advice of Counsel is not binding on the Internal Revenue Service or
the courts and neither North American nor Limited Duration has sought a ruling
with respect to the tax treatment of the Reorganization.
SHAREHOLDERS SHOULD CONSULT THEIR TAX ADVISORS REGARDING THE EFFECT, IF
ANY, OF THE PROPOSED TRANSACTION IN LIGHT OF THEIR INDIVIDUAL CIRCUMSTANCES.
BECAUSE THE FOREGOING DISCUSSION ONLY RELATES TO THE FEDERAL INCOME TAX
CONSEQUENCES OF THE PROPOSED TRANSACTION, SHAREHOLDERS SHOULD ALSO CONSULT
THEIR TAX ADVISORS AS TO STATE AND LOCAL TAX CONSEQUENCES, IF ANY, OF THE
PROPOSED TRANSACTION.
TAX CONSEQUENCES OF THE REORGANIZATION TO NORTH AMERICAN AND LIMITED
DURATION. Under the Code, the Reorganization may result in limitations on the
utilization of the capital loss carryovers of North American and Limited
Duration. The effect of any such limitations will depend on the existence and
amount of North American and Limited Duration capital loss carryovers, built-in
capital losses and built-in capital gains at the time of the Reorganization. A
fund will have built-in capital gains if the fair market value of its assets on
the date of the Reorganization exceeds its tax basis in such assets and a fund
will have built-in capital losses if its tax basis in its assets exceeds the
fair market value of such assets on the date of the Reorganization.
North American had capital loss carryovers of approximately $232.1 million
as of March 28, 2002, and Limited Duration had capital loss carryovers of
approximately $1.9 million as of April 30, 2002. Limited Duration's capital
loss carryovers and, if any, recognized built-in capital losses, will be
available to offset any capital gains recognized on the disposition of (i)
assets acquired by the Combined Fund after the date of the Reorganization; (ii)
assets of North American held by the Combined Fund, buy only to the extent such
capital gains are attributable to an increase in the value of such assets above
fair market value of such assets on the date of the Reorganization; and (iii)
assets of Limited Duration held by the Combined Fund. However, the Combined
Fund will be unable to utilize Limited Duration's capital loss carryovers and,
if any, recognized built-
14
in capital losses, to offset any capital gains recognized on the disposition of
the assets of North American held by the Combined Fund to the extent such
capital gains are attributable to the built-in capital gains of such assets on
the date of the Reorganization. As of April 30, 2002, Limited Duration had net
unrealized capital losses of approximately $500,000 and North American had net
unrealized capital gains of approximately $450,000.
In addition, under the Code, there will be a limitation on the amount of
North American's capital loss carryovers which can be used to offset capital
gains of the Combined Fund. While the actual amount of such limitation will be
determined at the time of the Reorganization, if, for example, the
Reorganization had occurred on March 28, 2002, each year only approximately
$4.3 million of North American's capital loss carryovers would have been able
to be used to offset capital gains of the Combined Fund.
DESCRIPTION OF SHARES
Limited Duration Shares to be issued pursuant to the Reorganization
Agreement will, when issued, be fully paid and non-assessable by Limited
Duration and transferable without restrictions and will have no preemptive
rights.
CAPITALIZATION TABLE (UNAUDITED)
The following table sets forth the capitalization of Limited Duration and
North American as of April 30, 2002 and on a pro forma combined basis as if the
Reorganization had occurred on that date:
NET ASSET
SHARES VALUE
NET ASSETS OUTSTANDING PER SHARE
-------------- ------------- ----------
North American .................... $ 84,216,208 9,725,743 $ 8.66
Limited Duration .................. $166,630,836 17,379,848 $ 9.59
Combined Fund (pro forma) ......... $250,847,044 26,161,517 $ 9.59
APPRAISAL RIGHTS
Shareholders will have no appraisal rights in connection with the
Reorganization.
COMPARISON OF INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS
INVESTMENT OBJECTIVES AND POLICIES
The investment objective of North American is to seek to earn a high level
of current income while maintaining relatively low volatility of principal. The
investment objective of Limited Duration is to seek to provide a high level of
current income, consistent with the preservation of capital.
North American seeks to achieve its investment objective by normally
investing at least 80% of its assets in fixed-income securities issued or
guaranteed by the United States, Canadian or Mexican governments, their
subdivisions, agencies or instrumentalities. North American normally invests at
least 50% of its net assets in U.S. government securities, and no more than 25%
each in Canadian and Mexican government securities. In the case of the United
States and Canada, a substantial portion of these securities are
mortgage-backed securities. The fund may also invest in collateralized mortgage
obligations, inverse floaters and stripped mortgage-backed securities. The
fund's Sub-Advisor, TCW Investment Management Company ("TCW"), allocates fund
assets among the three countries based on its analysis of market, economic and
political conditions in those countries. Up to 20% of the fund's assets may be
invested in U.S., Canadian or Mexican securities that are not government
securities, options and futures and reverse repurchase agreements and dollar
rolls.
15
North American may take temporary "defensive" positions in attempting to
respond to adverse market conditions. The fund may invest any amount of its
assets in cash or money market instruments in a defensive posture when the
Sub-Advisor believes it is advisable to do so. Although taking a defensive
posture is designed to protect the fund from an anticipated market downturn, it
could have the effect of reducing the benefit from any upswing in the market.
When the fund takes a defensive position, it may not achieve its investment
objective.
Limited Duration seeks to achieve its investment objective by normally
investing at least 65% of its assets in securities issued or guaranteed as to
the principal and interest by the U.S. government, its agencies or
instrumentalities (including zero coupon securities), investment grade
mortgage-backed securities, including collateralized mortgage obligations, and
investment grade corporate and other types of bonds. In selecting portfolio
investments to purchase or sell, the fund's Investment Manager, Morgan Stanley
Advisors, considers both domestic and international economic developments,
interest rate levels, the steepness of the yield curve and other factors, and
seeks to maintain an overall average duration for the fund's portfolio of three
years or less. Up to 25% of the fund's assets may be invested in investment
grade fixed-income securities issued by foreign governments or corporations,
asset-backed securities, futures, junk bonds and restricted securities.
The investment policies of both North American and Limited Duration are
not fundamental and may be changed by their respective Boards. The foregoing
discussion is a summary of the principal differences and similarities between
the investment policies of the funds. For a more complete discussion of each
fund's policies, see "Principal Investment Strategies" and "Additional
Investment Strategy Information" in each fund's Prospectus, and "Description of
the Fund and Its Investments and Risks" in each fund's Statement of Additional
Information.
INVESTMENT RESTRICTIONS
The investment restrictions adopted by North American and Limited Duration
as fundamental policies are substantially identical and are summarized under
the caption "Description of the Fund and Its Investments and Risks -- Fund
Policies/Investment Restrictions" in their respective Statements of Additional
Information. A fundamental investment restriction cannot be changed without the
vote of the majority of the outstanding voting securities of a fund, as defined
in the 1940 Act. The material differences are as follows: (a) Limited Duration
may not, as to 75% of its total assets (i) invest more than 5% of the value of
its total assets in the securities of any issuer (other than obligations
issued, or guaranteed, by the United States Government, its agencies or
instrumentalities), or (ii) purchase more than 10% of all oustanding voting
securities or any class of securities of any one issuer. North American, which
is registered as a non-diversified investment company, has no such restriction
although the fund has a non-fundamental policy restricting investments to no
more than 10% of voting securities of any issuer with respect to 75% of its
assets; and (b) each fund may not invest more than 5% of the value of its total
assets in securities of issuers in any one industry, except that North American
may concentrate in mortgage-backed securities (unless it has adopted a
temporary "defensive" posture).
ADDITIONAL INFORMATION ABOUT NORTH AMERICAN
AND LIMITED DURATION
GENERAL
For a discussion of the organization and operation of North American and
Limited Duration, see "Fund Management," and "Investment Objective" in, and the
cover page of, each fund's Prospectus, and "Description of the Fund and its
Investments and Risks -- Fund Policies/Investment Restrictions" in each fund's
Statement of Additional Information.
16
FINANCIAL INFORMATION
For certain financial information about North American and Limited
Duration, see "Financial Highlights" and "Past Performance" in their respective
Prospectuses.
MANAGEMENT
For information about the respective Board of Trustees, Investment
Manager, and the Distributor of North American and Limited Duration, see "Fund
Management" in their respective Prospectuses and "Management of the Fund" in
their respective Statements of Additional Information.
DESCRIPTION OF SECURITIES AND SHAREHOLDER INQUIRIES
For a description of the nature and most significant attributes of shares
of North American and Limited Duration, and information regarding shareholder
inquiries, see "Capital Stock and Other Securities" in their respective
Statements of Additional Information.
DIVIDENDS, DISTRIBUTIONS AND TAXES
For a discussion of North American's and Limited Duration's policies with
respect to dividends, distributions and taxes, see "Distributions" and "Tax
Consequences" in their respective Prospectuses as well as the discussion herein
under "Synopsis -- Purchases, Exchanges and Redemptions."
PURCHASES, REPURCHASES AND REDEMPTIONS
For a discussion of how North American's and Limited Duration's shares may
be purchased, repurchased and redeemed, see "How to Buy Shares," "How to
Exchange Shares" and "How to Sell Shares" in their respective Prospectuses.
MANAGEMENT'S DISCUSSION OF FUND PERFORMANCE
For a discussion of the performance of North American, see its Annual
Report for its fiscal year ended October 31, 2001 and its unaudited Semi-Annual
Report for the six-month period ended April 30, 2002. For a discussion of
Limited Duration's performance, see its Annual Report for its fiscal year ended
April 30, 2002 accompanying this Proxy Statement and Prospectus.
FINANCIAL STATEMENTS AND EXPERTS
The financial statements of North American, for the fiscal year ended
October 31, 2001, and Limited Duration, for the fiscal year ended April 30,
2002, that are incorporated by reference in the Statement of Additional
Information relating to the Registration Statement on Form N-14 of which this
Proxy Statement and Prospectus forms a part, have been audited by Deloitte &
Touche LLP, independent auditors. The financial statements have been
incorporated by reference in reliance upon such reports given upon the
authority of said firm as experts in accounting and auditing.
LEGAL MATTERS
Certain legal matters concerning the issuance of shares of Limited
Duration will be passed upon by Mayer, Brown, Rowe & Maw, New York, New York.
Such firm will rely on Massachusetts counsel as to matters of Massachusetts
law.
17
AVAILABLE INFORMATION
Additional information about North American and Limited Duration is
available, as applicable, in the following documents which are incorporated
herein by reference: (i) Limited Duration's Prospectus dated June 28, 2002
attached to this Proxy Statement and Prospectus, which Prospectus forms a part
of Post-Effective Amendment No. 11 to Limited Duration's Registration Statement
on Form N-1A (File Nos. 33-50857; 811-7117); (ii) Limited Duration's Annual
Report for its fiscal year ended April 30, 2002, accompanying this Proxy
Statement and Prospectus; (iii) North American's Prospectus dated December 31,
2001, which Prospectus forms a part of Post-Effective Amendment No. 12 to North
American's Registration Statement on Form N-1A (File Nos. 33-46049; 811-6572);
and (iv) North American's Annual Report for its fiscal year ended October 31,
2001 and its unaudited Semi-Annual Report for the six-month period ended April
30, 2002. The foregoing documents may be obtained without charge by calling
(800) 869-6397 (toll-free).
North American and Limited Duration are subject to the informational
requirements of the Securities Exchange Act of 1934, as amended, and in
accordance therewith, file reports and other information with the Commission.
Proxy material, reports and other information about North American and Limited
Duration which are of public record can be viewed and copied at the Securities
and Exchange Commission's Public Reference Room in Washington, D.C. Information
about the Reference Room's operations may be obtained by calling the SEC at
(202) 942-8090. Reports and other information about the Fund are available on
the EDGAR Database on the SEC's Internet site (www.sec.gov), and copies of this
information may be obtained, after paying a duplicating fee, by electronic
request at the following E-mail address: publicinfo@sec.gov, or by writing the
Public Reference Section of the SEC, Washington, D.C. 20549-0102.
OTHER BUSINESS
Management of North American knows of no business other than the matters
specified above which will be presented at the Meeting. Since matters not known
at the time of the solicitation may come before the Meeting, the proxy as
solicited confers discretionary authority with respect to such matters as
properly come before the Meeting, including any adjournment or adjournments
thereof, and it is the intention of the persons named as attorneys-in-fact in
the proxy to vote this proxy in accordance with their judgment on such matters.
By Order of the Board of Trustees
Barry Fink,
Secretary
July , 2002
18
EXHIBIT A
AGREEMENT AND PLAN OF REORGANIZATION
THIS AGREEMENT AND PLAN OF REORGANIZATION ("Agreement") is made as of this
25th day of April 2002, by and between MORGAN STANLEY LIMITED DURATION FUND, a
Massachusetts business trust ("Limited Duration"), and MORGAN STANLEY NORTH
AMERICAN GOVERNMENT INCOME TRUST, a Massachusetts business trust ("North
American").
This Agreement is intended to be and is adopted as a "plan of
reorganization" within the meaning of Treas. Reg. 1.368-2(g), for a
reorganization under Section 368(a)(1) of the Internal Revenue Code of 1986, as
amended (the "Code"). The reorganization ("Reorganization") will consist of the
transfer to Limited Duration of substantially all of the assets of North
American in exchange for the assumption by Limited Duration of all stated
liabilities of North American and the issuance by Limited Duration of shares of
beneficial interest, par value $0.01 per share (the "Limited Duration Shares"),
to be distributed, after the Closing Date hereinafter referred to, to the
shareholders of North American in liquidation of North American as provided
herein, all upon the terms and conditions hereinafter set forth in this
Agreement.
In consideration of the premises and of the covenants and agreements
hereinafter set forth, the parties hereto covenant and agree as follows:
1. THE REORGANIZATION AND LIQUIDATION OF NORTH AMERICAN
1.1 Subject to the terms and conditions herein set forth and on the basis
of the representations and warranties contained herein, North American agrees
to assign, deliver and otherwise transfer the North American Assets (as defined
in paragraph 1.2) to Limited Duration and Limited Duration agrees in exchange
therefor to assume all of North American's stated liabilities on the Closing
Date as set forth in paragraph 1.3(a) and to deliver to North American the
number of Limited Duration Shares, including fractional Limited Duration
Shares, determined in the manner set forth in paragraph 2.3. Such transactions
shall take place at the closing provided for in paragraph 3.1 ("Closing").
1.2 (a) The "North American Assets" shall consist of all property,
including without limitation, all cash (other than the "Cash Reserve" (as
defined in paragraph 1.3(b)), cash equivalents, securities and dividend and
interest receivables owned by North American, and any deferred or prepaid
expenses shown as an asset on North American's books on the Valuation Date.
(b) On or prior to the Valuation Date, North American will provide Limited
Duration with a list of all of North American's assets to be assigned,
delivered and otherwise transferred to Limited Duration and a list of the
stated liabilities to be assumed by Limited Duration pursuant to this
Agreement. North American reserves the right to sell any of the securities on
such list but will not, without the prior approval of Limited Duration, acquire
any additional securities other than securities of the type in which Limited
Duration is permitted to invest and in amounts agreed to in writing by Limited
Duration. Limited Duration will, within a reasonable time prior to the
Valuation Date, furnish North American with a statement of Limited Duration's
investment objectives, policies and restrictions and a list of the securities,
if any, on the list referred to in the first sentence of this paragraph that do
not conform to Limited Duration's investment objective, policies and
restrictions. In the event that North American holds any investments that
Limited Duration is not permitted to hold, North American will dispose of such
securities on or prior to the Valuation Date. In addition, if it is determined
that the portfolios of North American and Limited Duration, when aggregated,
would contain investments exceeding certain percentage limitations imposed upon
Limited Duration with respect to such investments, North American if requested
by Limited Duration will, on or prior to the Valuation Date, dispose
A-1
of and/or reinvest a sufficient amount of such investments as may be necessary
to avoid violating such limitations as of the Closing Date (as defined in
paragraph 3.1).
1.3 (a) North American will endeavor to discharge all of its liabilities
and obligations on or prior to the Valuation Date. Limited Duration will assume
all stated liabilities, which includes, without limitation, all expenses,
costs, charges and reserves reflected on an unaudited Statement of Assets and
Liabilities of North American prepared by the Treasurer of North American as of
the Valuation Date in accordance with generally accepted accounting principles
consistently applied from the prior audited period.
(b) On the Valuation Date, North American may establish a cash reserve,
which shall not exceed 5% of North American's net assets as of the close of
business on the Valuation Date ("Cash Reserve") to be retained by North
American and used for the payment of its liabilities not discharged prior to
the Valuation Date and for the expenses of dissolution.
1.4 In order for North American to comply with Section 852(a)(1) of the
Code and to avoid having any investment company taxable income or net capital
gain (as defined in Sections 852(b)(2) and 1222(11) of the Code, respectively)
in the short taxable year ending with its dissolution, North American will on
or before the Valuation Date (a) declare a dividend in an amount large enough
so that it will have declared dividends of all of its investment company
taxable income and net capital gain, if any, for such taxable year (determined
without regard to any deduction for dividends paid) and (b) distribute such
dividend.
1.5 On the Closing Date or as soon as practicable thereafter, North
American will distribute Limited Duration Shares received by North American
pursuant to paragraph 1.1 pro rata to its shareholders of record determined as
of the close of business on the Valuation Date ("North American Shareholders").
Such distribution will be accomplished by an instruction, signed by North
American's Secretary, to transfer Limited Duration Shares then credited to
North American's account on the books of Limited Duration to open accounts on
the books of Limited Duration in the names of the North American Shareholders
and representing the respective pro rata number of Limited Duration Shares due
such North American Shareholders. All issued and outstanding shares of North
American simultaneously will be canceled on North American's books; however,
share certificates representing interests in North American will represent a
number of Limited Duration Shares after the Closing Date as determined in
accordance with paragraph 2.3. Limited Duration will issue certificates
representing Limited Duration Shares in connection with such exchange only upon
the written request of a North American Shareholder.
1.6 Ownership of Limited Duration Shares will be shown on the books of
Limited Duration's transfer agent. Limited Duration Shares will be issued in
the manner described in Limited Duration's current Prospectus and Statement of
Additional Information.
1.7 Any transfer taxes payable upon issuance of Limited Duration Shares in
a name other than the registered holder of Limited Duration Shares on North
American's books as of the close of business on the Valuation Date shall, as a
condition of such issuance and transfer, be paid by the person to whom Limited
Duration Shares are to be issued and transferred.
1.8 Any reporting responsibility of North American is and shall remain the
responsibility of North American up to and including the date on which North
American is dissolved and deregistered pursuant to paragraph 1.9.
1.9 Within one year after the Closing Date, North American shall pay or
make provision for the payment of all its liabilities and taxes, and distribute
to the Shareholders of North American as of the close of business on the
Valuation Date any remaining amount of the Cash Reserve (as reduced by the
estimated cost of distributing it to Shareholders). If and to the extent that
any trust, escrow account, or other similar entity
A-2
continues after the close of such one-year period in connection either with
making provision for payment of liabilities or taxes or with distributions to
Shareholders of North American, such entity shall either (i) qualify as a
liquidating trust under Section 7701 of the Code (and applicable Treasury
Regulations thereunder) or other entity which does not constitute a
continuation of North American for Federal income tax purposes, or (ii) be
subject to a waiver under Section 368(a)(2)(G)(ii) of the complete distribution
requirement of Section 368(a)(2)(G)(i) of the Code. North American shall be
dissolved as a Massachusetts business trust and deregistered as an investment
company under the Investment Company Act of 1940, as amended ("1940 Act"),
promptly following the making of all distributions pursuant to paragraph 1.5
(and, in any event, within one year after the Closing Date).
1.10 Copies of all books and records maintained on behalf of North
American in connection with its obligations under the 1940 Act, the Code, state
blue sky laws or otherwise in connection with this Agreement will promptly
after the Closing be delivered to officers of Limited Duration or their
designee and Limited Duration or its designee shall comply with applicable
record retention requirements to which North American is subject under the 1940
Act.
2. VALUATION
2.1 The value of the North American Assets shall be the value of such
assets computed as of 4:00 p.m. on the New York Stock Exchange on the third
business day following the receipt of the requisite approval by shareholders of
North American of this Agreement or at such time on such earlier or later date
after such approval as may be mutually agreed upon in writing (such time and
date being hereinafter called the "Valuation Date"), using the valuation
procedures set forth in Limited Duration's then current Prospectus and
Statement of Additional Information.
2.2 The net asset value of a Limited Duration Share shall be the net asset
value per share computed on the Valuation Date, using the valuation procedures
set forth in Limited Duration's then current Prospectus and Statement of
Additional Information.
2.3 The number of Limited Duration Shares (including fractional shares, if
any) to be issued hereunder shall be determined by dividing the aggregate net
asset value of North American Shares (determined in accordance with paragraph
2.1) by the net asset value per share of Limited Duration (determined in
accordance with paragraph 2.2). For purposes of this paragraph, the aggregate
net asset value of shares of North American shall not include the amount of the
Cash Reserve.
2.4 All computations of value shall be made by Morgan Stanley Services
Company Inc. ("Morgan Stanley Services") in accordance with its regular
practice in pricing Limited Duration. Limited Duration shall cause Morgan
Stanley Services to deliver a copy of its valuation report at the Closing.
3. CLOSING AND CLOSING DATE
3.1 The Closing shall take place on the next business day following the
Valuation Date (the "Closing Date"). The Closing shall be held as of 9:00 a.m.
Eastern time, or at such other time as the parties may agree. The Closing shall
be held in a location mutually agreeable to the parties hereto. All acts taking
place at the Closing shall be deemed to take place simultaneously as of 9:00
a.m. Eastern time on the Closing Date unless otherwise provided.
3.2 Portfolio securities held by North American and represented by a
certificate or other written instrument shall be presented by it or on its
behalf to The Bank of New York (the "Custodian"), as custodian for Limited
Duration, for examination no later than five business days preceding the
Valuation Date. Such
A-3
portfolio securities (together with any cash or other assets) shall be
delivered by North American to the Custodian for the account of Limited
Duration on or before the Closing Date in conformity with applicable custody
provisions under the 1940 Act and duly endorsed in proper form for transfer in
such condition as to constitute good delivery thereof in accordance with the
custom of brokers. The portfolio securities shall be accompanied by all
necessary Federal and state stock transfer stamps or a check for the
appropriate purchase price of such stamps. Portfolio securities and instruments
deposited with a securities depository (as defined in Rule 17f-4 under the 1940
Act) shall be delivered on or before the Closing Date by book-entry in
accordance with customary practices of such depository and the Custodian. The
cash delivered shall be in the form of a Federal Funds wire, payable to the
order of "The Bank of New York, Custodian for Morgan Stanley Limited Duration
Fund."
3.3 In the event that on the Valuation Date, (a) the New York Stock
Exchange shall be closed to trading or trading thereon shall be restricted or
(b) trading or the reporting of trading on such Exchange or elsewhere shall be
disrupted so that, in the judgment of both Limited Duration and North American,
accurate appraisal of the value of the net assets of Limited Duration or the
North American Assets is impracticable, the Valuation Date shall be postponed
until the first business day after the day when trading shall have been fully
resumed without restriction or disruption and reporting shall have been
restored.
3.4 If requested, North American shall deliver to Limited Duration or its
designee (a) at the Closing, a list, certified by its Secretary, of the names,
addresses and taxpayer identification numbers of the North American
Shareholders and the number and percentage ownership of outstanding North
American shares owned by each such North American Shareholder, all as of the
Valuation Date, and (b) as soon as practicable after the Closing, all original
documentation (including Internal Revenue Service forms, certificates,
certifications and correspondence) relating to the North American Shareholders'
taxpayer identification numbers and their liability for or exemption from
back-up withholding. Limited Duration shall issue and deliver to such Secretary
a confirmation evidencing delivery of Limited Duration Shares to be credited on
the Closing Date to North American or provide evidence satisfactory to North
American that such Limited Duration Shares have been credited to North
American's account on the books of Limited Duration. At the Closing, each party
shall deliver to the other such bills of sale, checks, assignments, share
certificates, if any, receipts or other documents as such other party or its
counsel may reasonably request.
4. COVENANTS OF LIMITED DURATION AND NORTH AMERICAN
4.1 Except as otherwise expressly provided herein with respect to North
American, Limited Duration and North American each will operate its business in
the ordinary course between the date hereof and the Closing Date, it being
understood that such ordinary course of business will include customary
dividends and other distributions.
4.2 Limited Duration will prepare and file with the Securities and
Exchange Commission ("Commission") a registration statement on Form N-14 under
the Securities Act of 1933, as amended ("1933 Act"), relating to Limited
Duration Shares ("Registration Statement"). North American will provide Limited
Duration with the Proxy Materials as described in paragraph 4.3 below, for
inclusion in the Registration Statement. North American will further provide
Limited Duration with such other information and documents relating to North
American as are reasonably necessary for the preparation of the Registration
Statement.
4.3 North American will call a meeting of its shareholders to consider and
act upon this Agreement and to take all other action necessary to obtain
approval of the transactions contemplated herein. North American will prepare
the notice of meeting, form of proxy and proxy statement (collectively, "Proxy
Materials") to be
A-4
used in connection with such meeting; provided that Limited Duration will
furnish North American with its currently effective prospectus for inclusion in
the Proxy Materials and with such other information relating to Limited
Duration as is reasonably necessary for the preparation of the Proxy Materials.
4.4 North American will assist Limited Duration in obtaining such
information as Limited Duration reasonably requests concerning the beneficial
ownership of North American shares.
4.5 Subject to the provisions of this Agreement, Limited Duration and
North American will each take, or cause to be taken, all action, and do or
cause to be done, all things reasonably necessary, proper or advisable to
consummate and make effective the transactions contemplated by this Agreement.
4.6 North American shall furnish or cause to be furnished to Limited
Duration within 30 days after the Closing Date a statement of North American's
assets and liabilities as of the Closing Date, which statement shall be
certified by North American's Treasurer and shall be in accordance with
generally accepted accounting principles consistently applied. As promptly as
practicable, but in any case within 60 days after the Closing Date, North
American shall furnish Limited Duration, in such form as is reasonably
satisfactory to Limited Duration, a statement certified by North American's
Treasurer of North American's earnings and profits for Federal income tax
purposes that will be carried over to Limited Duration pursuant to Section 381
of the Code.
4.7 As soon after the Closing Date as is reasonably practicable, North
American (a) shall prepare and file all Federal and other tax returns and
reports of North American required by law to be filed with respect to all
periods ending on or before the Closing Date but not theretofore filed and (b)
shall pay all Federal and other taxes shown as due thereon and/or all Federal
and other taxes that were unpaid as of the Closing Date, including without
limitation, all taxes for which the provision for payment was made as of the
Closing Date (as represented in paragraph 5.2(k)).
4.8 Limited Duration agrees to use all reasonable efforts to obtain the
approvals and authorizations required by the 1933 Act and the 1940 Act and to
make such filings required by the state Blue Sky and securities laws as it may
deem appropriate in order to continue its operations after the Closing Date.
5. REPRESENTATIONS AND WARRANTIES
5.1 Limited Duration represents and warrants to North American as follows:
(a) Limited Duration is a validly existing Massachusetts business trust
with full power to carry on its business as presently conducted;
(b) Limited Duration is a duly registered, open-end, management
investment company, and its registration with the Commission as an
investment company under the 1940 Act and the registration of its shares
under the 1933 Act are in full force and effect;
(c) All of the issued and outstanding shares of Limited Duration have
been offered and sold in compliance in all material respects with
applicable registration requirements of the 1933 Act and state securities
laws. Shares of Limited Duration are registered in all jurisdictions in
which they are required to be registered under state securities laws and
other laws, and said registrations, including any periodic reports or
supplemental filings, are complete and current, all fees required to be
paid have been paid, and Limited Duration is not subject to any stop order
and is fully qualified to sell its shares in each state in which its shares
have been registered;
(d) The current Prospectus and Statement of Additional Information of
Limited Duration conform in all material respects to the applicable
requirements of the 1933 Act and the 1940 Act and the regulations
thereunder and do not include any untrue statement of a material fact or
omit to state any material fact required to be stated therein or necessary
to make the statements therein, in light of the circumstances under which
they were made, not misleading;
A-5
(e) Limited Duration is not in, and the execution, delivery and
performance of this Agreement will not result in a, material violation of
any provision of Limited Duration's Declaration of Trust or By-Laws or of
any agreement, indenture, instrument, contract, lease or other undertaking
to which Limited Duration is a party or by which it is bound;
(f) No litigation or administrative proceeding or investigation of or
before any court or governmental body is presently pending or, to its
knowledge, threatened against Limited Duration or any of its properties or
assets which, if adversely determined, would materially and adversely
affect its financial condition or the conduct of its business; and Limited
Duration knows of no facts that might form the basis for the institution of
such proceedings and is not a party to or subject to the provisions of any
order, decree or judgment of any court or governmental body which
materially and adversely affects, or is reasonably likely to materially and
adversely effect, its business or its ability to consummate the
transactions herein contemplated;
(g) The Statement of Assets and Liabilities, Statement of Operations,
Statement of Changes in Net Assets and Financial Highlights for the year
ended April 30, 2002 of Limited Duration audited by Deloitte & Touche LLP
(copies of which have been furnished to North American), fairly present, in
all material respects, Limited Duration's financial condition as of such
date in accordance with generally accepted accounting principles, and its
results of such operations, changes in its net assets and financial
highlights for such period, and as of such date there were no known
liabilities of Limited Duration (contingent or otherwise) not disclosed
therein that would be required in accordance with generally accepted
accounting principles to be disclosed therein;
(h) All issued and outstanding Limited Duration Shares are, and at the
Closing Date will be, duly and validly issued and outstanding, fully paid
and nonassessable with no personal liability attaching to the ownership
thereof, except as set forth under the caption "Capital Stock and Other
Securities" in Limited Duration's current Statement of Additional
Information incorporated by reference in the Statement of Additional
Information to this Registration Statement. Limited Duration does not have
outstanding any options, warrants or other rights to subscribe for or
purchase any of its shares;
(i) The execution, delivery and performance of this Agreement have been
duly authorized by all necessary action on the part of Limited Duration,
and this Agreement constitutes a valid and binding obligation of Limited
Duration enforceable in accordance with its terms, subject as to
enforcement, to bankruptcy, insolvency, reorganization, moratorium and
other laws relating to or affecting creditors rights and to general equity
principles. No other consents, authorizations or approvals are necessary in
connection with Limited Duration's performance of this Agreement;
(j) Limited Duration Shares to be issued and delivered to North American,
for the account of the North American Shareholders, pursuant to the terms
of this Agreement will at the Closing Date have been duly authorized and,
when so issued and delivered, will be duly and validly issued Limited
Duration Shares, and will be fully paid and non-assessable with no personal
liability attaching to the ownership thereof, except as set forth under the
caption "Capital Stock and Other Securities" in Limited Duration's current
Statement of Additional Information incorporated by reference in the
Statement of Additional Information to this Registration Statement;
(k) All material Federal and other tax returns and reports of Limited
Duration required by law to be filed on or before the Closing Date have
been filed and are correct, and all Federal and other taxes shown as due or
required to be shown as due on said returns and reports have been paid or
provision has been made for the payment thereof, and to the best of Limited
Duration's knowledge, no such return is currently under audit and no
assessment has been asserted with respect to any such return;
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(l) For each taxable year since its inception, Limited Duration has met
the requirements of Subchapter M of the Code for qualification and
treatment as a "regulated investment company" and neither the execution or
delivery of nor the performance of its obligations under this Agreement
will adversely affect, and no other events are reasonably likely to occur
which will adversely affect the ability of Limited Duration to continue to
meet the requirements of Subchapter M of the Code;
(m) Since April 30, 2002 there has been no change by Limited Duration in
accounting methods, principles, or practices, including those required by
generally accepted accounting principles;
(n) The information furnished or to be furnished by Limited Duration for
use in registration statements, proxy materials and other documents which
may be necessary in connection with the transactions contemplated hereby
shall be accurate and complete in all material respects and shall comply in
all material respects with Federal securities and other laws and
regulations applicable thereto; and
(o) The Proxy Materials to be included in the Registration Statement
(only insofar as they relate to Limited Duration) will, on the effective
date of the Registration Statement and on the Closing Date, not contain any
untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the statements therein,
in light of the circumstances under which such statements were made, not
materially misleading.
5.2 North American represents and warrants to Limited Duration as follows:
(a) North American is a validly existing Massachusetts business trust
with full power to carry on its business as presently conducted;
(b) North American is a duly registered, open-end, management investment
company, and its registration with the Commission as an investment company
under the 1940 Act and the registration of its shares under the 1933 Act
are in full force and effect;
(c) All of the issued and outstanding shares of beneficial interest of
North American have been offered and sold in compliance in all material
respects with applicable requirements of the 1933 Act and state securities
laws. Shares of North American are registered in all jurisdictions in which
they are required to be registered and said registrations, including any
periodic reports or supplemental filings, are complete and current, all
fees required to be paid have been paid, and North American is not subject
to any stop order and is fully qualified to sell its shares in each state
in which its shares have been registered;
(d) The current Prospectus and Statement of Additional Information of
North American conform in all material respects to the applicable
requirements of the 1933 Act and the 1940 Act and the regulations
thereunder and do not include any untrue statement of a material fact or
omit to state any material fact required to be stated therein or necessary
to make the statements therein, in light of the circumstances under which
they were made, not misleading;
(e) North American is not, and the execution, delivery and performance of
this Agreement will not result, in a material violation of any provision of
North American's Declaration of Trust or By-Laws or of any agreement,
indenture, instrument, contract, lease or other undertaking to which North
American is a party or by which it is bound;
(f) No litigation or administrative proceeding or investigation of or
before any court or governmental body is presently pending or, to its
knowledge, threatened against North American or any of its properties or
assets which, if adversely determined, would materially and adversely
affect its financial condition or the conduct of its business; and North
American knows of no facts that might form the basis
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for the institution of such proceedings and is not a party to or subject to
the provisions of any order, decree or judgment of any court or
governmental body which materially and adversely affects, or is reasonably
likely to materially and adversely effect, its business or its ability to
consummate the transactions herein contemplated;
(g) The Statement of Assets and Liabilities, Statement of Operations,
Statement of Changes in Net Assets and Financial Highlights of North
American for the year ended October 31, 2001, audited by Deloitte & Touche
LLP (copies of which have been or will be furnished to Limited Duration)
fairly present, in all material respects, North American's financial
condition as of such date, and its results of operations, changes in its
net assets and financial highlights for such period in accordance with
generally accepted accounting principles, and as of such date there were no
known liabilities of North American (contingent or otherwise) not disclosed
therein that would be required in accordance with generally accepted
accounting principles to be disclosed therein;
(h) North American has no material contracts or other commitments (other
than this Agreement) that will be terminated with liability to it prior to
the Closing Date;
(i) All issued and outstanding shares of North American are, and at the
Closing Date will be, duly and validly issued and outstanding, fully paid
and nonassessable with no personal liability attaching to the ownership
thereof, except as set forth under the caption "Capital Stock and Other
Securities" in North American's current Statement of Additional Information
incorporated by reference in the Statement of Additional Information to
this Registration Statement. North American does not have outstanding any
options, warrants or other rights to subscribe for or purchase any of its
shares, nor is there outstanding any security convertible to any of its
shares. All such shares will, at the time of Closing, be held by the
persons and in the amounts set forth in the list of shareholders submitted
to Limited Duration pursuant to paragraph 3.4;
(j) The execution, delivery and performance of this Agreement will have
been duly authorized prior to the Closing Date by all necessary action on
the part of North American, and subject to the approval of North American's
shareholders, this Agreement constitutes a valid and binding obligation of
North American, enforceable in accordance with its terms, subject as to
enforcement to bankruptcy, insolvency, reorganization, moratorium and other
laws relating to or affecting creditors rights and to general equity
principles. No other consents, authorizations or approvals are necessary in
connection with North American's performance of this Agreement;
(k) All material Federal and other tax returns and reports of North
American required by law to be filed on or before the Closing Date shall
have been filed and are correct and all Federal and other taxes shown as
due or required to be shown as due on said returns and reports have been
paid or provision has been made for the payment thereof, and to the best of
North American's knowledge, no such return is currently under audit and no
assessment has been asserted with respect to any such return;
(l) For each taxable year since its inception, North American has met all
the requirements of Subchapter M of the Code for qualification and
treatment as a "regulated investment company" and neither the execution or
delivery of, nor the performance of its obligations under, this Agreement
will adversely affect, and no other events are reasonably likely to occur
which will adversely affect the ability of North American to continue to
meet the requirements of Subchapter M of the Code;
(m) At the Closing Date, North American will have good and valid title to
the North American Assets, subject to no liens (other than the obligation,
if any, to pay the purchase price of portfolio securities purchased by
North American which have not settled prior to the Closing Date), security
interests or other
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encumbrances, and full right, power and authority to assign, deliver and
otherwise transfer such assets hereunder, and upon delivery and payment for
such assets, Limited Duration will acquire good and marketable title
thereto, subject to no restrictions on the full transfer thereof, including
any restrictions as might arise under the 1933 Act;
(n) On the effective date of the Registration Statement, at the time of
the meeting of North American's shareholders and on the Closing Date, the
Proxy Materials (exclusive of the currently effective Limited Duration
Prospectus contained therein) will (i) comply in all material respects with
the provisions of the 1933 Act, the Securities Exchange Act of 1934, as
amended ("1934 Act") and the 1940 Act and the regulations thereunder and
(ii) not contain any untrue statement of a material fact or omit to state a
material fact required to be stated therein or necessary to make the
statements therein not misleading. Any other information furnished by North
American for use in the Registration Statement or in any other manner that
may be necessary in connection with the transactions contemplated hereby
shall be accurate and complete and shall comply in all material respects
with applicable Federal securities and other laws and regulations
thereunder;
(o) North American will, on or prior to the Valuation Date, declare one
or more dividends or other distributions to shareholders that, together
with all previous dividends and other distributions to shareholders, shall
have the effect of distributing to the shareholders all of its investment
company taxable income and net capital gain, if any, through the Valuation
Date (computed without regard to any deduction for dividends paid);
(p) North American has maintained or has caused to be maintained on its
behalf all books and accounts as required of a registered investment company
in compliance with the requirements of Section 31 of the 1940 Act and the
Rules thereunder; and
(q) North American is not acquiring Limited Duration Shares to be issued
hereunder for the purpose of making any distribution thereof other than in
accordance with the terms of this Agreement.
6. CONDITIONS PRECEDENT TO OBLIGATIONS OF NORTH AMERICAN
The obligations of North American to consummate the transactions provided
for herein shall be subject, at its election, to the performance by Limited
Duration of all the obligations to be performed by it hereunder on or before
the Closing Date and, in addition thereto, the following conditions:
6.1 All representations and warranties of Limited Duration contained in
this Agreement shall be true and correct in all material respects as of the
date hereof and, except as they may be affected by the transactions
contemplated by this Agreement, as of the Closing Date with the same force and
effect as if made on and as of the Closing Date;
6.2 Limited Duration shall have delivered to North American a certificate
of its President and Treasurer, in a form reasonably satisfactory to North
American and dated as of the Closing Date, to the effect that the
representations and warranties of Limited Duration made in this Agreement are
true and correct at and as of the Closing Date, except as they may be affected
by the transactions contemplated by this Agreement, and as to such other
matters as North American shall reasonably request;
6.3 North American shall have received a favorable opinion from Mayer,
Brown, Rowe & Maw, counsel to Limited Duration, dated as of the Closing Date,
to the effect that:
(a) Limited Duration is a validly existing Massachusetts business trust,
and has the power to own all of its properties and assets and to carry on
its business as presently conducted (Massachusetts counsel may be relied
upon in delivering such opinion); (b) Limited Duration is a duly
registered, open-end,
A-9
management investment company, and its registration with the Commission as
an investment company under the 1940 Act is in full force and effect; (c)
this Agreement has been duly authorized, executed and delivered by Limited
Duration and, assuming that the Registration Statement complies with the
1933 Act, the 1934 Act and the 1940 Act and regulations thereunder and
assuming due authorization, execution and delivery of this Agreement by
North American, is a valid and binding obligation of Limited Duration
enforceable against Limited Duration in accordance with its terms, subject
as to enforcement, to bankruptcy, insolvency, reorganization, moratorium
and other laws relating to or affecting creditors rights and to general
equity principles; (d) Limited Duration Shares to be issued to North
American Shareholders as provided by this Agreement are duly authorized and
upon such delivery will be validly issued, fully paid and non-assessable
(except as set forth under the caption "Capital Stock and Other Securities"
in Limited Duration's Statement of Additional Information), and no
shareholder of Limited Duration has any preemptive rights to subscription
or purchase in respect thereof (Massachusetts counsel may be relied upon in
delivering such opinion); (e) the execution and delivery of this Agreement
did not, and the consummation of the transactions contemplated hereby will
not, violate Limited Duration's Declaration of Trust or By-Laws; and (f) to
the knowledge of such counsel, no consent, approval, authorization or order
of any court or governmental authority of the United States or any state is
required for the consummation by Limited Duration of the transactions
contemplated herein, except such as have been obtained under the 1933 Act,
the 1934 Act and the 1940 Act and such as may be required under state
securities laws; and
6.4 As of the Closing Date, there shall have been no material change in
the investment objective, policies and restrictions nor any increase in the
investment management fees or annual fees pursuant to Limited Duration's 12b-1
plan of distribution from those described in Limited Duration's Prospectus
dated June 28, 2002 and Statement of Additional Information dated June 28,
2002.
7. CONDITIONS PRECEDENT TO OBLIGATIONS OF LIMITED DURATION
The obligations of Limited Duration to complete the transactions provided
for herein shall be subject, at its election, to the performance by North
American of all the obligations to be performed by it hereunder on or before
the Closing Date and, in addition thereto, the following conditions:
7.1 All representations and warranties of North American contained in this
Agreement shall be true and correct in all material respects as of the date
hereof and, except as they may be affected by the transactions contemplated by
this Agreement, as of the Closing Date with the same force and effect as if
made on and as of the Closing Date;
7.2 North American shall have delivered to Limited Duration at the Closing
a certificate of its President and its Treasurer, in form and substance
satisfactory to Limited Duration and dated as of the Closing Date, to the
effect that the representations and warranties of North American made in this
Agreement are true and correct at and as of the Closing Date, except as they
may be affected by the transactions contemplated by this Agreement, and as to
such other matters as Limited Duration shall reasonably request;
7.3 North American shall have delivered to Limited Duration a statement of
the North American Assets and its liabilities, together with a list of North
American's portfolio securities and other assets showing the respective
adjusted bases and holding periods thereof for income tax purposes, as of the
Closing Date, certified by the Treasurer of North American;
7.4 North American shall have delivered to Limited Duration within three
business days after the Closing a letter from PricewaterhouseCoopers LLP with
respect to the taxable years ended October 31, 1999 and 2000, and a letter from
Deloitte & Touche LLP for the taxable year ended October 31, 2001, each dated
as of the
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Closing Date stating that (a) such respective firm has performed a limited
review of the Federal and state income tax returns of North American for each
of the respective taxable years and, based on such limited review, nothing came
to their attention that caused them to believe that such returns did not
properly reflect, in all material respects, the Federal and state income tax
liabilities of North American for the periods covered thereby, (b) for the
period from October 31, 2001 to and including the Closing Date, Deloitte &
Touche LLP has performed a limited review (based on unaudited financial data)
to ascertain the amount of applicable Federal, state and local taxes and has
determined that same either have been paid or reserves have been established
for payment of such taxes, and, based on such limited review, nothing came to
their attention that caused them to believe that the taxes paid or reserves set
aside for payment of such taxes were not adequate in all material respects for
the satisfaction of all Federal, state and local tax liabilities for the period
from October 31, 2001 to and including the Closing Date and (c) based on such
limited reviews, nothing came to their attention that caused them to believe
that North American would not qualify as a regulated investment company for
Federal income tax purposes for any such year or period;
7.5 Limited Duration shall have received at the Closing a favorable
opinion from Mayer, Brown, Rowe & Maw, counsel to North American, dated as of
the Closing Date to the effect that:
(a) North American is a validly existing Massachusetts business trust and
has the power to own all of its properties and assets and to carry on its
business as presently conducted (Massachusetts counsel may be relied upon
in delivering such opinion); (b) North American is a duly registered,
open-end, management investment company under the 1940 Act, and its
registration with the Commission as an investment company under the 1940
Act is in full force and effect; (c) this Agreement has been duly
authorized, executed and delivered by North American and, assuming that the
Registration Statement complies with the 1933 Act, the 1934 Act and the
1940 Act and the regulations thereunder and assuming due authorization,
execution and delivery of this Agreement by Limited Duration, is a valid
and binding obligation of North American enforceable against North American
in accordance with its terms, subject as to enforcement, to bankruptcy,
insolvency, reorganization, moratorium and other laws relating to or
affecting creditors rights and to general equity principles; (d) the
execution and delivery of this Agreement did not, and the consummation of
the transactions contemplated hereby will not, violate North American's
Declaration of Trust or By-Laws; and (e) to the knowledge of such counsel,
no consent, approval, authorization or order of any court or governmental
authority of the United States or any state is required for the
consummation by North American of the transactions contemplated herein,
except such as have been obtained under the 1933 Act, the 1934 Act and the
1940 Act and such as may be required under state securities laws; and
7.6 On the Closing Date, the North American Assets shall include no assets
that Limited Duration, by reason of limitations of the fund's Declaration of
Trust or otherwise, may not properly acquire.
8. FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF LIMITED DURATION AND NORTH
AMERICAN
The obligations of North American and Limited Duration hereunder are each
subject to the further conditions that on or before the Closing Date:
8.1 This Agreement and the transactions contemplated herein shall have
been approved by the requisite vote of the holders of the outstanding shares of
North American in accordance with the provisions of North American's
Declaration of Trust, and certified copies of the resolutions evidencing such
approval shall have been delivered to Limited Duration;
8.2 On the Closing Date, no action, suit or other proceeding shall be
pending before any court or governmental agency in which it is sought to
restrain or prohibit, or obtain damages or other relief in connection with,
this Agreement or the transactions contemplated herein;
A-11
8.3 All consents of other parties and all other consents, orders and
permits of Federal, state and local regulatory authorities (including those of
the Commission and of state Blue Sky and securities authorities, including
"no-action" positions of and exemptive orders from such Federal and state
authorities) deemed necessary by Limited Duration or North American to permit
consummation, in all material respects, of the transactions contemplated herein
shall have been obtained, except where failure to obtain any such consent,
order or permit would not involve risk of a material adverse effect on the
assets or properties of Limited Duration or North American;
8.4 The Registration Statement shall have become effective under the 1933
Act, no stop orders suspending the effectiveness thereof shall have been issued
and, to the best knowledge of the parties hereto, no investigation or
proceeding for that purpose shall have been instituted or be pending,
threatened or contemplated under the 1933 Act;
8.5 North American shall have declared and paid a dividend or dividends
and/or other distribution or distributions that, together with all previous
such dividends or distributions, shall have the effect of distributing to the
North American Shareholders all of North American's investment company taxable
income (computed without regard to any deduction for dividends paid) and all of
its net capital gain (after reduction for any capital loss carry-forward and
computed without regard to any deduction for dividends paid) for all taxable
years ending on or before the Closing Date; and
8.6 The parties shall have received the opinion of the law firm of Mayer,
Brown, Rowe & Maw (based on such representations as such law firm shall
reasonably request), addressed to Limited Duration and North American, which
opinion may be relied upon by the shareholders of North American, substantially
to the effect that, for Federal income tax purposes:
(a) The transfer of North American's assets in exchange for Limited
Duration Shares and the assumption by Limited Duration of certain stated
liabilities of North American followed by the distribution by North
American of Limited Duration Shares to the North American Shareholders in
exchange for their North American shares pursuant to and in accordance with
the terms of the Reorganization Agreement will constitute a
"reorganization" within the meaning of Section 368(a)(1)(C) of the Code,
and North American and Limited Duration will each be a "party to a
reorganization" within the meaning of Section 368(b) of the Code;
(b) No gain or loss will be recognized by Limited Duration upon the
receipt of the assets of North American solely in exchange for Limited
Duration Shares and the assumption by Limited Duration of the stated
liabilities of North American;
(c) No gain or loss will be recognized by North American upon the
transfer of the assets of to Limited Duration in exchange for Limited
Duration Shares and the assumption by Limited Duration of the stated
liabilities or upon the distribution of Limited Duration Shares to the
North American Shareholders in exchange for their North American shares;
(d) No gain or loss will be recognized by the North American Shareholders
upon the exchange of the North American shares for Limited Duration Shares;
(e) The aggregate tax basis for Limited Duration Shares received by each
North American Shareholder pursuant to the reorganization will be the same
as the aggregate tax basis of the North American Shares held by each such
North American Shareholder immediately prior to the Reorganization;
(f) The holding period of Limited Duration Shares to be received by each
North American Shareholder will include the period during which the North
American Shares surrendered in exchange therefor were held (provided such
North American Shares were held as capital assets on the date of the
Reorganization);
A-12
(g) The tax basis of the assets of North American acquired by Limited
Duration will be the same as the tax basis of such assets to North American
immediately prior to the Reorganization; and
(h) The holding period of the assets of North American in the hands of
Limited Duration will include the period during which those assets were
held by North American.
Notwithstanding anything herein to the contrary, neither Limited Duration
nor North American may waive the conditions set forth in this paragraph 8.6.
9. FEES AND EXPENSES
9.1 (a) Limited Duration shall bear its expenses incurred in connection
with the entering into, and carrying out of, the provisions of this
Agreement, including legal, accounting, Commission registration fees and Blue
Sky expenses. North American shall bear its expenses incurred in connection
with the entering into and carrying out of the provisions of this Agreement,
including legal and accounting fees, printing, filing and proxy solicitation
expenses and portfolio transfer taxes (if any) incurred in connection with
the consummation of the transactions contemplated herein.
(b) In the event the transactions contemplated herein are not consummated
by reason of North American being either unwilling or unable to go forward
(other than by reason of the nonfulfillment or failure of any condition to
North American's obligations specified in this Agreement), North American's
only obligation hereunder shall be to reimburse Limited Duration for all
reasonable out-of-pocket fees and expenses incurred by Limited Duration in
connection with those transactions.
(c) In the event the transactions contemplated herein are not consummated
by reason of Limited Duration being either unwilling or unable to go
forward (other than by reason of the nonfulfillment or failure of any
condition to Limited Duration's obligations specified in this Agreement),
Limited Duration's only obligation hereunder shall be to reimburse North
American for all reasonable out-of-pocket fees and expenses incurred by
North American in connection with those transactions.
10. ENTIRE AGREEMENT; SURVIVAL OF WARRANTIES
10.1 This Agreement constitutes the entire agreement between the parties.
10.2 The representations, warranties and covenants contained in this
Agreement or in any document delivered pursuant hereto or in connection
herewith shall survive the consummation of the transactions contemplated
herein, except that the representations, warranties and covenants of North
American hereunder shall not survive the dissolution and complete liquidation
of North American in accordance with Section 1.9.
11. TERMINATION
11.1 This Agreement may be terminated and the transactions contemplated
hereby may be abandoned at any time prior to the Closing:
(a) by the mutual written consent of North American and Limited Duration;
(b) by either Limited Duration or North American by notice to the other,
without liability to the terminating party on account of such termination
(providing the terminating party is not otherwise in material default or
breach of this Agreement) if the Closing shall not have occurred on or
before December 31, 2002; or
(c) by either Limited Duration or North American, in writing without
liability to the terminating party on account of such termination (provided
the terminating party is not otherwise in material default
A-13
or breach of this Agreement), if (i) the other party shall fail to perform
in any material respect its agreements contained herein required to be
performed on or prior to the Closing Date, (ii) the other party materially
breaches any of its representations, warranties or covenants contained
herein, (iii) the North American shareholders fail to approve this
Agreement at any meeting called for such purpose at which a quorum was
present or (iv) any other condition herein expressed to be precedent to the
obligations of the terminating party has not been met and it reasonably
appears that it will not or cannot be met.
11.2 (a) Termination of this Agreement pursuant to paragraphs 11.1 (a) or
(b) shall terminate all obligations of the parties hereunder and there
shall be no liability for damages on the part of Limited Duration or North
American, or the trustees or officers of Limited Duration or North
American, to any other party or its trustees or officers.
(b) Termination of this Agreement pursuant to paragraph 11.1 (c) shall
terminate all obligations of the parties hereunder and there shall be no
liability for damages on the part of Limited Duration or North American, or
the trustees or officers of Limited Duration or North American, except that
any party in breach of this Agreement shall, upon demand, reimburse the
non-breaching party for all reasonable out-of-pocket fees and expenses
incurred in connection with the transactions contemplated by this
Agreement, including legal, accounting and filing fees.
12. AMENDMENTS
This Agreement may be amended, modified or supplemented in such manner as
may be mutually agreed upon in writing by the parties.
13. MISCELLANEOUS
13.1 The article and paragraph headings contained in this Agreement are
for reference purposes only and shall not affect in any way the meaning or
interpretation of this Agreement.
13.2 This Agreement may be executed in any number of counterparts, each of
which shall be deemed an original.
13.3 This Agreement shall be governed by and construed in accordance with
the laws of the Commonwealth of Massachusetts.
13.4 This Agreement shall bind and inure to the benefit of the parties
hereto and their respective successors and assigns, but no assignment or
transfer hereof or of any rights or obligations hereunder shall be made by any
party without the written consent of the other party. Nothing herein expressed
or implied is intended or shall be construed to confer upon or give any person,
firm or corporation, other than the parties hereto and their respective
successors and assigns, any rights or remedies under or by reason of this
Agreement.
13.5 The obligations and liabilities of Limited Duration hereunder are
solely those of Limited Duration. It is expressly agreed that no shareholder,
nominee, trustee, officer, agent, or employee of Limited Duration shall be
personally liable hereunder. The execution and delivery of this Agreement have
been authorized by the trustees of Limited Duration and signed by authorized
officers of Limited Duration acting as such, and neither such authorization by
such trustees nor such execution and delivery by such officers shall be deemed
to have been made by any of them individually or to impose any liability on any
of them personally.
13.6 The obligations and liabilities of North American hereunder are
solely those of North American. It is expressly agreed that no shareholder,
nominee, trustee, officer, agent, or employee of North American shall be
personally liable hereunder. The execution and delivery of this Agreement have
been authorized by the
A-14
trustees of North American and signed by authorized officers of North American
acting as such, and neither such authorization by such trustees nor such
execution and delivery by such officers shall be deemed to have been made by
any of them individually or to impose any liability on any of them personally.
IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement
to be executed by a duly authorized officer.
MORGAN STANLEY NORTH AMERICAN
GOVERNMENT INCOME TRUST
By: /s/ CHARLES A. FIUMEFREDDO
--------------------------------------------
Name: Charles A. Fiumefreddo
Title: Chairman
MORGAN STANLEY LIMITED DURATION FUND
By: /s/ BARRY FINK
--------------------------------------------
Name: Barry Fink
Title: Vice President
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[MORGAN STANLEY LOGO]
Morgan Stanley Limited Duration Fund
A MUTUAL FUND THAT SEEKS TO
PROVIDE A HIGH LEVEL OF CURRENT INCOME,
CONSISTENT WITH THE PRESERVATION OF CAPITAL
[COVER PHOTO]
Prospectus - June 28, 2002
THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR DISAPPROVED THESE
SECURITIES OR PASSED UPON THE ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
Contents
The Fund INVESTMENT OBJECTIVE........................................ 1
PRINCIPAL INVESTMENT STRATEGIES............................. 1
PRINCIPAL RISKS............................................. 2
PAST PERFORMANCE............................................ 4
FEES AND EXPENSES........................................... 5
ADDITIONAL INVESTMENT STRATEGY INFORMATION.................. 5
ADDITIONAL RISK INFORMATION................................. 6
FUND MANAGEMENT............................................. 7
Shareholder Information PRICING FUND SHARES......................................... 8
HOW TO BUY SHARES........................................... 8
HOW TO EXCHANGE SHARES...................................... 10
HOW TO SELL SHARES.......................................... 11
DISTRIBUTIONS............................................... 13
TAX CONSEQUENCES............................................ 13
Financial Highlights ............................................................ 15
Morgan Stanley Funds ............................................................ INSIDE BACK COVER
THIS PROSPECTUS CONTAINS IMPORTANT INFORMATION ABOUT THE FUND.
PLEASE READ IT CAREFULLY AND KEEP IT FOR FUTURE REFERENCE.
[Sidebar]
INCOME
An investment objective having the goal of selecting securities to pay out
income rather than rise in price.
[End Sidebar]
The Fund
[ICON] INVESTMENT OBJECTIVE
- --------------------------------------------------------------------------------
Morgan Stanley Limited Duration Fund seeks to provide a high level of current
income, consistent with the preservation of capital.
[ICON] PRINCIPAL INVESTMENT STRATEGIES
- --------------------------------------------------------------------------------
The Fund will normally invest at least 65% of its
assets in securities issued or guaranteed as to
principal and interest by the U.S. Government, its
agencies or instrumentalities (including zero coupon
securities), investment grade mortgage-backed
securities, including collateralized mortgage
obligations, and investment grade corporate and other
types of bonds. In selecting portfolio investments to
purchase or sell, the "Investment Manager," Morgan
Stanley Investment Advisors Inc., considers both
domestic and international
economic developments, interest rate levels, the steepness of the yield curve
and other factors, and seeks to maintain an overall average duration for the
Fund's portfolio of three years or less.
Bonds are fixed-income debt securities. The issuer of the debt security borrows
money from the investor who buys the security. Most debt securities pay either
fixed or adjustable rates of interest at regular intervals until they mature, at
which point investors get their principal back. The Fund's fixed-income
investments may include zero coupon securities, which are purchased at a
discount and accrue interest, but make no payments until maturity.
Mortgage-Backed Securities. Certain of the U.S. government securities in which
the Fund may invest are mortgage-backed securities. One type of mortgage-backed
security, in which the Fund may invest, is a mortgage pass-through security.
These securities represent a participation interest in a pool of residential
mortgage loans originated by U.S. governmental or private lenders such as banks.
They differ from conventional debt securities, which provide for periodic
payment of interest in fixed amounts and principal payments at maturity or on
specified call dates. Mortgage pass-through securities provide for monthly
payments that are a "pass-through" of the monthly interest and principal
payments made by the individual borrowers on the pooled mortgage loans. Mortgage
pass-through securities may be collateralized by mortgages with fixed rates of
interest or adjustable rates.
Collateralized Mortgage Obligations. Collateralized mortgage obligations
("CMOs") are debt obligations collateralized by mortgage loans or mortgage
pass-through securities (collectively "Mortgage Assets"). Payments of principal
and interest on the Mortgage Assets and any reinvestment income are used to make
payments on the CMOs. CMOs are issued in multiple classes. Each class has a
fixed or floating rate and a stated maturity or final distribution date. The
principal and interest on the Mortgage Assets may be allocated among the classes
in a number of different ways. Certain classes will, as a result of the
allocation, have more predictable cash flows than others.
As a general matter, the more predictable the cash flow, the lower the yield
relative to other Mortgage Assets. The less predictable the cash flow, the
higher the yield and the greater the risk. The Fund may invest in any class of
CMO.
In addition, the Fund may invest in foreign securities, asset-backed securities,
restricted securities and "junk bonds", and may engage in futures transactions.
1
In pursuing the Fund's investment objective, the Investment Manager has
considerable leeway in deciding which investments it buys, holds or sells on a
day-to-day basis -- and which trading strategies it uses. For example, the
Investment Manager in its discretion may determine to use some permitted trading
strategies while not using others.
[ICON] PRINCIPAL RISKS
- --------------------------------------------------------------------------------
There is no assurance that the Fund will achieve its investment objective. The
Fund's share price and yield will fluctuate with changes in the market value
and/or yield of the Fund's portfolio securities. Neither the value nor the yield
of the U.S. government securities that the Fund invests in (or the value or
yield of the Fund's shares) is guaranteed by the U.S. Government. When you sell
Fund shares, they may be worth less than what you paid for them and,
accordingly, you can lose money investing in this Fund.
Fixed-Income Securities. All fixed-income securities, such as bonds, are subject
to two types of risk: credit risk and interest rate risk. Credit risk refers to
the possibility that the issuer of a security will be unable to make interest
payments and repay the principal on its debt. Certain of the Fund's investments
may have speculative characteristics.
Interest rate risk refers to fluctuations in the value of a fixed-income
security resulting from changes in the general level of interest rates. When the
general level of interest rates goes up, the prices of most fixed-income
securities go down. When the general level of interest rates goes down, the
prices of most fixed-income securities go up. (Zero coupon securities are
typically subject to greater price fluctuations than comparable securities that
pay interest.)
Maturity and Duration. Traditionally, a debt security's term-to-maturity has
been used as an indicator for the sensitivity of the security's price to changes
in interest rates (which is the interest rate risk or volatility of the
security). However, term-to-maturity measures only the time until a debt
security provides its final payment, taking no account of the pattern of the
security's payments prior to maturity.
Duration is a measure of the expected life of a fixed income security that was
developed as a more precise measure of interest rate sensitivity than
term-to-maturity. A portfolio with a lower average duration generally should
experience less price volatility in response to changes in interest rates than a
portfolio with a higher average duration. Duration incorporates a bond's yield,
coupon interest payments, final maturity and call features into one measure.
Duration is one of the fundamental tools used by the Investment Manager in the
selection of fixed income securities. Duration takes the length of the time
intervals between the present time and the time that the interest and principal
payments are scheduled or, in the case of a callable bond, expected to be
received, and weights them by the present values of the cash to be received at
each future point in time. For any fixed income security with interest payments
occurring prior to the payment of principal, duration is always less than
maturity.
There are some situations where even the standard duration calculation does not
properly reflect the interest rate exposure of a security. For example, floating
and variable rate securities often have final maturities of ten or more years;
however; their interest rate exposure corresponds to the frequency of the coupon
reset. Another example where the interest rate exposure is not properly captured
by duration is the case of mortgage pass-through securities. The stated final
maturity of such securities generally is thirty years, but current prepayment
rates are more critical in determining the securities' interest rate exposure.
In these and other similar situations, the
2
Investment Manager will use analytical techniques that incorporate the economic
life of a security into the determination of its interest rate exposure.
Mortgage-Backed Securities. Mortgage-backed securities in which the Fund may
invest have different risk characteristics than traditional debt securities.
Although generally the value of fixed-income securities increases during periods
of falling interest rates and decreases during periods of rising interest rates,
this is not always the case with mortgage-backed securities.
This is due to the fact that principal on underlying mortgages may be prepaid at
any time, as well as other factors. Generally, prepayments will increase during
a period of falling interest rates and decrease during a period of rising
interest rates. The rate of prepayments also may be influenced by economic and
other factors. Prepayment risk includes the possibility that, as interest rates
fall, securities with stated interest rates may have the principal prepaid
earlier than expected, requiring the Fund to invest the proceeds at generally
lower interest rates.
Investments in mortgage-backed securities are made based upon, among other
things, expectations regarding the rate of prepayments on underlying mortgage
pools. Rates of prepayment, faster or slower than expected by the Investment
Manager, could reduce the Fund's yield, increase the volatility of the Fund
and/or cause a decline in net asset value. Mortgage-backed securities,
especially privately issued mortgage-backed securities, are more volatile and
less liquid than other traditional types of securities.
Collateralized Mortgage Obligations. The principal and interest on the Mortgage
Assets comprising a CMO may be allocated among the several classes of a CMO in
many ways. The general goal in allocating cash flows on Mortgage Assets to the
various classes of a CMO is to create certain tranches on which the expected
cash flows have a higher degree of predictability than do the underlying
Mortgage Assets. As a general matter, the more predictable the cash flow is on a
particular CMO tranche, the lower the anticipated yield on that tranche at the
time of issue will be relative to the prevailing market yields on the Mortgage
Assets. As part of the process of creating more predictable cash flows on
certain tranches of a CMO, one or more tranches generally must be created that
absorb most of the changes in the cash flows on the underlying Mortgage Assets.
The yields on these tranches are generally higher than prevailing market yields
on other mortgage related securities with similar average lives. Principal
prepayments on the underlying Mortgage Assets may cause the CMOs to be retired
substantially earlier than their stated maturities or final distribution dates.
Because of the uncertainty of the cash flows on these tranches, the market
prices and yields of these tranches are more volatile and may increase or
decrease in value substantially with changes in interest rates and/or the rates
of prepayment. Due to the possibility that prepayments (on home mortgages and
other collateral) will alter the cash flow on CMOs, it is not possible to
determine in advance the final maturity date or average life. Faster prepayment
will shorten the average life and slower prepayments will lengthen it. In
addition, if the collateral securing CMOs or any third party guarantees are
insufficient to make payments, the Fund could sustain a loss.
Other Risks. The performance of the Fund also will depend on whether or not the
Investment Manager is successful in applying the Fund's investment strategies.
The Fund is also subject to other risks from its permissible investments
including the risks associated with investments in foreign securities and
asset-backed securities, restricted securities, and "junk bonds" and futures
transactions. For more information about these risks, see the "Additional Risk
Information" section.
Shares of the Fund are not bank deposits and are not guaranteed or insured by
the FDIC or any other government agency.
3
[Sidebar]
ANNUAL TOTAL RETURNS
This chart shows how the performance of the Fund's shares has varied from year
to year over the past 7 calendar years.
AVERAGE ANNUAL
TOTAL RETURNS
This table compares the Fund's average annual total returns with those of a
broad measure of market performance over time. The Fund's returns assume you
sold your shares at the end of each period (unless otherwise noted).
[End Sidebar]
[ICON] PAST PERFORMANCE
- --------------------------------------------------------------------------------
The bar chart and table below provide some indication of the risks of investing
in the Fund. The Fund's past performance (before and after taxes) does not
indicate how the Fund will perform in the future.
ANNUAL TOTAL RETURNS -- CALENDAR YEARS
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED
GRAPHIC
1995 11.86%
'96 4.54%
'97 6.41%
'98 6.97%
'99 2.73%
2000 7.01%
'01 8.04%
YEAR-TO-DATE TOTAL RETURN AS OF
MARCH 31, 2002 WAS 0.30%.
During the periods shown in the bar chart, the
highest return for a calendar quarter was 3.74%
(quarter ended June 30, 1995) and the lowest return
for a calendar quarter was -1.35% (quarter ended
December 31, 1994).
AVERAGE ANNUAL TOTAL RETURNS (AS OF DECEMBER 31, 2001)
- ---------------------------------------------------------------------------------
LIFE OF FUND
PAST 1 YEAR PAST 5 YEARS (SINCE 1/10/94)
- ---------------------------------------------------------------------------------
Limited Duration Fund (formerly
known as Morgan Stanley Short-
Term Bond Fund) Returns Before
Taxes 8.04% 6.22% 5.68%
- ---------------------------------------------------------------------------------
Returns After Taxes on
Distributions(1) 5.83% 3.79% 3.53%
- ---------------------------------------------------------------------------------
Returns After Taxes on
Distributions and Sale of Fund
Shares 4.86% 3.75% 3.57%
- ---------------------------------------------------------------------------------
Lehman Brothers U.S. Credit Index
(1-5 Year)(2) 9.73% 7.08% 6.69%
- ---------------------------------------------------------------------------------
1 These returns do not reflect any tax consequences from a sale of your
shares at the end of each period but they do reflect any applicable sales
charges on such a sale.
2 The Lehman Brothers U.S. Credit Index (1-5 Year) includes U.S. corporate
and specified foreign debentures and secured notes with maturities of one
to five years. The Index does not include any expenses, fees or charges.
The Index is unmanaged and should not be considered an investment.
The above table shows after tax returns for the Fund. After tax returns are
calculated using the historical highest individual federal marginal income tax
rates during the period shown and do not reflect the impact of state and local
taxes. Actual after tax returns depend on an investor's tax situation and may
differ from those shown.
4
[Sidebar]
ANNUAL FUND
OPERATING EXPENSES
These expenses are deducted from the Fund's assets and are based on expenses
paid for the fiscal year ended April 30, 2002.
[End Sidebar]
[ICON] FEES AND EXPENSES
- --------------------------------------------------------------------------------
The table below briefly describes the fees and expenses that you may pay if you
buy and hold shares of the Fund. The Fund is a no-load fund. The Fund does not
charge account or exchange fees.
ANNUAL FUND OPERATING EXPENSES
- ----------------------------------------------------------------------
Management fee 0.70%*
- ----------------------------------------------------------------------
Distribution and service (12b-1) fees None
- ----------------------------------------------------------------------
Other expenses 0.22%*
- ----------------------------------------------------------------------
Total annual Fund operating expenses 0.92%*
- ----------------------------------------------------------------------
* During the fiscal year ended April 30, 2002, the Investment Manager
waived its compensation and assumed operating expenses (except brokerage
fees) without limitation to the extent such compensation and expenses
exceeded 0.80% of the Fund's daily net assets on an annualized basis. The
Investment Manager will continue to assume all operating expenses (except
brokerage fees) and waive its compensation to the extent they exceed
0.80% of the Fund's daily net assets, on an annualized basis, until
December 31, 2002. For the fiscal year ended April 30, 2002, taking the
waiver of expenses into account, the actual management fee was 0.58% of
the Fund's daily net assets and the actual other expenses were 0.22% of
the Fund's daily net assets.
Example
This example is intended to help you compare the cost of investing in the Fund
with the cost of investing in other mutual funds.
The example assumes that you invest $10,000 in the Fund, your investment has a
5% return each year, and the Fund's operating expenses remain the same. Although
your actual costs may be higher or lower, the tables below show your costs at
the end of each period based on these assumptions.
EXPENSES OVER TIME
----------------------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
----------------------------------------------------
$94 $293 $509 $1,131
----------------------------------------------------
[ICON] ADDITIONAL INVESTMENT STRATEGY INFORMATION
- --------------------------------------------------------------------------------
This section provides additional information relating to the Fund's principal
investment strategies.
Foreign Securities. The Fund may invest up to 25% of its net assets in
investment grade fixed-income securities issued by foreign governments or
corporations.
Asset-Backed Securities. The Fund may invest in asset-backed securities. The
securitization techniques used to develop mortgage-backed securities are also
applied to a broad range of other assets. Various types of assets, primarily
automobile and credit card receivables and home equity loans, are being
securitized in pass-through structures similar to the mortgage pass-through
structures.
Futures. The Fund may invest in futures with respect to financial instruments
and interest rate indexes. The Fund may use futures to facilitate allocation of
the Fund's investments among asset classes, to increase or decrease the Fund's
exposure to a bond market or to seek to protect against a decline in securities
or an increase in prices of securities that may be purchased.
5
Junk Bonds and Restricted Securities. The Fund's investments may also include
"Rule 144A" fixed-income securities, which are subject to resale restrictions.
Up to 5% of the Fund's net assets may be invested in fixed-income securities
rated lower than investment grade, or if unrated, are of comparable quality as
determined by the Investment Manager (commonly known as "junk bonds").
The percentage limitations relating to the composition of the Fund's portfolio
apply at the time the Fund acquires an investment. Subsequent percentage changes
that result from market fluctuations will generally not require the Fund to sell
any portfolio security. However, the Fund may be required to sell its illiquid
securities holdings, if any, in response to fluctuations in the value of such
holdings. The Fund may change its principal investment strategies without
shareholder approval; however, you would be notified of any changes.
[ICON] ADDITIONAL RISK INFORMATION
- --------------------------------------------------------------------------------
This section provides additional information relating to the principal risks of
investing in the Fund.
Foreign Securities. The Fund's investments in foreign securities involve risks
in addition to the risks associated with domestic securities. One additional
risk may be currency risk. While the price of Fund shares is quoted in U.S.
dollars, the Fund generally may convert U.S. dollars to a foreign market's local
currency to purchase a security in that market. If the value of that local
currency falls relative to the U.S. dollar, the U.S. dollar value of the foreign
security will decrease. This is true even if the foreign security's local price
remains unchanged.
Foreign securities also have risks related to economic and political
developments abroad, including expropriation, confiscatory taxation, exchange
control regulation, limitations on the use or transfer of Fund assets, and any
effects of foreign social, economic or political instability. Foreign companies,
in general, are not subject to the regulatory requirements of U.S. companies
and, as such, there may be less publicly available information about these
companies. Moreover, foreign accounting, auditing and financial reporting
standards generally are different from those applicable to U.S. companies.
Finally, in the event of a default of any foreign debt obligations, it may be
more difficult for the Fund to obtain or enforce a judgment against the issuers
of the securities.
Securities of foreign issuers may be less liquid than comparable securities of
U.S. issuers and, as such, their price changes may be more volatile.
Furthermore, foreign exchanges and broker-dealers are generally subject to less
government and exchange scrutiny and regulation than their U.S. counterparts. In
addition, differences in clearance and settlement procedures in foreign markets
may occasion delays in settlement of the Fund's trades effected in those markets
and could result in losses to the Fund due to subsequent declines in the value
of the securities subject to the trades.
Asset-Backed Securities. Asset-backed securities have risk characteristics
similar to mortgage-backed securities. Like mortgage-backed securities, they
generally decrease in value as a result of interest rate increases, but may
benefit less than other fixed-income securities from declining interest rates,
principally because of prepayments. Also, as in the case of mortgage-backed
securities, prepayments generally increase during a period of declining interest
rates although other factors, such as changes in credit use and payment
patterns, may also influence prepayment rates. Asset-backed securities also
involve the risk that various federal and state consumer laws and other legal
and economic factors may result in the collateral backing the securities being
insufficient to support payment on the securities.
6
[Sidebar]
MORGAN STANLEY INVESTMENT ADVISORS INC.
The Investment Manager is widely recognized as a leader in the mutual fund
industry and together with Morgan Stanley Services Company Inc., its
wholly-owned subsidiary, had approximately $130 billion in assets under
management as of May 30, 2002.
[End Sidebar]
Futures. If the Fund invests in futures, its participation in these markets
would subject it to certain risks. The Investment Manager's predictions of
movements in the direction of the stock, bond or interest rate markets may be
inaccurate, and the adverse consequences to the Fund (e.g., a reduction in the
Fund's net asset value or a reduction in the amount of income available for
distribution) may leave the Fund in a worse position than if these strategies
were not used. Other risks inherent in the use of futures include, for example,
the possible imperfect correlation between the price of futures contracts and
the movements in the prices of the securities being hedged, and the possible
absence of a liquid secondary market for any particular instrument.
Junk Bonds and Restricted Securities. The Fund's investments in junk bonds pose
significant risks. The prices of junk bonds are likely to be more sensitive to
adverse economic changes or individual corporate developments than higher rated
securities. During an economic downturn or substantial period of rising interest
rates, junk bond issuers and, in particular, highly leveraged issuers may
experience financial stress that would adversely affect their ability to service
their principal and interest payment obligations, to meet their projected
business goals or to obtain additional financing. In the event of a default, the
Fund may incur additional expenses to seek recovery. The secondary market for
junk bonds may be less liquid than the markets for higher quality securities
and, as such, may have an adverse effect on the market prices of certain
securities. Many junk bonds are issued as Rule 144A securities. Rule 144A
securities could have the effect of increasing the level of Fund illiquidity to
the extent a Fund may be unable to find qualified institutional buyers
interested in purchasing the securities. The illiquidity of the market may also
adversely affect the ability of the Fund's Trustees to arrive at a fair value
for certain junk bonds at certain times and could make it difficult for the Fund
to sell certain securities.
[ICON] FUND MANAGEMENT
- --------------------------------------------------------------------------------
The Fund has retained the Investment Manager --
Morgan Stanley Investment Advisors Inc. -- to provide
administrative services, manage its business affairs
and invest its assets, including the placing of
orders for the purchase and sale of portfolio
securities. The Investment Manager is a wholly-owned
subsidiary of Morgan Stanley, a preeminent global
financial services firm that maintains leading market
positions in each of its three primary businesses:
securities, asset management and credit services. Its
address is 1221 Avenue of the Americas, New York, NY
10020.
The Fund is managed by the Taxable Fixed-Income
Group. Current members of the team include David S.
Horowitz, a Vice President of the Investment Manager,
and Menglin Luo, a Vice President of the Investment
Manager.
The Fund pays the Investment Manager a monthly management fee as full
compensation for the services and facilities furnished to the Fund, and for Fund
expenses assumed by the Investment Manager. The fee is based on the Fund's
average daily net assets. For the fiscal year ended April 30, 2002, the Fund
paid total compensation to the Investment Manager amounting to 0.58% of the
Fund's average daily net assets. This amount reflects the waiver of fees and
assumption of expenses. The Investment Manager has undertaken through
December 31, 2002, to continue to assume operating expenses of the Fund (except
brokerage fees) and waive its compensation to the extent they exceed 0.80% of
the Fund's daily net assets on an annualized basis.
7
[Sidebar]
CONTACTING A
FINANCIAL ADVISOR
If you are new to the Morgan Stanley Funds and would like to contact a Financial
Advisor, call toll-free 1-866-MORGAN8 for the telephone number of the Morgan
Stanley office nearest you. You may also access our office locator on our
Internet site at: www.morganstanley.com/funds
[End Sidebar]
Shareholder Information
[ICON] PRICING FUND SHARES
- --------------------------------------------------------------------------------
The price of Fund shares, called "net asset value," is based on the value of the
Fund's portfolio securities.
The net asset value per share of the Fund is determined once daily at 4:00 p.m.
Eastern time on each day that the New York Stock Exchange is open (or, on days
when the New York Stock Exchange closes prior to 4:00 p.m., at such earlier
time). Shares will not be priced on days that the New York Stock Exchange is
closed.
The value of the Fund's portfolio securities is based on the securities' market
price when available. When a market price is not readily available, including
circumstances under which the Investment Manager determines that a security's
market price is not accurate, a portfolio security is valued at its fair value,
as determined under procedures established by the Fund's Board of Trustees. In
these cases, the Fund's net asset value will reflect certain portfolio
securities' fair value rather than their market price. With respect to
securities that are primarily listed on foreign exchanges, the value of the
Fund's portfolio securities may change on days when you will not be able to
purchase or sell your shares.
An exception to the Fund's general policy of using market prices concerns its
short-term debt portfolio securities. Debt securities with remaining maturities
of sixty days or less at the time of purchase are valued at amortized cost.
However, if the cost does not reflect the securities' market value, these
securities will be valued at their fair value.
[ICON] HOW TO BUY SHARES
- --------------------------------------------------------------------------------
You may open a new account to buy Fund shares or buy
additional Fund shares for an existing account by
contacting your Morgan Stanley Financial Advisor or
other authorized financial representative. Your
Financial Advisor will assist you, step-by-step, with
the procedures to invest in the Fund. You may also
purchase shares directly by calling the Fund's
transfer agent and requesting an application.
When you buy Fund shares, the shares are purchased at
the next share price calculated after we receive your
purchase order. Your payment is due on the third
business day after you place your purchase order. We
reserve the right to reject any order for the
purchase of Fund shares.
8
[Sidebar]
EASYINVEST-SM-
A purchase plan that allows you to transfer money automatically from your
checking or savings account or from a Money Market Fund on a semi-monthly,
monthly or quarterly basis. Contact your Morgan Stanley Financial Advisor for
further information about this service.
[End Sidebar]
MINIMUM INVESTMENT AMOUNTS
- ---------------------------------------------------------------------------------------------
MINIMUM INVESTMENT
-------------------
INVESTMENT OPTIONS INITIAL ADDITIONAL
- ---------------------------------------------------------------------------------------------
Regular Accounts $1,000 $100
- ---------------------------------------------------------------------------------------------
Individual Retirement Account $1,000 $100
- ---------------------------------------------------------------------------------------------
Coverdell Education Savings
Account $ 500 $100
- ---------------------------------------------------------------------------------------------
EASYINVEST-SM-
(Automatically from your
checking or savings account or
Money Market Fund) $ 100* $100*
- ---------------------------------------------------------------------------------------------
* Provided your schedule of investments totals $1,000 in twelve months.
There is no minimum investment amount if you purchase Fund shares through:
(1) the Investment Manager's mutual fund asset allocation plan, (2) a program,
approved by the Fund's distributor, in which you pay an asset-based fee for
advisory, administrative and/or brokerage services, (3) the following programs
approved by the Fund's distributor: (i) qualified state tuition plans described
in Section 529 of the Internal Revenue Code and (ii) certain other investment
programs that do not charge an asset-based fee, or (4) employer-sponsored
employee benefit plan accounts.
Subsequent Investments Sent Directly to the Fund. In addition to buying
additional Fund shares for an existing account by contacting your Morgan Stanley
Financial Advisor, you may send a check directly to the Fund. To buy additional
shares in this manner:
- - Write a "letter of instruction" to the Fund specifying the name(s) on the
account, the account number, the social security or tax identification number,
and the investment amount. The letter must be signed by the account owner(s).
- - Make out a check for the total amount payable to: Morgan Stanley Limited
Duration Fund.
- - Mail the letter and check to Morgan Stanley Trust at P.O. Box 1040, Jersey
City, NJ 07303.
PLAN OF DISTRIBUTION The Fund has adopted a Plan of Distribution in accordance
with Rule 12b-1 under the Investment Company Act of 1940. The Plan allows the
Fund's distributor to use its own assets or those of its affiliates, including
the Investment Manager to pay distribution fees for the sale and distribution
of Fund shares.
9
[ICON] HOW TO EXCHANGE SHARES
- --------------------------------------------------------------------------------
Permissible Fund Exchanges. You may exchange shares of the Fund for shares of
other continuously offered Morgan Stanley Funds if the Fund shares were acquired
in an exchange of shares initially purchased in a Multi-Class Fund or an FSC
Fund (subject to a front-end sales charge). In that case, the shares may be
subsequently re-exchanged for shares of the same Class of any Multi-Class Fund
or FSC Fund or for shares of another No-Load Fund, a Money Market Fund, North
American Government Income Trust or Short-Term U.S. Treasury Trust. Of course,
if an exchange is not permitted, you may sell shares of the Fund and buy another
fund's shares with the proceeds.
See the inside back cover of this PROSPECTUS for each Morgan Stanley Fund's
designation as a Multi-Class Fund, No-Load Fund, Money Market Fund or FSC Fund.
If a Morgan Stanley Fund is not listed, consult the inside back cover of that
fund's prospectus for its designation.
Exchanges may be made after shares of the fund acquired by purchase have been
held for thirty days. There is no waiting period for exchanges of shares
acquired by exchange or dividend reinvestment. The current prospectus for each
fund describes its investment objective(s), policies and investment minimums,
and should be read before investment. Since exchanges are available only into
continuously offered Morgan Stanley Funds, exchanges are not available into any
new Morgan Stanley Fund during its initial offering period, or when shares of a
particular Morgan Stanley Fund are not being offered for purchase.
Exchange Procedures. You can process an exchange by contacting your Morgan
Stanley Financial Advisor or other authorized financial representative.
Otherwise, you must forward an exchange privilege authorization form to the
Fund's transfer agent -- Morgan Stanley Trust -- and then write the transfer
agent or call (800) 869-NEWS to place an exchange order. You can obtain an
exchange privilege authorization form by contacting your Financial Advisor or
other authorized financial representative, or by calling (800) 869-NEWS. If you
hold share certificates, no exchanges may be processed until we have received
all applicable share certificates.
An exchange to any Morgan Stanley Fund (except a Money Market Fund) is made on
the basis of the next calculated net asset values of the funds involved after
the exchange instructions are accepted. When exchanging into a Money Market
Fund, the Fund's shares are sold at their next calculated net asset value and
the Money Market Fund's shares are purchased at their net asset value on the
following business day.
The Fund may terminate or revise the exchange privilege upon required notice.
The check writing privilege is not available for Money Market Fund shares you
acquire in an exchange.
Telephone Exchanges. For your protection when calling Morgan Stanley Trust, we
will employ reasonable procedures to confirm that exchange instructions
communicated over the telephone are genuine. These procedures may include
requiring various forms of personal identification such as name, mailing
address, social security or other tax identification number. Telephone
instructions also may be recorded.
Telephone instructions will be accepted if received by the Fund's transfer agent
between 9:00 a.m. and 4:00 p.m. Eastern time on any day the New York Stock
Exchange is open for business. During periods of drastic economic or market
changes, it is possible that the telephone exchange procedures may be difficult
to implement, although this has not been the case with the Fund in the past.
10
Margin Accounts. If you have pledged your Fund shares in a margin account,
contact your Morgan Stanley Financial Advisor or other authorized financial
representative regarding restrictions on the exchange of such shares.
Tax Considerations of Exchanges. If you exchange shares of the Fund for shares
of another Morgan Stanley Fund there are important tax considerations. For tax
purposes, the exchange out of the Fund is considered a sale of Fund shares --
and the exchange into the other fund is considered a purchase. As a result, you
may realize a capital gain or loss.
You should review the "Tax Consequences" section and consult your own tax
professional about the tax consequences of an exchange.
Limitations on Exchanges. Certain patterns of past exchanges and/or purchase or
sale transactions involving the Fund or other Morgan Stanley Funds may result in
the Fund limiting or prohibiting, at its discretion, additional purchases and/or
exchanges. Determinations in this regard may be made based on the frequency or
dollar amount of the previous exchanges or purchase or sale transactions. You
will be notified in advance of limitations on your exchange privileges.
For further information regarding exchange privileges, you should contact your
Morgan Stanley Financial Advisor or call (800) 869-NEWS.
[ICON] HOW TO SELL SHARES
- --------------------------------------------------------------------------------
You can sell some or all of your Fund shares at any time. Your shares will be
sold at the next price calculated after we receive your order to sell as
described below.
OPTIONS PROCEDURES
- --------------------------------------------------------------------------------
CONTACT YOUR To sell your shares, simply call your Morgan Stanley
FINANCIAL ADVISOR Financial Advisor or other authorized financial
representative.
------------------------------------------------------------
[ICON] Payment will be sent to the address to which the account is
registered, or deposited in your brokerage account.
- --------------------------------------------------------------------------------
BY LETTER You can also sell your shares by writing a "letter of
instruction" that includes:
[ICON] - your account number;
- the name of the Fund;
- the dollar amount or the number of shares you wish to
sell; and
- the signature of each owner as it appears on the account.
- --------------------------------------------------------------------------------
11
OPTIONS PROCEDURES
- --------------------------------------------------------------------------------
BY LETTER, If you are requesting payment to anyone other than the
CONTINUED registered owner(s) or that payment be sent to any address
other than the address of the registered owner(s) or
pre-designated bank account, you will need a signature
guarantee. You can generally obtain a signature guarantee
from an eligible guarantor acceptable to Morgan Stanley
Trust. (You should contact Morgan Stanley Trust at
(800) 869-NEWS for a determination as to whether a
particular institution is an eligible guarantor.) A notary
public CANNOT provide a signature guarantee. Additional
documentation may be required for shares held by a
corporation, partnership, trustee or executor.
------------------------------------------------------------
Mail the letter to Morgan Stanley Trust at P.O. Box 983,
Jersey City, NJ 07303. If you hold share certificates, you
must return the certificates, along with the letter and any
required additional documentation.
------------------------------------------------------------
A check will be mailed to the name(s) and address in which
the account is registered, or otherwise according to your
instructions.
- --------------------------------------------------------------------------------
SYSTEMATIC If your investment in all of the Morgan Stanley Funds has a
WITHDRAWAL PLAN total market value of at least $10,000, you may elect to
withdraw amounts of $25 or more, or in any whole percentage
of a fund's balance (provided the amount is at least $25),
on a monthly, quarterly, semi-annual or annual basis, from
any fund with a balance of at least $1,000. Each time you
add a fund to the plan, you must meet the plan requirements.
------------------------------------------------------------
[ICON] To sign up for the Systematic Withdrawal Plan, contact your
Morgan Stanley Financial Advisor or call (800) 869-NEWS. You
may terminate or suspend your plan at any time. Please
remember that withdrawals from the plan are sales of shares,
not Fund "distributions," and ultimately may exhaust your
account balance. The Fund may terminate or revise the plan
at any time.
- --------------------------------------------------------------------------------
Payment for Sold Shares. After we receive your complete instructions to sell as
described above, a check will be mailed to you within seven days, although we
will attempt to make payment within one business day. Payment may also be sent
to your brokerage account.
Payment may be postponed or the right to sell your shares suspended under
unusual circumstances. If you request to sell shares that were recently
purchased by check, your sale will not be effected until it has been verified
that the check has been honored.
Tax Considerations. Normally, your sale of Fund shares is subject to federal and
state income tax. You should review the "Tax Consequences" section of this
PROSPECTUS and consult your own tax professional about the tax consequences of a
sale.
Involuntary Sales. The Fund reserves the right, on sixty days' notice, to sell
the shares of any shareholder (other than shares held in an IRA or
403(b) Custodial Account) whose shares, due to sales by the shareholder, have a
value below $100, or in the case of an account opened through EASYINVEST -SM-,
if after 12 months the shareholder has invested less than $1,000 in the account.
12
[Sidebar]
TARGETED DIVIDENDS-SM-
You may select to have your Fund distributions automatically invested in another
Morgan Stanley Fund that you own. Contact your Morgan Stanley Financial Advisor
for further information about this service.
[End Sidebar]
However, before the Fund sells your shares in this manner, we will notify you
and allow you sixty days to make an additional investment in an amount that will
increase the value of your account to at least the required amount before the
sale is processed.
Margin Accounts. If you have pledged your Fund shares in a margin account,
contact your Morgan Stanley Financial Advisor or other authorized financial
representative regarding restrictions on the sale of such shares.
[ICON] DISTRIBUTIONS
- --------------------------------------------------------------------------------
The Fund passes substantially all of its earnings
from income and capital gains along to its investors
as "distributions." The Fund earns interest from
fixed-income investments. These amounts are passed
along to Fund shareholders as "income dividend
distributions." The Fund realizes capital gains
whenever it sells securities for a higher price than
it paid for them. These amounts may be passed along
as "capital gain distributions."
Normally, income dividends are declared on each day
the New York Stock Exchange is open for business, and
are distributed to shareholders monthly. Capital
gains, if any, are usually distributed in December.
The Fund,
however, may retain and reinvest any long-term capital gains. The Fund may at
times make payments from sources other than income or capital gains that
represent a return of a portion of your investment.
Distributions are reinvested automatically in additional shares of the Fund and
automatically credited to your account, unless you request in writing that all
distributions be paid in cash. If you elect the cash option, the Fund will mail
a check to you no later than seven business days after the distribution is
declared. However, if you purchase Fund shares through a Financial Advisor
within three business days prior to the record date for the distribution, the
distribution will automatically be paid to you in cash, even if you did not
request to receive all distributions in cash. No interest will accrue on
uncashed checks. If you wish to change how your distributions are paid, your
request should be received by the Fund's transfer agent, Morgan Stanley Trust,
at least five business days prior to the record date of the distributions.
[ICON] TAX CONSEQUENCES
- --------------------------------------------------------------------------------
As with any investment, you should consider how your Fund investment will be
taxed. The tax information in this PROSPECTUS is provided as general
information. You should consult your own tax professional about the tax
consequences of an investment in the Fund.
Unless your investment in the Fund is through a tax-deferred retirement account,
such as a 401(k) plan or IRA, you need to be aware of the possible tax
consequences when:
- - The Fund makes distributions; and
- - You sell Fund shares, including an exchange to another Morgan Stanley Fund.
13
Taxes on Distributions. Your distributions are normally subject to federal and
state income tax when they are paid, whether you take them in cash or reinvest
them in Fund shares. A distribution also may be subject to local income tax. Any
income dividend distributions and any short-term capital gain distributions are
taxable to you as ordinary income. Any long-term capital gain distributions are
taxable as long-term capital gains, no matter how long you have owned shares in
the Fund.
Every January, you will be sent a statement (IRS Form 1099-DIV) showing the
taxable distributions paid to you in the previous year. The statement provides
information on your dividends and capital gains for tax purposes.
Taxes on Sales. Your sale of Fund shares normally is subject to federal and
state income tax and may result in a taxable gain or loss to you. A sale also
may be subject to local income tax. Your exchange of Fund shares for shares of
another Morgan Stanley Fund is treated for tax purposes like a sale of your
original shares and a purchase of your new shares. Thus, the exchange may, like
a sale, result in a taxable gain or loss to you and will give you a new tax
basis for your new shares.
When you open your Fund account, you should provide your social security or tax
identification number on your investment application. By providing this
information, you will avoid being subject to a federal backup withholding tax
(approximately 30% currently) on taxable distributions and redemption proceeds.
Any withheld amount would be sent to the IRS as an advance tax payment.
14
Financial Highlights
The financial highlights table is intended to help you understand the Fund's
financial performance for the periods indicated. Certain information reflects
financial results for a single Fund share throughout each period. The total
returns in the table represent the rate an investor would have earned or lost on
an investment in the Fund (assuming reinvestment of all dividends and
distributions).
This information has been audited by Deloitte & Touche LLP, independent
auditors, whose report, along with the Fund's financial statements, is included
in the annual report, which is available upon request.
FOR THE YEAR ENDED APRIL 30,
--------------------------------------------------------------------------
2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------------------
SELECTED PER SHARE DATA:
- ---------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of period $9.44 $9.20 $9.49 $9.49 $9.50
- ---------------------------------------------------------------------------------------------------------------------------------
Income (loss) from investment operations:
Net investment income 0.41(2) 0.55 0.51 0.56 0.65
Net realized and unrealized gain (loss) 0.19(2) 0.24 (0.29) -- --
-------- -------- -------- -------- --------
Total income from investment operations 0.60 0.79 0.22 0.56 0.65
- ---------------------------------------------------------------------------------------------------------------------------------
Less dividends from net investment income (0.45) (0.55) (0.51) (0.56) (0.66)
- ---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $9.59 $9.44 $9.20 $9.49 $9.49
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN+ 6.50% 8.82% 2.36% 6.00% 7.02%
- ---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS(1):
- ---------------------------------------------------------------------------------------------------------------------------------
Expenses 0.80% 0.80% 0.80% 0.31% --
- ---------------------------------------------------------------------------------------------------------------------------------
Net investment income 3.94%(2) 5.87% 5.43% 5.68% 6.52%
- ---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
- ---------------------------------------------------------------------------------------------------------------------------------
Net assets, end of period, in thousands $166,631 $109,917 $118,694 $186,442 $107,699
- ---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate 327% 133% 71% 58% 55%
- ---------------------------------------------------------------------------------------------------------------------------------
+ Calculated based on the net asset value as of the last business day of
the period.
(1) If the Fund had borne all expenses that were assumed or waived by the
Investment Manager, the annualized expense and net investment income
ratios would have been as follows:
EXPENSE NET INVESTMENT
PERIOD ENDED RATIO INCOME RATIO
- ------------ --------- ----------------
APRIL 30,
2002 0.92% 3.82%
APRIL 30,
2001 0.92 5.75
APRIL 30,
2000 0.90 5.33
APRIL 30,
1999 0.88 5.11
APRIL 30,
1998 1.10 5.42
(2) Effective May 1, 2001, the Fund has adopted the provisions of the AICPA
Audit and Accounting Guide for Investment Companies, as revised, related
to premiums and discounts on debt securities. The effect of this change
for the year ended April 30, 2002 was to decrease net investment income
per share by $0.06, increase net realized and unrealized gain or loss per
share by $0.06 and decrease the ratio of net investment income to average
net assets by 0.65%. The Financial Highlights data presented in this
table for prior periods has not been restated to reflect this change.
15
Notes
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16
Morgan Stanley Funds
- -----------------------------------------
- - GLOBAL/INTERNATIONAL FUNDS
Competitive Edge Fund - "Best Ideas" Portfolio
European Growth Fund
Fund of Funds - International Portfolio
Global Dividend Growth Securities
Global Utilities Fund
International Fund
International SmallCap Fund
International Value Equity Fund
Japan Fund
Latin American Growth Fund
Pacific Growth Fund
- - GROWTH FUNDS
21st Century Trend Fund
Aggressive Equity Fund
All Star Growth Fund
American Opportunities Fund
Capital Growth Securities
Capital Opportunities Trust
Developing Growth Securities Trust
Financial Services Trust
Growth Fund
Health Sciences Trust
Information Fund
KLD Social Index Fund
Market Leader Trust
Mid-Cap Value Fund
Nasdaq-100 Index Fund
Natural Resource Development Securities
New Discoveries Fund
Next Generation Trust
Special Growth Fund
Special Value Fund
Tax-Managed Growth Fund
Technology Fund
- - GROWTH + INCOME FUNDS
Balanced Growth Fund
Balanced Income Fund
Convertible Securities Trust
Dividend Growth Securities
Equity Fund
Fund of Funds - Domestic Portfolio
Income Builder Fund
Real Estate Fund
S&P 500 Index Fund
S&P 500 Select Fund
Small-Mid Special Value Fund
Strategist Fund
Total Market Index Fund
Total Return Trust
Utilities Fund
Value Fund
Value-Added Market Series/
Equity Portfolio
- - INCOME FUNDS
Diversified Income Trust
Federal Securities Trust
High Yield Securities
Intermediate Income Securities
Limited Duration Fund (NL)
Liquid Asset Fund (MM)
North American Government Income Trust
Short-Term U.S. Treasury Trust
U.S. Government Money Market Trust (MM)
U.S. Government Securities Trust
- - TAX-FREE INCOME FUNDS
California Tax-Free Daily Income Trust (MM)
California Tax-Free Income Fund
Hawaii Municipal Trust (FSC)
Limited Term Municipal Trust (NL)
Multi-State Municipal Series Trust (FSC)
New York Municipal Money Market Trust (MM)
New York Tax-Free Income Fund
Tax-Exempt Securities Trust
Tax-Free Daily Income Trust (MM)
- --------------------------------------------------------------------------------
THERE MAY BE FUNDS CREATED AFTER THIS PROSPECTUS WAS PUBLISHED. PLEASE CONSULT
THE INSIDE BACK COVER OF A NEW FUND'S PROSPECTUS FOR ITS DESIGNATION, E.G.,
MULTI-CLASS FUND OR MONEY MARKET FUND.
UNLESS OTHERWISE NOTED, EACH LISTED MORGAN STANLEY FUND, EXCEPT FOR NORTH
AMERICAN GOVERNMENT INCOME TRUST AND SHORT-TERM U.S. TREASURY TRUST, IS A
MULTI-CLASS FUND. A MULTI-CLASS FUND IS A MUTUAL FUND OFFERING MULTIPLE
CLASSES OF SHARES. THE OTHER TYPES OF FUNDS ARE: NL - NO-LOAD (MUTUAL) FUND;
MM - MONEY MARKET FUND; FSC - A MUTUAL FUND SOLD WITH A FRONT-END SALES CHARGE
AND A DISTRIBUTION (12b-1) FEE.
[MORGAN STANLEY LOGO]
Additional information about the Fund's investments is available in the Fund's
ANNUAL and SEMI-ANNUAL REPORTS TO SHAREHOLDERS. In the Fund's ANNUAL REPORT, you
will find a discussion of the market conditions and investment strategies that
significantly affected the Fund's performance during its last fiscal year. The
Fund's STATEMENT OF ADDITIONAL INFORMATION also provides additional information
about the Fund. The STATEMENT OF ADDITIONAL INFORMATION is incorporated herein
by reference (legally is part of this PROSPECTUS). For a free copy of any of
these documents, to request other information about the Fund, or to make
shareholder inquiries, please call:
(800) 869-NEWS
You also may obtain information about the Fund by calling your Morgan Stanley
Financial Advisor or by visiting our Internet site at:
www.morganstanley.com/funds
Information about the Fund (including the STATEMENT OF ADDITIONAL INFORMATION)
can be viewed and copied at the Securities and Exchange Commission's Public
Reference Room in Washington, DC. Information about the Reference Room's
operations may be obtained by calling the SEC at (202) 942-8090. Reports and
other information about the Fund are available on the EDGAR Database on the
SEC's Internet site (www.sec.gov), and copies of this information may be
obtained, after paying a duplicating fee, by electronic request at the following
E-mail address: publicinfo@sec.gov, or by writing the Public Reference Section
of the SEC, Washington, DC 20549-0102.
TICKER SYMBOL:
MSLDX
------
(THE FUND'S INVESTMENT COMPANY ACT FILE NO. IS 811-7117)
Morgan Stanley
Limited Duration Fund
[COVER PHOTO]
A MUTUAL FUND THAT SEEKS
TO PROVIDE A HIGH LEVEL
OF CURRENT INCOME, CONSISTENT
WITH THE PRESERVATION OF CAPITAL
Prospectus - June 28, 2002
[GRAPHIC OMITTED]
MorganStanley
Morgan Stanley North American Government Income Trust
A mutual fund that seeks to earn a high level of current income while
maintaining relatively low volatility of principal
[GRAPHIC OMITTED]
Prospectus December 31, 2001
THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR DISAPPROVED THESE
SECURITIES OR PASSED UPON THE ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
Contents
The Fund INVESTMENT OBJECTIVE..............................1
PRINCIPAL INVESTMENT STRATEGIES...................1
PRINCIPAL RISKS...................................3
PAST PERFORMANCE..................................6
FEES AND EXPENSES.................................7
ADDITIONAL INVESTMENT STRATEGY INFORMATION........7
ADDITIONAL RISK INFORMATION.......................8
FUND MANAGEMENT...................................9
Shareholder Information PRICING FUND SHARES..............................10
HOW TO BUY SHARES................................10
HOW TO EXCHANGE SHARES...........................12
HOW TO SELL SHARES...............................14
DISTRIBUTIONS....................................15
TAX CONSEQUENCES.................................16
Financial Highlights ................................................17
Morgan Stanley Funds .................................INSIDE BACK COVER
THIS PROSPECTUS CONTAINS IMPORTANT INFORMATION
ABOUT THE FUND. PLEASE READ IT CAREFULLY AND KEEP
IT FOR FUTURE REFERENCE.
The Fund
[GRAPHIC OMITTED]
INVESTMENT OBJECTIVE
- ----------------------------
Morgan Stanley North American Government Income Trust seeks to earn a high
level of current income while maintaining relatively low volatility of
principal.
[GRAPHIC OMITTED]
PRINCIPAL INVESTMENT STRATEGIES
- ---------------------------------------
The Fund will normally invest at least 80% of its
assets in fixed-income securities issued or guaranteed
by the United States, Canadian or Mexican governments,
their subdivisions, agencies or instrumentalities.
These securities are referred to generally as
"government securities." In the case of the United
States and Canada, a substantial portion of these
securities will be mortgage-backed securities.
[sidebar]
INCOME
An investment objective having the goal of selecting securities to pay out
income rather than rise in price.
[end sidebar]
The Fund will normally invest at least 50% of its net assets in U.S. government
securities, and no more than 25% each in Canadian or Mexican government
securities. The Fund will invest in fixed-income securities that are investment
grade; the Fund's investments in Canadian government securities, however, will
be rated at least A by Moody's Investors Services Inc. ("Moody's") or Standard
& Poor's Corporation ("S&P") or, if not rated, determined to be of comparable
quality by the Fund's "Sub-Advisor," TCW Investment Management Company.
The Sub-Advisor will allocate Fund assets among the three countries based on
its analysis of market, economic and political conditions in those countries.
When deciding whether to buy, hold or sell a security for the Fund, the
Sub-Advisor will consider various factors, such as changes in interest rates
and currency exchange rates, to attempt to take advantage of favorable
investment opportunities in each country. The Sub-Advisor expects that, under
normal circumstances, the weighted average maturity (or period until the next
time the interest rate is reset) of the Fund's investment securities will be no
greater than 3 years. In addition, the Fund will purchase Mexican government
securities that have remaining maturities of one year or less.
Mortgage-Backed Securities. One type of mortgage-backed security, in which the
Fund may invest, is a mortgage pass-through security. These securities
represent a participation interest in a pool of residential mortgage loans
originated by governmental or private lenders such as banks. They differ from
conventional debt securities, which provide for periodic payment of interest in
fixed amounts and principal payments at maturity or on specified call dates.
Mortgage pass-through securities provide for monthly payments that are a
"pass-through" of the monthly interest and principal payments made by the
individual borrowers on the pooled mortgage loans.
The U.S. mortgage pass-through securities in which the Fund may invest include
those issued or guaranteed by the Government National Mortgage Association
("GNMA" or "Ginnie Mae"), the Federal National Mortgage Association ("FNMA" or
"Fannie Mae") and the Federal Home Loan Mortgage Corporation ("FHLMC" or
"Freddie Mac"). GNMA certificates are backed by the "full faith
1
and credit" of the United States. FNMA and FHLMC certificates are not backed by
the full faith and credit of the United States but the issuing agency or
instrumentality has the right to borrow, to meet its obligations, from an
existing line of credit with the U.S. Treasury.
Collateralized Mortgage Obligations. The Fund may invest in "CMOs" --
collateralized mortgage obligations. CMOs are debt obligations collateralized
by mortgage loans or mortgage pass-through securities (collectively "Mortgage
Assets"). Payments of principal and interest on the Mortgage Assets and any
reinvestment income are used to make payments on the CMOs. CMOs are issued in
multiple classes. Each class has a specific fixed or floating coupon rate and a
stated maturity or final distribution date. The principal and interest on the
Mortgage Assets may be allocated among the classes in a number of different
ways. Certain classes will, as a result of the collection, have more
predictable cash flows than others. As a general matter, the more predictable
the cash flow, the lower the yield relative to other Mortgage Assets. The less
predictable the cash flow, the higher the yield and the greater the risk. The
Fund may invest in any class of CMO.
Inverse Floaters. The Fund may invest up to 10% of its net assets in inverse
floaters. An inverse floater has a coupon rate that moves in the direction
opposite to that of a designated interest rate index.
Stripped Mortgage-Backed Securities. The Fund may purchase stripped
mortgage-backed securities, which are usually structured in two classes. One
class entitles the holder to receive all or most of the interest but little or
none of the principal of a pool of Mortgage Assets (the interest-only or "IO"
Class), while the other class entitles the holder to receive all or most of the
principal but little or none of the interest (the principal-only or "PO"
Class).
Other Securities. The Fund may invest up to 20% of its assets in securities
that are not government securities. This group of securities also will be
issued by U.S., Canadian or Mexican issuers and may include corporate debt
securities and securities backed by other assets, such as automobile or credit
card receivables or home equity loans. They are rated at least Aa by Moody's or
AA by S&P or, if not rated, determined to be of comparable quality by the
Sub-Advisor.
Fixed-income securities are debt securities and can take the form of bonds,
notes or commercial paper. The issuer of the debt security borrows money from
the investor who buys the security. Most debt securities pay either fixed or
adjustable rates of interest at regular intervals until they mature, at which
point investors get their principal back. The Fund's fixed-income investments
may include zero coupon securities, which are purchased at a discount and
either (i) pay no interest, or (ii) accrue interest, but make no payments until
maturity.
In addition, the Fund may invest in futures, options, reverse repurchase
agreements and dollar rolls.
In pursuing the Fund's investment objective, the Sub-Advisor has considerable
leeway in deciding which investments it buys, holds or sells on a day-to-day
basis -- and which trading or investment strategies it uses. For example, the
Sub-Advisor in its discretion may determine to use some permitted trading or
investment strategies while not using others.
2
[GRAPHIC OMITTED]
PRINCIPAL RISKS
- ----------------------
There is no assurance that the Fund will achieve its investment objective. The
Fund's share price and yield will fluctuate with changes in the market value of
the Fund's portfolio securities. When you sell Fund shares, they may be worth
less than what you paid for them and, accordingly, you can lose money investing
in this Fund.
Fixed-Income Securities. All fixed-income securities are subject to two types
of risk: credit risk and interest rate risk. Credit risk refers to the
possibility that the issuer of a security will be unable to make interest
payments and/or repay the principal on its debt. While the Fund invests in
investment grade securities, these securities may have speculative
characteristics.
Interest rate risk refers to fluctuations in the value of a fixed-income
security resulting from changes in the general level of interest rates. When
the general level of interest rates goes up, the prices of most fixed-income
securities go down. When the general level of interest rates goes down, the
prices of most fixed-income securities go up. (Zero coupon securities are
typically subject to greater price fluctuations than comparable securities that
pay interest.)
Mortgage-Backed Securities. Mortgage-backed securities have different risk
characteristics than traditional debt securities. Although generally the value
of fixed-income securities increases during periods of falling interest rates
and decreases during periods of rising interest rates, this is not always the
case with mortgage-backed securities. This is due to the fact that principal on
underlying mortgages may be prepaid at any time as well as other factors.
Generally, prepayments will increase during a period of falling interest rates
and decrease during a period of rising interest rates. The rate of prepayments
also may be influenced by economic and other factors. Prepayment risk includes
the possibility that, as interest rates fall, securities with stated interest
rates may have the principal prepaid earlier than expected, requiring the Fund
to invest the proceeds at generally lower interest rates.
Investments in mortgage-backed securities are made based upon, among other
things, expectations regarding the rate of prepayments on underlying mortgage
pools. Rates of prepayment, faster or slower than expected by the Sub-Advisor,
could reduce the Fund's yield, increase the volatility of the Fund and/or cause
a decline in net asset value. Certain mortgage-backed securities in which the
Fund may invest may be more volatile and less liquid than other traditional
types of debt securities. The Fund may be subject to a risk referred to as
"extension risk," which is the possibility that rising interest rates may cause
owners of the underlying mortgages to pay off their mortgages at a slower than
expected rate. This risk may effectively change a security that was short or
intermediate term into a long term security. Long term securities generally
drop in value more dramatically when the general level of interest rates goes
up.
CMOs. Certain mortgage-backed securities in which the Fund may invest (e.g.,
certain classes of CMOs) may increase or decrease in value substantially with
changes in interest rates and/or the rates of prepayment. In addition, if the
collateral securing CMOs or any third party guarantees is insufficient to make
payments, the Fund could sustain a loss.
3
Inverse Floaters. Like most other fixed-income securities, the value of inverse
floaters will decrease as interest rates increase. They are more volatile,
however, than most other fixed-income securities because the coupon rate on an
inverse floater typically changes at a multiple of the change in the relevant
index rate. Thus, any rise in the index rate (as a consequence of an increase
in interest rates) causes a correspondingly greater drop in the coupon rate of
an inverse floater while a drop in the index rate causes a correspondingly
greater increase in the coupon of an inverse floater. The value of some inverse
floaters may also increase or decrease substantially because of changes in the
rate of prepayments.
Stripped Mortgage-Backed Securities. IOs tend to decrease in value
substantially if interest rates decline and prepayment rates become more rapid.
POs tend to decrease in value substantially if interest rates increase and the
rate of repayment decreases.
Foreign Securities. The Fund's investments in foreign securities involve risks
in addition to the risks associated with domestic securities. One additional
risk is currency risk. While the price of Fund shares is quoted in U.S.
dollars, the Fund generally converts U.S. dollars to a foreign market's local
currency to purchase a security in that market. If the value of that local
currency falls relative to the U.S. dollar, the U.S. dollar value of the
foreign security will decrease. This is true even if the foreign security's
local price remains unchanged.
Foreign securities also have risks related to economic and political
developments abroad, including effects of foreign social, economic or political
instability. Foreign issuers, in general, are not subject to the regulatory
requirements of U.S. issuers and, as such, there may be less publicly available
information about these issuers. Moreover, foreign accounting, auditing and
financial reporting standards generally are different from those applicable to
U.S. issuers. Finally, in the event of a default of any foreign debt
obligations, it may be more difficult for the Fund to obtain or enforce a
judgment against the issuers of the securities.
Securities of foreign issuers may be less liquid than comparable securities of
U.S. issuers and, as such, their price changes may be more volatile.
Furthermore, foreign exchanges and broker-dealers are generally subject to less
government and exchange scrutiny and regulation than their U.S. counterparts.
In addition, differences in clearance and settlement procedures in foreign
markets may occasion delays in settlement of the Fund's trades effected in
those markets and could result in losses to the Fund due to subsequent declines
in the value of the securities subject to the trades.
The Mexican securities in which the Fund may invest are issued by a developing
country. Compared to the United States and other developed countries,
developing countries may have relatively unstable governments, economies based
on only a few industries and securities markets that trade a small number of
securities. Prices of these securities tend to be especially volatile and, in
the past, securities in these countries have offered greater potential loss
than securities of companies located in developed countries.
4
Canadian and Mexican Securities. The Canadian debt securities market is
significantly smaller than the U.S. debt securities market. In particular, the
Canadian mortgage-backed securities market is of recent origin, and, although
continued growth is anticipated, is less well developed and less liquid than
its U.S. counterpart.
Because the Fund may invest in Mexican debt instruments, investors in the Fund
should be aware of certain special considerations associated with investing in
debt obligations of the Mexican government.
The Mexican government has exercised and continues to exercise a significant
influence over many aspects of the private sector in Mexico. Mexican government
actions concerning the economy could have a significant effect on market
conditions and prices and yields of Mexican debt obligations, including those
in which the Fund invests. Mexico is currently a major debtor nation (among
developing countries) to commercial banks and foreign governments.
The value of the Fund's investments may be affected by changes in oil prices,
interest rates, taxation and other political or economic developments in
Mexico, including recent rates of inflation which have exceeded the rates of
inflation in the U.S. and Canada. The Fund can provide no assurance that future
developments in the Mexican economy will not impair the Fund's investment
flexibility, operations or ability to achieve its investment objective.
Other Risks. The performance of the Fund also will depend on whether the
Sub-Advisor is successful in applying the Fund's investment strategies. In
addition, the Fund is subject to other risks from its permissible investments
including those risks associated with futures, options and reverse repurchase
agreements and dollar rolls. For information about these risks, see the
"Additional Risk Information" section.
Shares of the Fund are not bank deposits and are not guaranteed or insured by
the FDIC or any other government agency.
5
[GRAPHIC OMITTED]
PAST PERFORMANCE
- -------------------------
The bar chart and table below provide some indication of the risks of investing
in the Fund. The Fund's past performance does not indicate how the Fund will
perform in the future.
[GRAPHIC OMITTED]
ANNUAL TOTAL RETURNS -- CALENDAR YEARS
1993 8.11%
'94 -15.59%
'95 16.00% Year-to-date total
'96 4.01% return as of
'97 7.89% September 30, 2001
'98 6.75% was 3.96%.
'99 2.35%
2000 7.97%
[sidebar]
ANNUAL TOTAL RETURNS
This chart shows how the performance of the Fund's shares has varied from year
to year over the past 8 calendar years.
[end sidebar]
During the periods shown in the bar chart, the highest return for a calendar
quarter was 5.65% (quarter ended June 30, 1995) and the lowest return for a
calendar quarter was -- 10.51% (quarter ended December 31, 1994).
[sidebar]
AVERAGE ANNUAL
TOTAL RETURNS
This table compares the Fund's average annual total returns with those of a
broad measure of market performance over time.
[end sidebar]
AVERAGE ANNUAL TOTAL RETURNS (AS OF DECEMBER 31, 2000)
- -------------------------------------------------------------------------------
LIFE OF FUND
PAST 1 YEAR PAST 5 YEARS (SINCE 7/31/92)
- -------------------------------------------------------------------------------
Morgan Stanley North
American Government
Income Trust 7.97% 5.77% 4.50%
- -------------------------------------------------------------------------------
Lehman Brothers U.S. Credit
Index (1-5 Year)(1) 8.48% 6.16% 6.50%
- -------------------------------------------------------------------------------
(1) The Lehman Brothers U.S. Credit Index (1-5 Year) (formerly Lehman Brothers
Mutual Fund Short (1-5) Investment Grade Debt Index) includes U.S. corporate
and specified foreign debentures and secured notes with maturities of one to
five years. The Index does not include any expenses, fees or charges. The
Index is unmanaged and should not be considered an investment.
6
[GRAPHIC OMITTED]
FEES AND EXPENSES
- --------------------------
The table below briefly describes the fees and expenses that you may pay if you
buy and hold shares of the Fund. The Fund does not impose any initial or
deferred sales charges and does not charge account or exchange fees.
[sidebar]
ANNUAL FUND
OPERATING EXPENSES
These expenses are deducted from
the Fund's assets and are based on
expenses paid for the fiscal year
ended October 31, 2001.
[end sidebar]
ANNUAL FUND OPERATING EXPENSES
- ---------------------------------------------------------------
Management fee 0.65%
- ---------------------------------------------------------------
Distribution and service (12b-1) fees 0.73%
- ---------------------------------------------------------------
Other expenses 0.42%
- ---------------------------------------------------------------
Total annual Fund operating expenses 1.80%
- ---------------------------------------------------------------
Example
This example is intended to help you compare the cost of investing in the Fund
with the cost of investing in other mutual funds.
The example assumes that you invest $10,000 in the Fund, your investment has a
5% return each year, and the Fund's operating expenses remain the same.
Although your actual costs may be higher or lower, the table below shows your
costs at the end of each period based on these assumptions.
1 YEAR 3 YEARS 5 YEARS 10 YEARS
- -------------------------------------------------
$183 $566 $975 $2,116
- -------------------------------------------------
[GRAPHIC OMITTED]
ADDITIONAL INVESTMENT STRATEGY INFORMATION
- ----------------------------------------------------
This section provides additional information relating to the Fund's principal
investment strategies.
Options and Futures. The Fund may invest in put and call options and futures
with respect to financial instruments and interest rate indexes. The Fund may
use options and futures to facilitate allocation of the Fund's investments
among asset classes, to increase or decrease the Fund's exposure to a bond
market, to generate income or to seek to protect against a decline in
securities or an increase in prices of securities that may be purchased.
Reverse Repurchase Agreements and Dollar Rolls. The Fund may use reverse
repurchase agreements and dollar rolls as part of its investment strategy.
Reverse repurchase agreements involve sales by the Fund of portfolio assets
concurrently with an agreement by the Fund to repurchase the same assets at a
later date at a fixed price. The Fund may enter into dollar rolls in which the
Fund sells securities for delivery in the current month and simultaneously
contracts to repurchase substantially similar (same type and coupon) securities
on a specified future date.
7
Defensive Investing. The Fund may take temporary "defensive" positions in
attempting to respond to adverse market conditions. The Fund may invest any
amount of its assets in cash or money market instruments in a defensive posture
when the Sub-Advisor believes it is advisable to do so. Although taking a
defensive posture is designed to protect the Fund from an anticipated market
downturn, it could have the effect of reducing the benefit from any upswing in
the market. When the Fund takes a defensive position, it may not achieve its
investment objective.
The percentage limitations relating to the composition of the Fund's portfolio
apply at the time the Fund acquires an investment. Subsequent percentage
changes that result from market fluctuations will generally not require the
Fund to sell any portfolio security. However, the Fund may be required to sell
its illiquid securities holdings, if any, in response to fluctuations in the
value of such holdings. The Fund may change its principal investment strategies
without shareholder approval; however, you would be notified of any changes.
[GRAPHIC OMITTED]
ADDITIONAL RISK INFORMATION
- -----------------------------------
This section provides additional information relating to the principal risks of
investing in the Fund.
Options and Futures. If the Fund invests in options and/or futures, its
participation in these markets would subject it to certain risks. The
Investment Manager's or Sub-Advisor's predictions of movements in the direction
of the stock, bond or interest rate markets may be inaccurate, and the adverse
consequences to the Fund (e.g., a reduction in the Fund's net asset value or a
reduction in the amount of income available for distribution) may leave the
Fund in a worse position than if these strategies were not used. Other risks
inherent in the use of options and futures include, for example, the possible
imperfect correlation between the price of options and futures contracts and
movements in the prices of the securities being hedged, and the possible
absence of a liquid secondary market for any particular instrument. Certain
options may be over-the-counter options, which are options negotiated with
dealers; there is no secondary market for these investments.
Reverse Repurchase Agreements and Dollar Rolls. Reverse repurchase agreements
and dollar rolls involve the risk that the market value of the securities the
Fund is obligated to repurchase under the agreement may decline below the
repurchase price. In the event the buyer of securities under a reverse
repurchase agreement or dollar roll files for bankruptcy or becomes insolvent,
the Fund's use of proceeds of the agreement may be restricted pending a
determination by the other party, or its trustee or receiver, whether to
enforce the Fund's obligation to repurchase the securities. Reverse repurchase
agreements and dollar rolls are speculative techniques involving leverage, and
are considered borrowings by the Fund.
8
[GRAPHIC OMITTED]
FUND MANAGEMENT
- -------------------------
The Fund has retained the Investment Manager -- Morgan
Stanley Investment Advisors Inc. -- to provide
administrative services, manage its business affairs
and supervise the investment of its assets. The
Investment Manager has, in turn, contracted with the
Sub-Advisor -- TCW Investment Management Company -- to
invest the Fund's assets, including the placing of
orders for the purchase and sale of portfolio
securities. The Investment Manager is a wholly-owned
subsidiary of Morgan Stanley Dean Witter & Co., a
preeminent global financial services firm that
maintains leading market positions in each of its three
primary businesses: securities, asset management and
credit services. Its address is 1221 Avenue of the
Americas, New York, NY 10020.
[sidebar]
MORGAN STANLEY INVESTMENT ADVISORS INC.
The Investment Manager is widely recognized as a leader in the mutual fund
industry and together with Morgan Stanley Services Company Inc., its
wholly-owned subsidiary, had approximately $135 billion in assets under
management as of November 30, 2001.
[end sidebar]
The Sub-Advisor, together with its affiliated companies, manages approximately
$79.5 billion, at November 30, 2001, primarily for institutional investors. The
Sub-Advisor's main business office is located at 865 South Figueroa Street,
Suite 1800, Los Angeles, California 90017. The Sub-Advisor is a wholly-owned
subsidiary of the TCW Group, Inc. ("TCW Group"), whose direct and indirect
subsidiaries provide a variety of trust, investment management and investment
advisory services. Societe Generale Asset Management, S.A., a wholly-owned
subsidiary of Societe Generale, S.A., owns a majority interest in TCW Group.
Philip A. Barach and Jeffrey E. Gundlach, Group Managing Directors of the
Sub-Advisor, and Frederick H. Horton, Managing Director of the Sub-Advisor, are
the Fund's primary portfolio managers, and have been so for over five years.
Messrs. Barach, Gundlach and Horton have each been portfolio managers with
affiliates of the Sub-Advisor for over five years.
The Fund pays the Investment Manager a monthly management fee as full
compensation for the services and facilities furnished to the Fund, and for
Fund expenses assumed by the Investment Manager. The fee is based on the Fund's
average daily net assets. For the fiscal year ended October 31, 2001, the Fund
accrued total compensation to the Investment Manager amounting to 0.65% of the
Fund's average daily net assets. The Investment Manager pays the Sub-Advisor
compensation equal to 40% of its compensation for services and facilities
furnished to the Fund.
9
Shareholder Information
[GRAPHIC OMITTED]
PRICING FUND SHARES
- ---------------------------
The price of Fund shares, called "net asset value," is based on the value of
the Fund's portfolio securities.
The net asset value per share of the Fund is determined once daily at 4:00 p.m.
Eastern time on each day that the New York Stock Exchange is open (or, on days
when the New York Stock Exchange closes prior to 4:00 p.m., at such earlier
time). Shares will not be priced on days that the New York Stock Exchange is
closed.
The value of the Fund's portfolio securities is based on the securities' market
price when available. When a market price is not readily available, including
circumstances under which the Investment Manager and/or Sub-Advisor determines
that a security's market price is not accurate, a portfolio security is valued
at its fair value, as determined under procedures established by the Fund's
Board of Trustees. In these cases, the Fund's net asset value will reflect
certain portfolio securities' fair value rather than their market price. With
respect to securities that are primarily listed on foreign exchanges, the value
of the Fund's portfolio securities may change on days when you will not be able
to purchase or sell your shares.
An exception to the Fund's general policy of using market prices concerns its
short-term debt portfolio securities. Debt securities with remaining maturities
of sixty days or less at the time of purchase are valued at amortized cost.
However, if the cost does not reflect the securities' market value, these
securities will be valued at their fair value.
[GRAPHIC OMITTED]
HOW TO BUY SHARES
- --------------------------
You may open a new account to buy Fund shares or buy
additional Fund shares for an existing account by
contacting your Morgan Stanley Financial Advisor or
other authorized financial representative. Your
Financial Advisor will assist you, step-by-step, with
the procedures to invest in the Fund. You may also
purchase shares directly by calling the Fund's transfer
agent and requesting an application.
[sidebar]
CONTACTING A
FINANCIAL ADVISOR
If you are new to the Morgan Stanley Family of Funds and would like to contact
a Financial Advisor, call (toll-free) 1-866-MORGAN8 for the telephone number of
the Morgan Stanley office nearest you. You may also access our office locator
on our Internet site at: www.morganstanley.com/funds
[end sidebar]
When you buy Fund shares, the shares are purchased at
the next share price calculated after we receive your
purchase order. Your payment is due on the third
business day after you place your purchase order. We
reserve the right to reject any order for the purchase
of Fund shares.
10
[sidebar]
EASYINVEST(Service Mark)
A purchase plan that allows you to transfer money automatically from your
checking or savings account or from a Money Market Fund on a semi-monthly,
monthly or quarterly basis. Contact your Morgan Stanley Financial Advisor for
further information about this service.
[end sidebar]
MINIMUM INVESTMENT AMOUNTS
- -------------------------------------------------------------------------------
MINIMUM INVESTMENT
------------------------
INVESTMENT OPTIONS INITIAL ADDITIONAL
- -------------------------------------------------------------------------------
Regular accounts $ 1,000 $ 100
- -------------------------------------------------------------------------------
Individual Retirement Accounts: Regular IRAs $ 1,000 $ 100
Education IRAs $ 500 $ 100
- -------------------------------------------------------------------------------
EasyInvest(Service Mark)
(Automatically from your
checking or savings account
or Money Market Fund) $ 100* $ 100*
- -------------------------------------------------------------------------------
* Provided your schedule of investments totals $1,000 in twelve months.
There is no minimum investment amount if you purchase Fund shares through: (1)
the Investment Manager's mutual fund asset allocation plan, (2) a program,
approved by the Fund's distributor, in which you pay an asset-based fee for
advisory, administrative and/or brokerage services, (3) the following programs
approved by the Fund's distributor: (i) qualified state tuition plans described
in Section 529 of the Internal Revenue Code and (ii) certain other investment
programs that do not charge an asset-based fee, or (4) employer-sponsored
employee benefit plan accounts.
Subsequent Investments Sent Directly to the Fund. In addition to buying
additional Fund shares for an existing account by contacting your Morgan
Stanley Financial Advisor, you may send a check directly to the Fund. To buy
additional shares in this manner:
o Write a "letter of instruction" to the Fund specifying the name(s) on the
account, the account number, the social security or tax identification
number, and the investment amount. The letter must be signed by the account
owner(s).
o Make out a check for the total amount payable to: Morgan Stanley North
American Government Income Trust.
o Mail the letter and check to Morgan Stanley Trust at P.O. Box 1040, Jersey
City, NJ 07303.
PLAN OF DISTRIBUTION (RULE 12b-1 FEES) The Fund has adopted a Plan of
Distribution in accordance with Rule 12b-1 under the Investment Company Act of
1940. The Plan allows the Fund to pay distribution fees of up to 0.75% for the
sale and distribution of these shares. It also allows the Fund to pay for
services to shareholders. Because these fees are paid out of the Fund's assets
on an ongoing basis, over time these fees will increase the cost of your
investment and may cost you more than paying other types of sales charges.
11
[GRAPHIC OMITTED]
HOW TO EXCHANGE SHARES
- --------------------------------
Permissible Fund Exchanges. You may only exchange shares of the Fund for
shares of other continuously offered Morgan Stanley Funds if the Fund shares
were acquired in an exchange of shares initially purchased in a Multi-Class
Fund or an FSC Fund (subject to a front-end sales charge). In that case, the
shares may be subsequently re-exchanged for shares of the same Class of any
Multi-Class Fund or FSC Fund or for shares of a No-Load Fund, a Money Market
Fund or Short-Term U.S. Treasury Trust. Of course, if an exchange is not
permitted, you may sell shares of the Fund and buy another Fund's shares with
the proceeds.
See the inside back cover of this Prospectus for each Morgan Stanley Fund's
designation as a Multi-Class Fund, No-Load Fund, Money Market Fund or FSC Fund.
If a Morgan Stanley Fund is not listed, consult the inside back cover of that
fund's current prospectus for its designation.
The current prospectus for each fund describes its investment objective(s),
policies and investment minimums, and should be read before investment. Since
exchanges are available only into continuously offered Morgan Stanley Funds,
exchanges are not available into any new Morgan Stanley Fund during its initial
offering period, or when shares of a particular Morgan Stanley Fund are not
being offered for purchase.
Exchange Procedures. You can process an exchange by contacting your Morgan
Stanley Financial Advisor or other authorized financial representative.
Otherwise, you must forward an exchange privilege authorization form to the
Fund's transfer agent -- Morgan Stanley Trust -- and then write the transfer
agent or call (800) 869-NEWS to place an exchange order. You can obtain an
exchange privilege authorization form by contacting your Financial Advisor or
other authorized financial representative, or by calling (800) 869-NEWS. If you
hold share certificates, no exchanges may be processed until we have received
all applicable share certificates.
An exchange to any Morgan Stanley Fund (except a Money Market Fund) is made on
the basis of the next calculated net asset values of the funds involved after
the exchange instructions are accepted. When exchanging into a Money Market
Fund, the Fund's shares are sold at their next calculated net asset value and
the Money Market Fund's shares are purchased at their net asset value on the
following business day.
The Fund may terminate or revise the exchange privilege upon required notice.
The check writing privilege is not available for Money Market Fund shares you
acquire in an exchange.
Telephone Exchanges. For your protection when calling Morgan Stanley Trust, we
will employ reasonable procedures to confirm that exchange instructions
communicated over the telephone are genuine. These procedures may include
requiring various forms of personal identification such as name, mailing
address, social security or other tax identification number. Telephone
instructions also may be recorded.
Telephone instructions will be accepted if received by the Fund's transfer
agent between 9:00 a.m. and 4:00 p.m. Eastern time on any day the New York
Stock Exchange is open for business. During periods
12
of drastic economic or market changes, it is possible that the telephone
exchange procedures may be difficult to implement, although this has not been
the case with the Fund in the past.
Exchanging Shares of Another Fund Subject to a Contingent Deferred Sales Charge
("CDSC"). There are special considerations when you exchange shares subject to a
CDSC of another Morgan Stanley Fund for shares of the Fund. When determining the
length of time you held the shares and the corresponding CDSC rate, any period
(starting at the end of the month) during which you held shares of the Fund will
not be counted. Thus, in effect the "holding period" for purposes of calculating
the CDSC is frozen upon exchanging into the Fund. Nevertheless, if shares
subject to a CDSC are exchanged for shares of the Fund, you will receive a
credit when you sell the shares equal to the distribution (12b-1) fees, if any,
you paid on those shares while in the Fund up to the amount of any applicable
CDSC. See the prospectus of the fund that charges the CDSC for more details.
Margin Accounts. If you have pledged your Fund shares in a margin account,
contact your Morgan Stanley Financial Advisor or other authorized financial
representative regarding restrictions on the exchange of such shares.
Tax Considerations of Exchanges. If you exchange shares of the Fund for shares
of another Morgan Stanley Fund there are important tax considerations. For tax
purposes, the exchange out of the Fund is considered a sale of Fund shares --
and the exchange into the other fund is considered a purchase. As a result, you
may realize a capital gain or loss.
You should review the "Tax Consequences" section and consult your own tax
professional about the tax consequences of an exchange.
Limitations on Exchanges. Certain patterns of past exchanges and/or purchase or
sale transactions involving the Fund or other Morgan Stanley Funds may result
in the Fund limiting or prohibiting, at its discretion, additional purchases
and/or exchanges. Determinations in this regard may be made based on the
frequency or dollar amount of the previous exchanges or purchase or sale
transactions. You will be notified in advance of limitations on your exchange
privileges.
For further information regarding exchange privileges, you should contact your
Morgan Stanley Financial Advisor or call (800) 869-NEWS.
13
[GRAPHIC OMITTED]
HOW TO SELL SHARES
- ---------------------------
You can sell some or all of your Fund shares at any time. Your shares will be
sold at the next price calculated after we receive your order to sell as
described below.
OPTIONS PROCEDURES
- ------------------ ---------------------------------------------------------------------------------------------------
Contact Your To sell your shares, simply call your Morgan Stanley Financial Advisor or other authorized
Financial Advisor financial representative.
---------------------------------------------------------------------------------------------------
[GRAPHIC OMITTED] Payment will be sent to the address to which the account is registered, or deposited in your
brokerage account.
---------------------------------------------------------------------------------------------------
By Letter You can also sell your shares by writing a "letter of instruction" that includes:
[GRAPHIC OMITTED] o your account number;
o the name of the Fund;
o the dollar amount or the number of shares you wish to sell; and
o the signature of each owner as it appears on the account.
---------------------------------------------------------------------------------------------------
If you are requesting payment to anyone other than the registered owner(s) or that payment be
sent to any address other than the address of the registered owner(s) or pre-designated bank
account, you will need a signature guarantee. You can generally obtain a signature guarantee
from an eligible guarantor acceptable to Morgan Stanley Trust. (You should contact Morgan
Stanley Trust at (800) 869-NEWS for determination as to whether a particular institution is an
eligible guarantor.) A notary public cannot provide a signature guarantee. Additional
documentation may be required for shares held by a corporation, partnership, trustee or
executor.
---------------------------------------------------------------------------------------------------
Mail the letter to Morgan Stanley Trust at P.O. Box 983, Jersey City, NJ 07303. If you hold share
certificates, you must return the certificates, along with the letter and any required additional
documentation.
---------------------------------------------------------------------------------------------------
A check will be mailed to the name(s) and address in which the account is registered, or
otherwise according to your instructions.
---------------------------------------------------------------------------------------------------
Systematic If your investment in all of the Morgan Stanley Family of Funds has a total market value of at
Withdrawal Plan least $10,000, you may elect to withdraw amounts of $25 or more, or in any whole percentage
[GRAPHIC OMITTED] of a fund's balance (provided the amount is at least $25), on a monthly, quarterly, semi-annual or
annual basis, from any fund with a balance of at least $1,000. Each time you add a fund to the
plan, you must meet the plan requirements.
---------------------------------------------------------------------------------------------------
To sign up for the Systematic Withdrawal Plan, contact your Morgan Stanley Financial Advisor or
call (800) 869-NEWS. You may terminate or suspend your plan at any time. Please remember
that withdrawals from the plan are sales of shares, not Fund "distributions," and ultimately may
exhaust your account balance. The Fund may terminate or revise the plan at any time.
---------------------------------------------------------------------------------------------------
Payment for Sold Shares. After we receive your complete instructions to sell as
described above, a check will be mailed to you within seven days, although we
will attempt to make payment within one business day. Payment may also be sent
to your brokerage account.
14
Payment may be postponed or the right to sell your shares suspended under
unusual circumstances. If you request to sell shares that were recently
purchased by check, your sale will not be effected until it has been verified
that the check has been honored.
Tax Considerations. Normally, your sale of Fund shares is subject to federal
and state income tax. You should review the "Tax Consequences" section of this
Prospectus and consult your own tax professional about the tax consequences of
a sale.
Involuntary Sales. The Fund reserves the right, on sixty days' notice, to sell
the shares of any shareholder (other than shares held in an IRA or 403(b)
Custodial Account) whose shares, due to sales by the shareholder, have a value
below $100, or in the case of an account opened through EasyInvest(SM), if after
12 months the shareholder has invested less than $1,000 in the account.
However, before the Fund sells your shares in this manner, we will notify you
and allow you sixty days to make an additional investment in an amount that
will increase the value of your account to at least the required amount before
the sale is processed.
Margin Accounts. If you have pledged your Fund shares in a margin account,
contact your Morgan Stanley Financial Advisor or other authorized financial
representative regarding restrictions on the sale of such shares.
[GRAPHIC OMITTED]
DISTRIBUTIONS
- --------------------
The Fund passes substantially all of its earnings from
income and capital gains along to its investors as
"distributions." The Fund earns interest from
fixed-income investments. These amounts are passed
along to Fund shareholders as "income dividend
distributions." The Fund realizes capital gains
whenever it sells securities for a higher price than it
paid for them. These amounts may be passed along as
"capital gain distributions."
[sidebar]
TARGETED DIVIDENDS(Service Mark)
You may select to have your Fund distributions automatically invested in
another Morgan Stanley Fund that you own. Contact your Morgan Stanley Financial
Advisor for further information about this service.
[end sidebar]
Normally, income dividends are distributed to
shareholders monthly. Capital gains, if any, are
usually distributed in December. The Fund, however,
may retain and reinvest any long-term capital gains.
The Fund may at times make payments from sources other
than income or capital gains that represent a return of a portion of your
investment.
Distributions are reinvested automatically in additional shares of the Fund and
automatically credited to your account, unless you request in writing that all
distributions be paid in cash. If you elect the cash option, the Fund will mail
a check to you no later than seven business days after the distribution is
declared. However, if you purchase Fund shares through a Financial Advisor
within three business days prior to the record date for the distribution, the
distribution will automatically be paid to you in cash, even if you did not
request to receive all distributions in cash. No interest will accrue on
uncashed
15
checks. If you wish to change how your distributions are paid, your request
should be received by the Fund's transfer agent, Morgan Stanley Trust, at least
five business days prior to the record date of the distributions.
[GRAPHIC OMITTED]
TAX CONSEQUENCES
- -------------------------
As with any investment, you should consider how your Fund investment will be
taxed. The tax information in this Prospectus is provided as general
information. You should consult your own tax professional about the tax
consequences of an investment in the Fund.
Unless your investment in the Fund is through a tax-deferred retirement
account, such as a 401(k) plan or IRA, you need to be aware of the possible tax
consequences when:
o The Fund makes distributions; and
o You sell Fund shares, including an exchange to another Morgan Stanley
Fund.
Taxes on Distributions. Your distributions are normally subject to federal and
state income tax when they are paid, whether you take them in cash or reinvest
them in Fund shares. A distribution also may be subject to local income tax.
Any income dividend distributions and any short-term capital gain distributions
are taxable to you as ordinary income. Any long-term capital gain distributions
are taxable as long-term capital gains, no matter how long you have owned
shares in the Fund.
Every January, you will be sent a statement (IRS Form 1099-DIV) showing the
taxable distributions paid to you in the previous year. The statement provides
information on your dividends and capital gains for tax purposes.
Taxes on Sales. Your sale of Fund shares normally is subject to federal and
state income tax and may result in a taxable gain or loss to you. A sale also
may be subject to local income tax. Your exchange of Fund shares for shares of
another Morgan Stanley Fund is treated for tax purposes like a sale of your
original shares and a purchase of your new shares. Thus, the exchange may, like
a sale, result in a taxable gain or loss to you and will give you a new tax
basis for your new shares.
When you open your Fund account, you should provide your social security or tax
identification number on your investment application. By providing this
information, you will avoid being subject to a federal backup withholding tax
(approximately 30% currently) on taxable distributions and redemption proceeds.
Any withheld amount would be sent to the IRS as an advance tax payment.
16
Financial Highlights
The financial highlights table is intended to help you understand the Fund's
financial performance for the periods indicated. Certain information reflects
financial results for a single Fund share throughout each period. The total
returns in the table represent the rate an investor would have earned or lost
on an investment in the Fund (assuming reinvestment of all dividends and
distributions).
This information has been audited by Deloitte & Touche LLP, independent
auditors, whose report, along with the Fund's financial statements, is included
in the annual report, which is available upon request.
FOR THE YEAR ENDED OCTOBER 31,
- ----------------------------------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
SELECTED PER SHARE DATA:
Net asset value, beginning of period $8.60 $8.50 $8.60 $8.59 $8.39
- -------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM INVESTMENT OPERATIONS:
Net investment income 0.40 0.40 0.44 0.49 0.44
Net realized and unrealized gain (loss) 0.22 0.06 (0.09) (0.05) 0.19
Total income from investment operations 0.62 0.46 0.35 0.44 0.63
- -------------------------------------------------------------------------------------------------------------------------
LESS DIVIDENDS AND DISTRIBUTIONS FROM:
Net investment income (0.40) (0.36) (0.38) (0.43) (0.43)
Paid-in-capital -- -- (0.07) -- --
Total dividends and distributions (0.40) (0.36) (0.45) (0.43) (0.43)
- --------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $8.82 $8.60 $8.50 $8.60 $8.59
- --------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN+ 7.43% 5.55% 4.30% 5.13% 7.80%
- --------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses (before expense offset) 1.80%(1) 1.76%(1) 1.81%(1) 1.69%(1) 1.65%
Net investment income 4.51% 4.58% 5.11% 5.52% 5.18%
- --------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period, in thousands $90,611 $ 91,695 $120,303 $150,441 $212,040
Portfolio turnover rate 19% -- 43% 8% --
- --------------------------------------------------------------------------------------------------------------------------
+ Calculated based on the net asset value as of the last business day of
the period.
(1) Does not reflect the effect of expense offset of 0.01%.
17
Notes
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18
Notes
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19
Notes
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20
Morgan Stanley Funds
- --------------------------------------------------------------------------------
O GLOBAL/INTERNATIONAL FUNDS
Competitive Edge Fund - "Best Ideas" Portfolio
European Growth Fund
Fund of Funds - International Portfolio
Global Dividend Growth Securities
Global Utilities Fund
International Fund
International SmallCap Fund
International Value Equity Fund
Japan Fund
Latin American Growth Fund
Pacific Growth Fund
O GROWTH FUNDS
21st Century Trend Fund
Aggressive Equity Fund
All Star Growth Fund
American Opportunities Fund
Capital Growth Securities
Developing Growth Securities Trust
Financial Services Trust
Growth Fund
Health Sciences Trust
Information Fund
KLD Social Index Fund
Market Leader Trust
Mid-Cap Equity Trust
Mid-Cap Value Fund
Nasdaq-100 Index Fund
Natural Resource Development
Securities
New Discoveries Fund
Next Generation Trust
Small Cap Growth Fund
Special Value Fund
Tax-Managed Growth Fund
Technology Fund
O GROWTH + INCOME FUNDS
Balanced Growth Fund
Balanced Income Fund
Convertible Securities Trust
Dividend Growth Securities
Equity Fund
Fund of Funds - Domestic Portfolio
Income Builder Fund
Real Estate Fund
S&P 500 Index Fund
S&P 500 Select Fund
Strategist Fund
Total Market Index Fund
Total Return Trust
Utilities Fund
Value Fund
Value-Added Market Series/
Equity Portfolio
O INCOME FUNDS
Diversified Income Trust
Federal Securities Trust
High Yield Securities
Intermediate Income Securities
Limited Duration Fund(NL)
Liquid Asset Fund(MM)
North American Government
Income Trust
Short-Term U.S. Treasury Trust
U.S. Government Money Market Trust(MM)
U.S. Government Securities Trust
O TAX-FREE INCOME FUNDS
California Tax-Free Daily Income Trust(MM)
California Tax-Free Income Fund
Hawaii Municipal Trust(FSC)
Limited Term Municipal Trust(NL)
Multi-State Municipal Series Trust(FSC)
New York Municipal Money Market Trust(MM)
New York Tax-Free Income Fund
Tax-Exempt Securities Trust
Tax-Free Daily Income Trust(MM)
- --------------------------------------------------------------------------------
There may be funds created after this Prospectus was published. Please
consult the inside back cover of a new fund's prospectus for its
designations, e.g., Multi-Class Fund or Money Market Fund.
Unless otherwise noted, each listed Morgan Stanley Fund, except for North
American Government Income Trust and Short-Term U.S. Treasury Trust, is a
Multi-Class Fund. A Multi-Class Fund is a mutual fund offering multiple
Classes of shares. The other types of funds are: NL -- No-Load (Mutual)
Fund; MM -- Money Market Fund; FSC -- A mutual fund sold with a front-end
sales charge and a distribution (12b-1) fee.
[GRAPHIC OMITTED]
Additional information about the Fund's investments is available in the Fund's
Annual and Semi-Annual Reports to Shareholders. In the Fund's Annual Report, you
will find a discussion of the market conditions and investment strategies that
significantly affected the Fund's performance during its last fiscal year. The
Fund's Statement of Additional Information also provides additional information
about the Fund. The Statement of Additional Information is incorporated herein
by reference (legally is part of this Prospectus). For a free copy of any of
these documents to request other information about the Fund, or to make
shareholder inquiries, please call:
(800) 869-NEWS
You also may obtain information about the Fund by calling your Morgan Stanley
Financial Advisor or by visiting our Internet site at:
www.morganstanley.com/funds
Information about the Fund (including the Statement of Additional Information)
can be viewed and copied at the Securities and Exchange Commission's Public
Reference Room in Washington, DC. Information about the Reference Room's
operations may be obtained by calling the SEC at (202)942-8090. Reports and
other information about the Fund are available on the EDGAR Database on the
SEC's Internet site (www.sec.gov) and copies of this information may be
obtained, after paying a duplicating fee, by electronic request at the
following E-mail address: publicinfo@sec.gov, or by writing the Public
Reference Section of the SEC, Washington, DC 20549-0102.
TICKER SYMBOL:
NGTVX
(THE FUND'S INVESTMENT COMPANY ACT FILE NO. IS 811-6572)
[GRAPHIC OMITTED]
MorganStanley
Morgan Stanley North American
Government Income Trust
A mutual fund that seeks to earn a high level of current income
while maintaining relatively low volatility of principal
Prospectus December 31, 2001
Morgan Stanley Limited Duration Fund
LETTER TO THE SHAREHOLDERS / / APRIL 30, 2002
Dear Shareholder:
This annual report to shareholders of Morgan Stanley Limited Duration Fund
covers the 12-month period ended April 30, 2002. After continued economic
slowing for the first half of the period, pessimism about the economy deepened
in the wake of the September 11 attacks, accompanied by falling U.S. Treasury
yields.
In retrospect, the extent of the decline in yields was not warranted. Prior to
September 11, U.S. monetary and fiscal policy had been focused on stimulating
economic growth, a focus that intensified after the attacks. The Federal Reserve
Board cut the benchmark federal funds rate by a total of 475 basis points
(4.75 percent) in 2001, its most aggressive monetary-policy adjustment since
1984. As for fiscal policy, Congress passed reductions in personal tax rates as
well as a number of economically stimulative spending initiatives shortly after
the September attacks.
It is therefore not overly surprising that yields began to rise in early
November and that the economy began to show signs of recovery shortly
thereafter. Although yields generally rose through the last five months of the
review period, the pace of the rise was erratic, because the market repeatedly
second guessed both the strength of the economic recovery and the potential for
disruptive consequences from accounting scandals and escalating violence in the
Middle East. On balance, two-year Treasury yields fell by 186 basis points, from
4.28 percent during the first six months of the period, and then rose by about
80 basis points, from 2.42 percent to 3.22 percent, as the economy began to
recover. Similarly, five-year note yields fell by 141 basis points, from
4.89 percent during the first half of the period, and then rose by 93 basis
points, from 3.48 percent to 4.41 percent, during the second half.
At the beginning of the period, yields on corporate securities and
mortgage-backed securities remained high relative to Treasury yields. As the
period progressed and prepayment risk subsided, mortgage-backed securities fared
relatively well. The performance for corporate securities was less uniform.
Securities issued by firms perceived to have engaged in aggressive accounting
practices performed poorly, while those issued by firms not tainted by
accounting questions performed relatively well.
Performance and Portfolio Strategy
In December 2001, the name of the Fund changed from Morgan Stanley Short-Term
Bond Fund to Morgan Stanley Limited Duration Fund. The change enabled the Fund
to switch from a strategy based on average maturity to one based on average
duration. The change permits the Fund to invest relatively more in securities
that may have longer maturities but that, in our opinion, have shorter durations
and less interest-rate sensitivity. The change should allow us to broaden and
diversify the investment risks associated with the Fund and to invest a greater
portion of the Fund in investment-grade securities that have relatively generous
yields to maturity.
For the 12-month period ended April 30, 2002, the Fund returned 6.50 percent
versus 6.99 percent for the Lehman Brothers U.S. Credit Index (1-5 Year). During
the first half of the period, the Fund's performance relative to its benchmark
was hampered by its relatively shorter duration, because the Fund's three-year-
Morgan Stanley Limited Duration Fund
LETTER TO THE SHAREHOLDERS / / APRIL 30, 2002 CONTINUED
average-maturity limit made it impractical to maintain a duration as long as the
benchmark's 2.81 years. During the second half of the period the Fund moved to a
shorter duration, which insulated it partially from the effects of rising
interest rates.
Throughout the period, we maintained significant allocations to corporate and
mortgage-backed securities, which generally benefited from solid performance
relative to Treasury securities. With the change in the Fund's investment
parameters we were able to increase the allocation to short-duration mortgage
securities, which generally have relatively generous yields versus other
AAA-rated securities.
Looking Ahead
We believe that the United States is in a period of moderate economic growth
with inflation remaining at acceptable levels. Such a scenario would be
consistent with our view that Treasury yields are near levels consistent with
normal economic growth. It could, however, be relatively advantageous for
corporate and mortgage-backed securities, which constitute a significant portion
of the Fund. Adjustments to the Fund's maturity and portfolio composition will
be made as conditions warrant and opportunities become available.
We appreciate your ongoing support of Morgan Stanley Limited Duration Fund and
look forward to continuing to serve your investment needs.
Very truly yours,
[/S/ CHARLES A. FIUMEFREDDO] [/S/ MITCHELL M. MERIN]
Charles A. Fiumefreddo Mitchell M. Merin
CHAIRMAN OF THE BOARD PRESIDENT
Annual 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 and 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 am to 8:00 pm, ET.
Once our Customer Service Center has received your instructions, we will begin
sending individual copies for each account within 30 days.
2
Morgan Stanley Limited Duration Fund
FUND PERFORMANCE / / APRIL 30, 2002
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
GROWTH OF $10,000
($ in Thousands)
FUND LEHMAN(3)
January 1994 $10,000 $10,000
January 1994 $10,034 $10,000
April 1994 $9,799 $9,727
July 1994 $9,913 $9,898
October 1994 $9,977 $9,899
January 1995 $9,947 $10,027
April 1995 $10,265 $10,413
July 1995 $10,571 $10,779
October 1995 $10,805 $11,050
January 1996 $11,081 $11,406
April 1996 $11,018 $11,269
July 1996 $11,151 $11,428
October 1996 $11,400 $11,776
January 1997 $11,553 $11,926
April 1997 $11,666 $12,027
July 1997 $11,959 $12,442
October 1997 $12,140 $12,622
January 1998 $12,337 $12,881
April 1998 $12,484 $13,010
July 1998 $12,696 $13,219
October 1998 $12,998 $13,581
January 1999 $13,128 $13,791
April 1999 $13,234 $13,864
July 1999 $13,254 $13,797
October 1999 $13,349 $13,999
January 2000 $13,431 $14,000
April 2000 $13,546 $14,155
July 2000 $13,899 $14,529
October 2000 $14,138 $14,851
January 2001 $14,604 $15,495
April 2001 $14,740 $15,808
July 2001 $15,080 $16,294
October 2001 $15,565 $16,841
January 2002 $15,583 $16,775
April 2002 $15,698(2) $16,913
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE RETURNS. INVESTMENT RETURN AND
PRINCIPAL VALUE WILL FLUCTUATE. WHEN YOU SELL FUND SHARES, THEY MAY BE WORTH
LESS THAN THEIR ORIGINAL COST. THE GRAPH AND TABLE DO NOT REFLECT THE DEDUCTION
OF TAXES THAT A SHAREHOLDER WOULD PAY ON FUND DISTRIBUTIONS OR THE REDEMPTION OF
FUND SHARES.
AVERAGE ANNUAL TOTAL RETURNS
----------------------------------------------------------------------------------------------
PERIOD ENDED 4/30/2002
-------------------------
1 Year 6.50%(1)
5 Years 6.12%(1)
From Inception (1/10/94) 5.58%(1)
- - ---------------------
(1) FIGURE SHOWN ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS. THERE IS NO SALES
CHARGE.
(2) CLOSING VALUE ASSUMING A COMPLETE REDEMPTION ON APRIL 30, 2002.
(3) THE LEHMAN BROTHERS U.S. CREDIT INDEX (1-5 YEAR) (FORMERLY LEHMAN BROTHER
MUTUAL FUND SHORT (1-5) INVESTMENT GRADE DEBT INDEX) INCLUDES U.S.
CORPORATE AND SPECIFIED FOREIGN DEBENTURES AND SECURED NOTES WITH
MATURITIES OF ONE TO FIVE YEARS. THE INDEX DOES NOT INCLUDE ANY EXPENSES,
FEES OR CHARGES. THE INDEX IS UNMANAGED AND SHOULD NOT BE CONSIDERED AN
INVESTMENT.
3
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS / / APRIL 30, 2002
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- - -------------------------------------------------------------------------------------------------------------------
Corporate Bonds (26.9%)
AEROSPACE & DEFENSE (0.6%)
$ 475 Lockheed Martin Corp.............................. 7.25% 05/15/06 $ 505,789
390 Raytheon Co....................................... 8.20 03/01/06 424,271
55 Raytheon Co....................................... 6.75 08/15/07 57,024
------------
987,084
------------
AIRLINES (0.1%)
130 Southwest Airlines Co............................. 5.496 11/01/06 129,894
------------
AUTO PARTS: O.E.M. (0.5%)
405 Delphi Automotive Systems Corp.................... 6.125 05/01/04 414,539
385 Johnson Controls, Inc............................. 5.00 11/15/06 377,791
------------
792,330
------------
BROADCASTING (1.2%)
2,000 Clear Channel Communications Corp.**.............. 7.25 09/15/03 2,050,068
------------
CABLE/SATELLITE TV (1.5%)
530 Comcast Cable..................................... 6.375 01/30/06 531,759
1,000 Cox Enterprises Inc. - 144A* **................... 6.625 06/14/02 1,002,798
800 Rogers Cablesystems, Ltd.......................... 9.625 08/01/02 802,000
215 TCI Communications, Inc........................... 8.00 08/01/05 226,678
------------
2,563,235
------------
DEPARTMENT STORES (0.4%)
495 Federated Dept Stores............................. 8.50 06/15/03 519,221
130 May Dept Stores Co................................ 6.875 11/01/05 137,974
------------
657,195
------------
DISCOUNT STORES (0.2%)
310 Target Corp....................................... 7.50 02/15/05 334,166
------------
DRUGSTORE CHAINS (0.3%)
455 CVS Corp.......................................... 5.625 03/15/06 456,574
------------
ELECTRIC UTILITIES (0.3%)
525 Progress Energy Inc............................... 6.75 03/01/06 544,046
------------
ENVIRONMENTAL SERVICES (0.4%)
660 WMX Technologies Inc.............................. 7.00 10/15/06 676,641
------------
SEE NOTES TO FINANCIAL STATEMENTS
4
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS / / APRIL 30, 2002 CONTINUED
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- - -------------------------------------------------------------------------------------------------------------------
FINANCE/RENTAL/LEASING (2.5%)
$ 740 American General Finance Corp..................... 5.875% 07/14/06 $ 751,335
1,090 Ford Motor Credit Co.............................. 6.875 02/01/06 1,104,187
200 Ford Motor Credit Co.............................. 6.50 01/25/07 198,701
875 Household Finance Corp............................ 6.50 01/24/06 897,343
290 Household Finance Corp............................ 5.75 01/30/07 285,856
75 MBNA America Bank N.A............................. 7.75 09/15/05 80,491
445 MBNA America Bank N.A............................. 6.50 06/20/06 453,776
145 Prime Property Funding II - 144A*................. 6.80 08/15/02 146,420
220 Prime Property Funding II - 144A*................. 7.00 08/15/04 227,604
------------
4,145,713
------------
FINANCIAL CONGLOMERATES (1.6%)
1,305 General Electric Capital Corp.**.................. 5.375 03/15/07 1,314,725
395 General Motors Acceptance Corp.................... 7.50 07/15/05 419,642
765 J.P. Morgan Chase & Co............................ 5.35 03/01/07 759,505
160 Tyco Capital Corp................................. 5.625 05/17/04 154,383
85 Tyco Capital Corp................................. 6.50 02/07/06 80,547
------------
2,728,802
------------
FINANCIAL PUBLISHING/SERVICES (0.1%)
200 Reed Elsevier Capital............................. 6.125 08/01/06 205,400
------------
FOOD RETAIL (0.7%)
735 Kroger Co......................................... 7.375 03/01/05 781,967
350 Safeway Inc....................................... 6.15 03/01/06 359,729
------------
1,141,696
------------
FOOD: MEAT/FISH/DAIRY (0.2%)
270 ConAgra Foods, Inc................................ 6.00 09/15/06 275,235
------------
FOREIGN GOVERNMENT OBLIGATIONS (0.8%)
1,025 Quebec Province (Canada)**........................ 5.50 04/11/06 1,047,893
290 United Mexican States (Mexico).................... 8.625 03/12/08 316,825
------------
1,364,718
------------
FOREST PRODUCTS (0.5%)
815 Weyerhauser Company - 144A*....................... 5.50 03/15/05 824,839
------------
GAS DISTRIBUTORS (1.1%)
530 CMS Panhandle Holding Co.......................... 6.125 03/15/04 541,469
520 Consolidated Natural Gas Co....................... 5.375 11/01/06 512,063
SEE NOTES TO FINANCIAL STATEMENTS
5
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS / / APRIL 30, 2002 CONTINUED
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- - -------------------------------------------------------------------------------------------------------------------
$ 375 Nisource Finance Corp............................. 7.625% 11/15/05 $ 376,635
397 Ras Laffan Liquefied Natural Gas Co. Ltd. - 144A*
(Qatar).......................................... 7.628 09/15/06 415,914
------------
1,846,081
------------
HOME BUILDING (0.2%)
240 Centex Corp....................................... 9.75 06/15/05 268,545
------------
HOME FURNISHINGS (0.1%)
195 Mohawk Industries, Inc............................ 6.50 04/15/07 198,914
------------
HOME IMPROVEMENT CHAINS (0.4%)
565 Lowe's Co., Inc................................... 7.50 12/15/05 614,067
------------
HOSPITAL/NURSING MANAGEMENT (0.3%)
525 Tenet Healthcare Corp............................. 5.375 11/15/06 517,200
------------
HOTELS/RESORTS/CRUISELINES (0.6%)
280 Hyatt Equities LLC - 144A*........................ 9.25 05/15/05 294,991
435 Marriott International Inc. (Ser D)............... 8.125 04/01/05 467,388
295 Starwood Hotels Resorts........................... 7.375 05/01/07 296,844
------------
1,059,223
------------
INDUSTRIAL CONGLOMERATES (0.7%)
600 Honeywell International, Inc...................... 5.125 11/01/06 592,918
565 Tyco International Group S.A. (Luxembourg)........ 6.375 02/15/06 476,052
------------
1,068,970
------------
INSURANCE BROKERS (0.4%)
600 Marsh & McLennan Companies, Inc................... 5.375 03/15/07 604,051
------------
INTEGRATED OIL (0.4%)
585 Conoco Inc........................................ 5.90 04/15/04 604,940
------------
INVESTMENT BANKS/BROKERS (1.3%)
805 Credit Suisse F/B USA, Inc.**..................... 5.75 04/15/07 808,501
595 Goldman Sachs Group, Inc.......................... 7.625 08/17/05 643,678
730 Lehman Brothers Holdings, Inc.**.................. 6.25 05/15/06 752,114
------------
2,204,293
------------
SEE NOTES TO FINANCIAL STATEMENTS
6
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS / / APRIL 30, 2002 CONTINUED
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- - -------------------------------------------------------------------------------------------------------------------
INVESTMENT MANAGERS (0.6%)
$ 1,045 TIAA Global Markets - 144A*....................... 5.00% 03/01/07 $ 1,035,635
------------
LIFE/HEALTH INSURANCE (1.8%)
250 Equitable Life Assurance Corp. - 144A*............ 6.95 12/01/05 264,763
585 John Hancock Global Fund - 144A*.................. 5.625 06/27/06 588,892
625 Metropolitan Life Insurance Co. - 144A*........... 6.30 11/01/03 645,853
330 Monumental Global Funding II - 144A*.............. 6.05 01/19/06 340,970
650 Nationwide Mutual Insurance - 144A*............... 6.50 02/15/04 673,085
495 Prudential Insurance Co. - 144A*.................. 6.375 07/23/06 510,021
------------
3,023,584
------------
MAJOR BANKS (1.2%)
2,000 First Union Corp.**............................... 8.00 11/15/02 2,057,384
------------
MAJOR TELECOMMUNICATIONS (1.4%)
615 AT&T Corp. - 144A*................................ 6.50 11/15/06 589,232
455 Sprint Capital Corp............................... 6.00 01/15/07 416,210
595 Telus Corp. (Canada).............................. 7.50 06/01/07 605,226
675 WorldCom, Inc..................................... 7.875 05/15/03 506,250
340 WorldCom, Inc..................................... 6.50 05/15/04 200,600
------------
2,317,518
------------
MANAGED HEALTH CARE (0.7%)
475 Aetna, Inc........................................ 7.375 03/01/06 482,786
275 UnitedHealth Group Inc............................ 7.50 11/15/05 298,786
410 Wellpoint Health Network Inc...................... 6.375 06/15/06 423,100
------------
1,204,672
------------
MEDIA CONGLOMERATES (0.4%)
635 AOL Time Warner, Inc.............................. 6.125 04/15/06 621,658
------------
MOTOR VEHICLES (0.3%)
470 DaimierChrysler NA Holding........................ 6.40 05/15/06 480,105
------------
MULTI-LINE INSURANCE (1.0%)
465 AIG SunAmerica Global Finance VI - 144A*.......... 5.20 05/10/04 476,787
500 Farmers Insurance Exchange - 144A*................ 8.50 08/01/04 524,110
600 Hartford Financial Services Group, Inc.**......... 7.75 06/15/05 651,928
------------
1,652,825
------------
SEE NOTES TO FINANCIAL STATEMENTS
7
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS / / APRIL 30, 2002 CONTINUED
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- - -------------------------------------------------------------------------------------------------------------------
OIL & GAS PIPELINES (0.2%)
$ 415 Williams Companies, Inc........................... 6.50% 08/01/06 $ 402,776
------------
OIL & GAS PRODUCTION (0.2%)
300 Pemex Master Trust - 144A*........................ 7.875 02/01/09 308,625
------------
RAILROADS (0.5%)
300 Norfolk Southern Corp.**.......................... 7.875 02/15/04 318,613
470 Union Pacific Corp................................ 5.84 05/25/04 483,400
------------
802,013
------------
REAL ESTATE INVESTMENT TRUSTS (0.6%)
415 EOP Operating LP.................................. 8.375 03/15/06 450,866
555 Simon Property Group LP........................... 6.375 11/15/07 555,862
------------
1,006,728
------------
SPECIALTY TELECOMMUNICATIONS (0.2%)
490 Qwest Capital Funding Inc......................... 7.75 08/15/06 379,792
------------
WIRELESS TELECOMMUNICATIONS (0.4%)
595 AT&T Wireless Services, Inc....................... 7.35 03/01/06 594,735
------------
Total Corporate Bonds
(COST $44,983,467)..................................................................... 44,751,970
------------
U.S. Government & Agency Obligations (53.4%)
Mortgage Pass-Through Securities (29.0%)
2,153 Federal Home Loan Mortgage Corp. PC Gold.......... 6.00 08/01/02-09/01/03 2,196,961
176 Federal Home Loan Mortgage Corp. PC Gold.......... 6.50 07/01/02-09/01/02 179,874
15,050 Federal Home Loan Mortgage Corp. PC Gold.......... 7.50 *** 15,703,734
15,500 Federal Home Loan Mortgage Corp................... 6.00 *** 15,713,125
7,000 Federal Home Loan Mortgage Corp................... 7.00 *** 7,216,563
237 Federal National Mortgage Assoc................... 6.00 08/01/02-12/01/02 240,688
7,000 Federal National Mortgage Assoc................... 6.50 *** 7,052,500
------------
48,303,445
------------
U.S. Government Obligations (24.4%)
37,225 U.S. Treasury Notes**............................. 6.75 - 7.875 11/15/04-05/15/05 40,687,991
------------
Total U.S. Government & Agency Obligations
(COST $88,756,005)..................................................................... 88,991,436
------------
SEE NOTES TO FINANCIAL STATEMENTS
8
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS / / APRIL 30, 2002 CONTINUED
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- - -------------------------------------------------------------------------------------------------------------------
Asset Backed Securities (12.5%)
FINANCE/RENTAL/LEASING
$ 1,000 American Express Credit Account Master Trust
2001-2 A......................................... 6.40% 04/15/05 $ 1,016,085
135 CIT Marine Trust 1999-A AL........................ 5.80 04/15/10 138,555
1,200 Capital Auto Receivables Asset Trust 2002-2A...... 4.50 10/15/07 1,206,000
875 Chase Credit Card Master Trust 2001-4 A........... 5.50 11/17/08 900,117
1,100 Chase Manhattan Auto Owner Trust.................. 4.24 09/15/08 1,093,984
500 Connecticut RRB Special Purpose Trust CL&P-1...... 5.36 03/30/07 516,241
257 Daimler-Benz Vehicle Trust 1998-A A4.............. 5.22 12/22/03 257,394
2,200 Daimler Chrysler Auto Trust 2000-C A3............. 4.49 - 6.82 09/06/04-10/06/08 2,234,616
283 First Security Auto Owner Trust 1999-1 A4......... 5.74 06/15/04 286,192
1,307 Ford Credit Auto Owner Trust 2002-B............... 4.14 - 6.74 06/15/04-12/15/05 1,331,131
1,200 Harley Davidson Motorcycle Trust 2002-1........... 4.50 01/15/10 1,197,671
1,991 Honda Auto Receivables Owner Trust 2001-3 A2...... 2.76 - 6.62 02/18/04-10/17/05 2,005,493
1,325 Household Automotive Trust 2001-3 A3.............. 3.68 04/17/06 1,327,572
1,200 MBNA Master Card Trust 1997-J A................... 1.98 02/15/07 1,202,307
492 MMCA Automobile Trust 2000-1 A3................... 7.00 06/15/04 501,369
1,100 National City Auto Trust 2002-A................... 4.04 07/15/06 1,109,393
2,098 Nissan Auto Receivables Owner Trust 2002-A A3..... 3.58 - 7.01 09/15/03-02/15/07 2,133,228
900 Nissan Auto Receivables Owner Trust 2002 B........ 4.60 09/17/07 909,931
650 Nordstrom Private Label Credit Card Master
Trust - 144A* 2000-C A3.......................... 4.82 04/15/10 645,437
259 Peco Energy Transition Trust 1999-A A2............ 5.63 03/01/05 263,588
391 Premier Auto Trust 1999-2 A4...................... 5.59 02/09/04 396,279
82 Residential Funding Mortgage Securities Trust
2000-HI4 AI2..................................... 7.39 04/25/11 81,860
134 Toyota Auto Receivables Owner Trust 1999-A A3..... 6.15 08/16/04 134,303
------------
Total Asset Backed Securities
(COST $20,834,777)..................................................................... 20,888,746
------------
Collateralized Mortgage Obligations (1.0%)
U.S. Government Agencies
489 Federal Home Loan Mortgage Corp................... 6.50 03/15/29 499,507
1,059 Federal Home Loan Mortgage Corp. CMO 214.......... 6.60 03/15/29 1,089,587
------------
Total Collateralized Mortgage Obligations
(COST $1,587,547)...................................................................... 1,589,094
------------
SEE NOTES TO FINANCIAL STATEMENTS
9
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS / / APRIL 30, 2002 CONTINUED
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- - -------------------------------------------------------------------------------------------------------------------
Short-Term Investments (32.0%)
U.S. Government & Agency Obligations (a) (24.3%)
$15,000 Federal Home Loan Banks........................... 1.73 - 1.86% 05/03/02-06/26/02 $ 14,978,207
20,000 Federal Home Mortgage Corp........................ 1.67 - 3.58 05/31/02-07/03/02 19,949,381
5,000 Federal National Mortgage Assoc................... 1.77 06/05/02 4,991,396
550 U.S. Treasury Bill **............................. 1.88 10/17/02 545,146
------------
Total U.S. Government & Agency Obligations
(COST $40,464,129)..................................................................... 40,464,130
------------
Repurchase Agreement (7.7%)
12,912 Joint repurchase agreement account (dated
04/30/02; proceeds $12,912,683) (b)
(COST $12,912,000)................................ 1.905 05/01/02 12,912,000
------------
Total Short-Term Investments
(COST $53,376,129)..................................................................... 53,376,130
------------
Total Investments
(COST $209,537,925) (c).......................... 125.8% 209,597,376
Liabilities in Excess of Other Assets............. (25.8) (42,966,540)
----- ------------
Net Assets........................................ 100.0% $166,630,836
===== ============
- - ---------------------
* RESALE IS RESTRICTED TO QUALIFIED INSTITUTIONAL INVESTORS.
** SOME OR ALL OF THESE SECURITIES HAVE BEEN SEGREGATED IN CONNECTION WITH
SECURITIES PURCHASED ON A FORWARD COMMITMENT BASIS AND/OR FUTURES
CONTRACTS.
*** SECURITY PURCHASED ON A FORWARD COMMITMENT WITH AN APPROXIMATE PRINCIPAL
AMOUNT AND NO DEFINITE MATURITY DATE; THE ACTUAL PRINCIPAL AMOUNT AND
MATURITY DATE WILL BE DETERMINED UPON SETTLEMENT.
(a) PURCHASED ON A DISCOUNT BASIS. THE INTEREST RATE SHOWN HAS BEEN ADJUSTED
TO REFLECT A MONEY MARKET EQUIVALENT YIELD.
(b) COLLATERALIZED BY FEDERAL AGENCY AND U.S. TREASURY OBLIGATIONS.
(c) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES APPROXIMATES THE
AGGREGATE COST FOR BOOK PURPOSES. THE AGGREGATE GROSS UNREALIZED
APPRECIATION IS $1,038,758 AND THE AGGREGATE GROSS UNREALIZED
DEPRECIATION IS $979,307, RESULTING IN NET UNREALIZED APPRECIATION OF
$59,451.
LONG (SHORT) FUTURES CONTRACTS OPEN AT APRIL 30, 2002:
DESCRIPTION, UNDERLYING UNREALIZED
NUMBER OF DELIVERY MONTH, FACE AMOUNT APPRECIATION/
CONTRACTS LONG/SHORT AND YEAR AT VALUE DEPRECIATION
- - --------------------------------------------------------------------------------------------------
35 Long U.S. Treasury Notes June 2002 $ 3,711,641 $ 2,386
25 Long U.S. Treasury Notes June 2002 5,227,735 9,822
15 Long U.S. Treasury Bonds June 2002 1,534,688 10,253
289 Short U.S. Treasury Notes June 2002 (30,507,563) (87,844)
--------
Net unrealized depreciation................................................. $(65,383)
========
SEE NOTES TO FINANCIAL STATEMENTS
10
Morgan Stanley Limited Duration Fund
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
APRIL 30, 2002
Assets:
Investments in securities, at value (cost
$209,537,925).................................... $ 209,597,376
Receivable for:
Investments sold................................ 7,096,651
Interest........................................ 1,924,399
Shares of beneficial interest sold.............. 1,254,240
Prepaid expenses and other assets................. 49,720
---------------
Total Assets.................................. 219,922,386
---------------
Liabilities:
Payable for:
Investments purchased........................... 52,421,690
Shares of beneficial interest repurchased....... 618,706
Investment management fee....................... 104,081
Dividends to shareholders....................... 72,585
Variation margin................................ 22,858
Accrued expenses and other payables............... 51,630
---------------
Total Liabilities............................. 53,291,550
---------------
Net Assets.................................... $ 166,630,836
===============
Composition of Net Assets:
Paid-in-capital................................... $ 169,378,542
Net unrealized depreciation....................... (5,932)
Dividends in excess of net investment income...... (572,326)
Accumulated net realized loss..................... (2,169,448)
---------------
Net Assets.................................... $ 166,630,836
===============
Net Asset Value Per Share,
17,379,848 shares outstanding (unlimited
shares authorized of $.01 par value)....... $ 9.59
===============
SEE NOTES TO FINANCIAL STATEMENTS
11
Morgan Stanley Limited Duration Fund
FINANCIAL STATEMENTS CONTINUED
Statement of Operations
FOR THE YEAR ENDED APRIL 30, 2002
Net Investment Income:
Interest Income............................................. $6,403,612
---------
Expenses
Investment management fee................................... 945,845
Transfer agent fees and expenses............................ 87,612
Professional fees........................................... 67,821
Registration fees........................................... 60,080
Shareholder reports and notices............................. 52,247
Custodian fees.............................................. 16,560
Trustees' fees and expenses................................. 12,192
Other....................................................... 7,233
---------
Total Expenses.......................................... 1,249,590
Less: amounts waived/reimbursed............................. (168,625)
---------
Net Expenses............................................ 1,080,965
---------
Net Investment Income................................... 5,322,647
---------
Net Realized and Unrealized Gain (Loss):
Net realized gain (loss) on:
Investments............................................... 3,861,264
Futures contracts......................................... (287,415)
---------
Net Gain................................................ 3,573,849
---------
Net change in unrealized appreciation/depreciation on:
Investments............................................... (852,647)
Futures contracts......................................... (65,383)
---------
Net Depreciation........................................ (918,030)
---------
Net Gain................................................ 2,655,819
---------
Net Increase................................................ $7,978,466
=========
SEE NOTES TO FINANCIAL STATEMENTS
12
Morgan Stanley Limited Duration Fund
FINANCIAL STATEMENTS CONTINUED
Statement of Changes in Net Assets
FOR THE YEAR FOR THE YEAR
ENDED ENDED
APRIL 30, 2002 APRIL 30, 2001
-------------- --------------
Increase (Decrease) in Net Assets:
Operations:
Net investment income................... $ 5,322,647 $ 6,460,933
Net realized gain (loss)................ 3,573,849 (1,540,949)
Net change in unrealized
appreciation/depreciation.............. (918,030) 4,375,709
------------ ------------
Net Increase........................ 7,978,466 9,295,693
Dividends to shareholders from net
investment income...................... (6,198,203) (6,469,426)
Net increase (decrease) from
transactions in shares of beneficial
interest............................... 54,933,218 (11,603,065)
------------ ------------
Net Increase (Decrease)............. 56,713,481 (8,776,798)
Net Assets:
Beginning of period..................... 109,917,355 118,694,153
------------ ------------
End of Period
(Including dividends in excess of net
investment income of $572,326 and
$6,408, respectively).................. $166,630,836 $109,917,355
============ ============
SEE NOTES TO FINANCIAL STATEMENTS
13
Morgan Stanley Limited Duration Fund
NOTES TO FINANCIAL STATEMENTS / / APRIL 30, 2002
1. Organization and Accounting Policies
Morgan Stanley Limited Duration Fund (the "Fund"), formerly Morgan Stanley
Short-Term Bond Fund, is registered under the Investment Company Act of 1940, as
amended, as a diversified, open-end management investment company. The Fund's
investment objective is to provide a high level of current income consistent
with the preservation of capital. The Fund seeks to achieve its objective by
investing in a diversified portfolio of short-term fixed income securities. The
Fund was organized as a Massachusetts business trust on October 22, 1993 and
commenced operations on January 10, 1994.
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.
The following is a summary of significant accounting policies:
A. Valuation of Investments -- (1) all portfolio securities for which
over-the-counter market quotations are readily available are valued at the
latest available bid price prior to the time of valuation; (2) futures are
valued at the latest price published by the commodities exchange on which they
trade; (3) when market quotations are not readily available, including
circumstances under which it is determined by Morgan Stanley Investment Advisors
Inc. (the "Investment Manager") that sale and bid prices are not reflective of a
security's market value, portfolio securities are valued at their fair value as
determined in good faith under procedures established by and under the general
supervision of the Trustees (valuation of securities for which market quotations
are not readily available may be based upon current market prices of securities
which are comparable in coupon, rating and maturity or an appropriate matrix
utilizing similar factors); (4) certain portfolio securities may be valued by an
outside pricing service approved by the Trustees. The pricing service may
utilize a matrix system incorporating security quality, maturity and coupon as
the evaluation model parameters, and/or research and evaluations by its staff,
including review of broker-dealer market price quotations, if available, in
determining what it believes is the fair valuation of the portfolio securities
valued by such pricing service; and (5) short-term debt securities having a
maturity date of more than sixty days at the 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
14
Morgan Stanley Limited Duration Fund
NOTES TO FINANCIAL STATEMENTS / / APRIL 30, 2002 CONTINUED
identified cost method. Discounts are accreted and premiums are amortized over
the life of the respective securities. Interest income is accrued daily.
C. Joint Repurchase Agreement Account -- Pursuant to an Exemptive Order issued
by the Securities and Exchange Commission, the Fund, along with other affiliated
entities managed by the Investment Manager, may transfer uninvested cash
balances into one or more joint repurchase agreement accounts. These balances
are invested in one or more repurchase agreements for cash, or U.S. Treasury or
federal agency obligations.
D. Futures Contracts -- A futures contract is an agreement between two parties
to buy and sell financial instruments or contracts based on financial indices at
a set price on a future date. Upon entering into such a contract, the Fund is
required to pledge to the broker cash, U.S. government securities or other
liquid portfolio securities equal to the minimum initial margin requirements of
the applicable futures exchange. Pursuant to the contract, the Fund agrees to
receive from or pay to the broker an amount of cash equal to the daily
fluctuation in the value of the contract. Such receipts or payments known as
variation margin are recorded by the Fund as unrealized gains and losses. Upon
closing of the contract, the Fund realizes a gain or loss equal to the
difference between the value of the contract at the time it was opened and the
value at the time it was closed.
E. Federal Income Tax Status -- It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute substantially all of its taxable income to its
shareholders. Accordingly, no federal income tax provision is required.
F. Dividends and Distributions to Shareholders -- The Fund records dividends and
distributions to its shareholders on the ex-dividend date. 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 financial reporting purposes but not for tax purposes are reported as
dividends in excess of net investment income or distributions in excess of net
realized capital gains. To the extent they exceed net investment income and net
realized capital gains for tax purposes, they are reported as distributions of
paid-in-capital.
15
Morgan Stanley Limited Duration Fund
NOTES TO FINANCIAL STATEMENTS / / APRIL 30, 2002 CONTINUED
2. Investment Management Agreement
Pursuant to an Investment Management Agreement, the Fund pays the Investment
Manager a management fee, accrued daily and payable monthly, by applying the
annual rate of 0.70% to the net assets of the Fund determined as of the close of
each business day.
For the year ended April 30, 2002 and through December 31, 2002, the Investment
Manager has agreed to waive its fee and reimburse expenses to the extent they
exceed 0.80% of the daily net assets of the Fund.
3. Security Transactions and Transactions with Affiliates
The cost of purchases and proceeds from sales/prepayments of portfolio
securities, excluding short-term investments, for the year ended April 30, 2002
were $448,906,987, and $379,491,731, respectively. Included in the
aforementioned are purchases and sales/prepayments of U.S. Government securities
of $374,357,774 and $312,442,882, respectively.
Morgan Stanley Trust, an affiliate of the Investment Manager, is the Fund's
transfer agent.
4. Shares of Beneficial Interest
Transactions in shares of beneficial interest were as follows:
FOR THE YEAR FOR THE YEAR
ENDED ENDED
APRIL 30, 2002 APRIL 30, 2001
-------------------------- ---------------------------
SHARES AMOUNT SHARES AMOUNT
----------- ------------- ------------ -------------
Sold.......................... 35,638,246 $ 340,437,108 34,088,802 $ 318,978,719
Reinvestment of dividends..... 458,331 4,385,816 495,692 4,636,843
----------- ------------- ----------- -------------
36,096,577 344,822,924 34,584,494 323,615,562
Repurchased................... (30,358,372) (289,889,706) (35,850,061) (335,218,627)
----------- ------------- ----------- -------------
Net increase (decrease)....... 5,738,205 $ 54,933,218 (1,265,567) $ (11,603,065)
=========== ============= =========== =============
5. Federal Income Tax Status
During the year ended April 30, 2002, the Fund utilized approximately $2,421,000
of its net capital loss carryover. At April 30, 2002, the Fund had a net capital
loss carryover of approximately $1,890,000 of which $56,000 will be available
through April 30, 2008 and $1,834,000 will be available through April 30, 2009
to offset future capital gains to the extent provided by regulations.
Capital losses incurred after October 31 ("post-October losses") within the
taxable year are deemed to arise on the first business day of the Fund's next
taxable year. The Fund incurred and will elect to defer net capital losses of
approximately $345,000 during fiscal 2002.
16
Morgan Stanley Limited Duration Fund
NOTES TO FINANCIAL STATEMENTS / / APRIL 30, 2002 CONTINUED
As of April 30, 2002, the Fund had temporary book/tax differences primarily
attributable to post-October losses and book amortization of premiums on debt
securities and permanent book/tax differences primarily attributable to tax
adjustments on debt securities sold by the Fund. To reflect reclassifications
arising from the permanent differences, accumulated net realized loss was
charged and dividends in excess of net investment income was credited $586,346.
6. Purposes of and Risks Relating to Certain Financial Instruments
To hedge against adverse interest rate and market risks on portfolio positions
or anticipated positions, the Fund may enter into interest rate futures
contracts ("futures contracts").
These futures contracts involve elements of market risk in excess of the amount
reflected in the Statement and Assets and Liabilities. The Fund bears the risk
of an unfavorable change in the value of the underlying securities.
At April 30, 2002, the Fund had outstanding interest rate futures contracts.
7. Change in Accounting Policy
Effective May 1, 2001, the Fund has adopted the provisions of the AICPA Audit
and Accounting Guide for Investment Companies, as revised, related to premiums
and discounts on debt securities. The cumulative effect of this accounting
change had no impact on the net assets of the Fund, but resulted in a $276,708
decrease in the cost of securities and a corresponding decrease to undistributed
net investment income based on securities held as of April 30, 2001.
The effect of this change for the year ended April 30, 2002 was to decrease net
investment income by $881,963, increase unrealized appreciation by $324,738, and
increase net realized gain by $557,225. The statement of changes in net assets
and financial highlights for prior periods have not been restated to reflect
this change.
8. Fund Merger
On April 25, 2002, the Trustees of Morgan Stanley North American Government
Income Trust ("North American") approved a plan of reorganization whereby North
American would be merged into the Fund. The plan of reorganization is subject to
the consent of North American's shareholders at a special meeting to be held on
September 24, 2002. If approved, the assets of North American would be combined
with the assets of the Fund and shareholders of North American would become
shareholders of the Fund, receiving shares of the Fund equal to the value of
their holdings in North American.
17
Morgan Stanley Limited Duration Fund
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of beneficial interest
outstanding throughout each period:
FOR THE YEAR ENDED APRIL 30,
------------------------------------------------------
2002 2001 2000 1999 1998
---------- -------- -------- -------- --------
Selected Per Share Data:
Net asset value, beginning of
period....................... $ 9.44 $ 9.20 $ 9.49 $ 9.49 $ 9.50
------ ------ ------ ------ ------
Income (loss) from investment
operations:
Net investment income....... 0.41(2) 0.55 0.51 0.56 0.65
Net realized and unrealized
gain (loss)................ 0.19(2) 0.24 (0.29) - -
------ ------ ------ ------ ------
Total income from investment
operations................... 0.60 0.79 0.22 0.56 0.65
------ ------ ------ ------ ------
Less dividends from net
investment income............ (0.45) (0.55) (0.51) (0.56) (0.66)
------ ------ ------ ------ ------
Net asset value, end of
period....................... $ 9.59 $ 9.44 $ 9.20 $ 9.49 $ 9.49
====== ====== ====== ====== ======
Total Return+................. 6.50% 8.82% 2.36% 6.00% 7.02%
Ratios to Average Net
Assets(1):
Expenses...................... 0.80% 0.80% 0.80% 0.31% -
Net investment income......... 3.94%(2) 5.87% 5.43% 5.68% 6.52%
Supplemental Data:
Net assets, end of period, in
thousands.................... $166,631 $109,917 $118,694 $186,442 $107,699
Portfolio turnover rate....... 327% 133% 71% 58% 55%
- - ---------------------
+ CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF
THE PERIOD.
(1) IF THE FUND HAD BORNE ALL EXPENSES THAT WERE ASSUMED OR WAIVED BY THE
INVESTMENT MANAGER, THE ANNUALIZED EXPENSE AND NET INVESTMENT INCOME
RATIOS WOULD HAVE BEEN AS FOLLOWS:
EXPENSE NET INVESTMENT
PERIOD ENDED RATIO INCOME RATIO
- - ------------ --------- ----------------
APRIL 30, 2002 0.92% 3.82%
APRIL 30, 2001 0.92 5.75
APRIL 30, 2000 0.90 5.33
APRIL 30, 1999 0.88 5.11
APRIL 30, 1998 1.10 5.42
(2) EFFECTIVE MAY 1, 2001, THE FUND HAS ADOPTED THE PROVISIONS OF THE AICPA
AUDIT AND ACCOUNTING GUIDE FOR INVESTMENT COMPANIES, AS REVISED, RELATED
TO PREMIUMS AND DISCOUNTS ON DEBT SECURITIES. THE EFFECT OF THIS CHANGE
FOR THE YEAR ENDED APRIL 30, 2002 WAS TO DECREASE NET INVESTMENT INCOME
PER SHARE BY $0.06, INCREASE NET REALIZED AND UNREALIZED GAIN OR LOSS
PER SHARE BY $0.06 AND DECREASE THE RATIO OF NET INVESTMENT INCOME TO
AVERAGE NET ASSETS BY 0.65%. THE FINANCIAL HIGHLIGHTS DATA PRESENTED IN
THIS TABLE FOR PRIOR PERIODS HAS NOT BEEN RESTATED TO REFLECT THIS
CHANGE.
SEE NOTES TO FINANCIAL STATEMENTS
18
Morgan Stanley Limited Duration Fund
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Trustees of
Morgan Stanley Limited Duration Fund:
We have audited the accompanying statement of assets and liabilities of Morgan
Stanley Limited Duration Fund (the "Fund"), formerly Morgan Stanley Short-Term
Bond Fund, including the portfolio of investments, as of April 30, 2002, and the
related statements of operations for the year then ended and changes in net
assets for each of the two years in the period then ended, and the financial
highlights for each of the five years in the period then ended. These financial
statements and financial highlights are the responsibility of the Fund's
management. Our responsibility is to express an opinion on these financial
statements and financial highlights based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. Our procedures included confirmation of
securities owned as of April 30, 2002, by correspondence with the custodian and
brokers. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Morgan
Stanley Limited Duration Fund as of April 30, 2002, the results of its
operations for the year then ended, the changes in its net assets for each of
the two years in the period then ended, and the financial highlights for each of
the five years in the period then ended, in conformity with accounting
principles generally accepted in the United States of America.
Deloitte & Touche LLP
NEW YORK, NEW YORK
JUNE 10, 2002
2002 FEDERAL TAX NOTICE (UNAUDITED)
Of the Fund's ordinary income dividends paid during the fiscal
year ended April 30, 2002, 24.63% was attributable to qualifying
Federal obligations. Please consult your tax advisor to determine
if any portion of the dividends you received is exempt from state
income tax.
19
Morgan Stanley Limited Duration Fund
TRUSTEE AND OFFICER INFORMATION
Independent Trustees:
NUMBER OF
PORTFOLIOS
TERM OF IN FUND
POSITION(S) OFFICE AND COMPLEX
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF OVERSEEN
INDEPENDENT TRUSTEE REGISTRANT TIME SERVED* PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS BY TRUSTEE**
- - ------------------------- ----------- --------------- ------------------------------------------- --------------------
Michael Bozic (61) Trustee Trustee since Retired; Director or Trustee of the Morgan 129
c/o Mayer, Brown, Rowe & April 1994 Stanley Funds and the TCW/DW Term Trusts;
Maw formerly Vice Chairman of Kmart Corporation
Counsel to the (December 1998-October 2000), Chairman and
Independent Trustees Chief Executive Officer of Levitz Furniture
1675 Broadway Corporation (November 1995-November 1998)
New York, NY and President and Chief Executive Officer
of Hills Department Stores (May 1991-July
1995); formerly variously Chairman, Chief
Executive Officer, President and Chief
Operating Officer (1987-1991) of the Sears
Merchandise Group of Sears, Roebuck & Co.
Edwin J. Garn (69) Trustee Trustee since Director or Trustee of the Morgan Stanley 129
c/o Summit Ventures LLC January 1993 Funds and the TCW/DW Term Trusts; formerly
1 Utah Center United States Senator (R-Utah) (1974-1992)
201 S. Main Street and Chairman, Senate Banking Committee
Salt Lake City, UT (1980-1986); formerly Mayor of Salt Lake
City, Utah (1971-1974); formerly Astronaut,
Space Shuttle Discovery (April 12-19,
1985); Vice Chairman, Huntsman Corporation
(chemical company); member of the Utah
Regional Advisory Board of Pacific Corp.
Wayne E. Hedien (68) Trustee Trustee since Retired; Director or Trustee of the Morgan 129
c/o Mayer, Brown, Rowe & September 1997 Stanley Funds and the TCW/DW Term Trusts;
Maw formerly associated with the Allstate
Counsel to the Companies (1966-1994), most recently as
Independent Trustees Chairman of The Allstate Corporation (March
1675 Broadway 1993-December 1994) and Chairman and Chief
New York, NY Executive Officer of its wholly-owned
subsidiary, Allstate Insurance Company
(July 1989-December 1994).
NAME, AGE AND ADDRESS OF
INDEPENDENT TRUSTEE OTHER DIRECTORSHIPS HELD BY TRUSTEE
- - ------------------------- -----------------------------------
Michael Bozic (61) Director of Weirton Steel
c/o Mayer, Brown, Rowe & Corporation.
Maw
Counsel to the
Independent Trustees
1675 Broadway
New York, NY
Edwin J. Garn (69) Director of Franklin Covey (time
c/o Summit Ventures LLC management systems), BMW Bank of
1 Utah Center North America, Inc. (industrial
201 S. Main Street loan corporation), United Space
Salt Lake City, UT Alliance (joint venture between
Lockheed Martin and the Boeing
Company) and Nuskin Asia Pacific
(multilevel marketing); member of
the board of various civic and
charitable organizations.
Wayne E. Hedien (68) Director of The PMI Group Inc.
c/o Mayer, Brown, Rowe & (private mortgage insurance);
Maw Trustee and Vice Chairman of The
Counsel to the Field Museum of Natural History;
Independent Trustees director of various other business
1675 Broadway and charitable organizations.
New York, NY
20
Morgan Stanley Limited Duration Fund
TRUSTEE AND OFFICER INFORMATION CONTINUED
NUMBER OF
PORTFOLIOS
TERM OF IN FUND
POSITION(S) OFFICE AND COMPLEX
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF OVERSEEN
INDEPENDENT TRUSTEE REGISTRANT TIME SERVED* PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS BY TRUSTEE**
- - ------------------------- ----------- -------------- ------------------------------------------- --------------------
Dr. Manuel H. Johnson Trustee Trustee since Chairman of the Audit Committee and 129
(53) July 1991 Director or Trustee of the Morgan Stanley
c/o Johnson Smick Funds and the TCW/DW Term Trusts; Senior
International, Inc. Partner, Johnson Smick International, Inc.,
1133 Connecticut Avenue, a consulting firm; Co-Chairman and a
N.W. founder of the Group of Seven Council
Washington, D.C. (G7C), an international economic
commission; formerly Vice Chairman of the
Board of Governors of the Federal Reserve
System and Assistant Secretary of the U.S.
Treasury.
Michael E. Nugent (65) Trustee Trustee since Chairman of the Insurance Committee and 207
c/o Triumph Capital, L.P. July 1991 Director or Trustee of the Morgan Stanley
237 Park Avenue Funds and the TCW/DW Term Trusts;
New York, NY director/trustee of various investment
companies managed by Morgan Stanley
Investment Management Inc. and Morgan
Stanley Investments LP (since July 2001);
General Partner, Triumph Capital, L.P., a
private investment partnership; formerly
Vice President, Bankers Trust Company and
BT Capital Corporation (1984-1988).
John L. Schroeder (71) Trustee Trustee since Retired; Chairman of the Derivatives 129
c/o Mayer, Brown, Rowe & April 1994 Committee and Director or Trustee of the
Maw Morgan Stanley Funds and the TCW/DW Term
Counsel to the Trusts; formerly Executive Vice President
Independent Trustees and Chief Investment Officer of the Home
1675 Broadway Insurance Company (August 1991-September
New York, NY 1995).
NAME, AGE AND ADDRESS OF
INDEPENDENT TRUSTEE OTHER DIRECTORSHIPS HELD BY TRUSTEE
- - ------------------------- -----------------------------------
Dr. Manuel H. Johnson Director of NVR, Inc. (home
(53) construction); Chairman and Trustee
c/o Johnson Smick of the Financial Accounting
International, Inc. Foundation (oversight organization
1133 Connecticut Avenue, of the Financial Accounting
N.W. Standards Board).
Washington, D.C.
Michael E. Nugent (65) Director of various business
c/o Triumph Capital, L.P. organizations.
237 Park Avenue
New York, NY
John L. Schroeder (71) Director of Citizens Communications
c/o Mayer, Brown, Rowe & Company (telecommunications
Maw company).
Counsel to the
Independent Trustees
1675 Broadway
New York, NY
21
Morgan Stanley Limited Duration Fund
TRUSTEE AND OFFICER INFORMATION CONTINUED
Interested Trustees:
TERM OF
POSITION(S) OFFICE AND
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF
INTERESTED TRUSTEE REGISTRANT TIME SERVED* PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS
- - ------------------------- ------------------- --------------- -------------------------------------------
Charles A. Fiumefreddo Chairman, Director Trustee since Chairman, Director or Trustee and Chief
(68) or Trustee and July 1991 Executive Officer of the Morgan Stanley
c/o Morgan Stanley Trust Chief Executive Funds and the TCW/DW Term Trusts; formerly
Harborside Financial Officer Chairman, Chief Executive Officer and
Center, Director of the Investment Manager, the
Plaza Two, Distributor and Morgan Stanley Services,
Jersey City, NJ Executive Vice President and Director of
Morgan Stanley DW, Chairman and Director of
the Transfer Agent, and Director and/or
officer of various Morgan Stanley
subsidiaries (until June 1998).
James F. Higgins (54) Trustee Trustee since Senior Advisor of Morgan Stanley (since
c/o Morgan Stanley Trust June 2000 August 2000); Director of the Distributor
Harborside Financial and Dean Witter Realty Inc.; Director or
Center, Trustee of the Morgan Stanley Funds and the
Plaza Two, TCW/DW Term Trusts (since June 2000);
Jersey City, NJ previously President and Chief Operating
Officer of the Private Client Group of
Morgan Stanley (May 1999-August 2000),
President and Chief Operating Officer of
Individual Securities of Morgan Stanley
(February 1997-May 1999).
Philip J. Purcell (58) Trustee Trustee since Director or Trustee of the Morgan Stanley
1585 Broadway April 1994 Funds and the TCW/DW Term Trusts; Chairman
New York, NY of the Board of Directors and Chief
Executive Officer of Morgan Stanley and
Morgan Stanley DW; Director of the
Distributor; Chairman of the Board of
Directors and Chief Executive Officer of
Novus Credit Services Inc.; Director and/or
officer of various Morgan Stanley
subsidiaries.
NUMBER OF
PORTFOLIOS
IN FUND
COMPLEX
NAME, AGE AND ADDRESS OF OVERSEEN
INTERESTED TRUSTEE BY TRUSTEE** OTHER DIRECTORSHIPS HELD BY TRUSTEE
- - ------------------------- -------------------- -----------------------------------
Charles A. Fiumefreddo 129 None
(68)
c/o Morgan Stanley Trust
Harborside Financial
Center,
Plaza Two,
Jersey City, NJ
James F. Higgins (54) 129 None
c/o Morgan Stanley Trust
Harborside Financial
Center,
Plaza Two,
Jersey City, NJ
Philip J. Purcell (58) 129 Director of American Airlines, Inc.
1585 Broadway and its parent company, AMR
New York, NY Corporation.
- - ----------------------------
* EACH TRUSTEE SERVES AN INDEFINITE TERM, UNTIL HIS OR HER SUCCESSOR IS
ELECTED.
** THE FUND COMPLEX INCLUDES ALL OPEN AND CLOSED-END FUNDS (INCLUDING ALL
OF THEIR PORTFOLIOS) ADVISED BY MORGAN STANLEY INVESTMENT ADVISORS INC.
AND ANY FUNDS THAT HAVE AN INVESTMENT ADVISOR THAT IS AN AFFILIATED
PERSON OF MORGAN STANLEY INVESTMENT ADVISORS INC. (INCLUDING BUT NOT
LIMITED TO, MORGAN STANLEY INVESTMENT MANAGEMENT INC., MORGAN STANLEY
INVESTMENTS LP AND VAN KAMPEN ASSET MANAGEMENT INC.).
22
Morgan Stanley Limited Duration Fund
TRUSTEE AND OFFICER INFORMATION CONTINUED
Officers:
TERM OF
POSITION(S) OFFICE AND
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF
EXECUTIVE OFFICER REGISTRANT TIME SERVED*
- - ----------------------------------- ----------------------------------- -----------------------------------
Mitchell M. Merin (48) President President since May 1999
1221 Avenue of the Americas
New York, NY
Barry Fink (47) Vice President, Secretary and Vice President, Secretary and
1221 Avenue of the Americas General Counsel General Counsel since February 1997
New York, NY
Thomas F. Caloia (56) Treasurer Treasurer since April 1989
c/o Morgan Stanley Trust
Harborside Financial Center,
Plaza Two
Jersey City, NJ
NAME, AGE AND ADDRESS OF
EXECUTIVE OFFICER PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS
- - ----------------------------------- -------------------------------------------
Mitchell M. Merin (48) President and Chief Operating Officer of
1221 Avenue of the Americas Morgan Stanley Investment Management (since
New York, NY December 1998); President, Director (since
April 1997) and Chief Executive Officer
(since June 1998) of the Investment Manager
and Morgan Stanley Services; Chairman,
Chief Executive Officer and Director of the
Distributor (since June 1998); Chairman and
Chief Executive Officer (since June 1998)
and Director (since January 1998) of the
Transfer Agent; Director of various Morgan
Stanley subsidiaries; President of the
Morgan Stanley Funds and TCW/DW Term Trusts
(since May 1999); Trustee of various Van
Kampen investment companies (since December
1999); previously Chief Strategic Officer
of the Investment Manager and Morgan
Stanley Services and Executive Vice
President of the Distributor (April
1997-June 1998), Vice President of the
Morgan Stanley Funds (May 1997-April 1999),
and Executive Vice President of Morgan
Stanley.
Barry Fink (47) General Counsel (since May 2000) and
1221 Avenue of the Americas Managing Director (since December 2000) of
New York, NY Morgan Stanley Investment Management;
Managing Director (since December 2000),
and Secretary and General Counsel (since
February 1997) and Director (since July
1998) of the Investment Manager and Morgan
Stanley Services; Assistant Secretary of
Morgan Stanley DW; Vice President,
Secretary and General Counsel of the Morgan
Stanley Funds and TCW/DW Term Trusts (since
February 1997); Vice President and
Secretary of the Distributor; previously,
Senior Vice President, Assistant Secretary
and Assistant General Counsel of the
Investment Manager and Morgan Stanley
Services.
Thomas F. Caloia (56) First Vice President and Assistant
c/o Morgan Stanley Trust Treasurer of the Investment Manager, the
Harborside Financial Center, Distributor and Morgan Stanley Services;
Plaza Two Treasurer of the Morgan Stanley Funds.
Jersey City, NJ
- - ----------------------------
* EACH OFFICER SERVES AN INDEFINITE TERM, UNTIL HIS OR HER SUCCESSOR IS
ELECTED.
23
TRUSTEES [MORGAN STANLEY LOGO]
Michael Bozic
Charles A. Fiumefreddo
Edwin J. Garn
Wayne E. Hedien
James F. Higgins
Dr. Manuel H. Johnson
Michael E. Nugent [PHOTO]
Philip J. Purcell
John L. Schroeder
OFFICERS
Charles A. Fiumefreddo
Chairman and Chief Executive Officer
Mitchell M. Merin
President
Barry Fink
Vice President, Secretary and General Counsel
Thomas F. Caloia
Treasurer
TRANSFER AGENT
Morgan Stanley Trust
Harborside Financial Center - Plaza Two
Jersey City, New Jersey 07311
INDEPENDENT AUDITORS Morgan Stanley
Limited Duration Fund
Deloitte & Touche LLP
Two World Financial Center
New York, New York 10281
INVESTMENT MANAGER
Morgan Stanley Investment Advisors Inc.
1221 Avenue of the Americas
New York, New York 10020
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 ANNUAL REPORT
to prospective investors in the Fund unless
preceded or accompanied by an effective APRIL 30, 2002
Prospectus. Read the Prospectus carefully
before investing.
Morgan Stanley
Distributors Inc., member NASD. 37880RPT
Morgan Stanley North American Government Income Trust
Letter to the Shareholders [|] April 30, 2002
Dear Shareholder:
Bond-market volatility peaked in the fourth quarter of 2001 as interest rates
plummeted on news of economic weakness and soared on reports of economic
strength. The Federal Reserve lowered its target rate three times and by 125
basis points in the final quarter of the year, bringing the federal funds rate
down to 1.75 percent, a 40-year low. The terrorist attacks in September
thwarted the economy's first attempts at recovery, but by early December many
sectors appeared to be recovering. Retail sales, industrial production and
orders for durable goods posted increases along with home sales and consumer
confidence. U.S. Treasury yields began rising sharply during the first quarter
of 2002 in anticipation of a shift in monetary policy but fell substantially in
April on declines in the equity market. The central bank has kept its target
short-term interest rate at 1.75 percent because of lingering uncertainties
related to the strength of the economic recovery. The performance of the
Treasury market was mixed over the past six months as the yield on the
three-month Treasury bill fell 25 basis points while yields on two- and 10-year
Treasuries posted increases of 80 and 85 basis points, respectively. Mortgage
prepayments peaked early in the year after rates hit historic lows in November,
but refinancing activity has tapered off steadily over the past three months.
Performance and Portfolio Strategy
For the six-month period ended April 30, 2002, Morgan Stanley North American
Government Income Trust posted a total return of 0.07 percent, compared to 0.59
percent for the Lehman Brothers U.S. Government Index (1 - 5 Year).* According
to TCW Investment Management (TCW), the Fund's sub-advisor, the Fund's
underperformance relative to its index was due primarily to its longer-duration
holdings, which failed to keep pace with returns on short-term government
securities.
As of April 30, 2002, 100 percent of the Fund's portfolio was invested in the
United States. TCW continues to emphasize high-quality mortgage-backed
securities, including various types of collateralized mortgage obligations
(CMOs), pass-through securities and adjustable-rate mortgages (ARMs). The Fund
remains on the sidelines with respect to investing in both the Mexican and
Canadian markets. TCW continues to monitor these markets for attractive
investment opportunities relative to those in the United States.
Looking Ahead
Most economists expect U.S. gross domestic product (GDP) to moderate in the
second quarter, and many predict that the Fed will begin raising rates later
this year. TCW believes that continued strength in productivity should provide
some support to the Treasury market and allow the Fed to keep interest rates
- --------------
* The Lehman Brothers U.S. Government Index (1-5 Year) measures the
performance of all U.S. government agency and Treasury securities with
maturities of one to five years. The Index does not include any expenses,
fees or charges. The Index is unmanaged and should not be considered an
investment.
Morgan Stanley North American Government Income Trust
Letter to the Shareholders [|] April 30, 2002 continued
lower in the face of growth due to lessened concern about inflation.
Nonetheless, the Treasury market will remain vulnerable to further selling on
evidence of economic strength. TCW believes that the mortgage sector is
positioned to perform well in the coming months. The sub-advisor expects demand
to remain strong and looks for additional declines in volatility to continue
narrowing the spread between mortgages and Treasuries. According to TCW, the
mortgage sector continues to offer investors high levels of liquidity and
credit quality. Mortgage spreads remain above historic averages and are still
attractive relative to other fixed-income sectors. The Fund's investment
strategy remains focused on certain types of CMOs and other types of
well-structured securities as a means of reducing portfolio exposure to
prepayment risk. These factors underlie TCW's positive outlook on the
mortgage-backed securities sector.
On April 25, 2002, the Board of Trustees of Morgan Stanley North American
Government Income Trust approved an Agreement and Plan of Reorganization by and
between the Fund and Morgan Stanley Limited Duration Fund. This reorganization
would combine substantially all of the assets of the Fund with those of Limited
Duration Fund. Shareholders of the Fund would become shareholders of Limited
Duration Fund, receiving shares of Limited Duration Fund equal to the value of
their holdings in North American Government Income Trust. The reorganization is
subject to the approval of shareholders of the Fund at a special meeting
scheduled for September 24, 2002.
We appreciate your ongoing support of Morgan Stanley North American Government
Income Trust and look forward to continuing to serve your investment needs.
Very truly yours,
/s/ Charles A. Fieumefreddo /s/ Mitchel M. Merin
- --------------------------- -----------------------
Charles A. Fiumefreddo Mitchell M. Merin
Chairman of the Board President
Annual 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 and 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, 8:00am to 8:00pm, ET. Once
our Customer Service Center has received your instructions, we will begin
sending individual copies for each account within 30 days.
2
Morgan Stanley North American Government Income Trust
Fund Performance [|] April 30, 2002
Average Annual Total Returns
Period Ended 4/30/02
- ---------------------------
1 Year 2.96%(1)
5 Years 5.74%(1)
Since Inception (7/31/92) 4.42%(1)
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE RETURNS. INVESTMENT RETURN AND
PRINCIPAL VALUE WILL FLUCTUATE. WHEN YOU SELL FUND SHARES, THEY MAY BE WORTH
LESS THAN THEIR ORIGINAL COST. THE TABLE DOES NOT REFLECT THE DEDUCTION OF
TAXES THAT A SHAREHOLDER WOULD PAY ON FUND DISTRIBUTIONS OR THE REDEMPTION OF
FUND SHARES.
- ------------
(1) Figure shown assumes reinvestment of all distributions and does not
reflect the deduction of any sales charges.
3
Morgan Stanley North American Government Income Trust
Portfolio of Investments [|] April 30, 2002 (unaudited)
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------- ------------ ---------- -------------
U. S. Government Agency Mortgage-Backed Securities (58.6%)
$ 5,000 Federal Farm Credit Bank .................................. 6.25 % 12/02/02 $5,116,615
5,000 Federal Home Loan Mortgage Corp. .......................... 4.50 08/15/04 5,086,970
1,169 Federal Home Loan Mortgage Corp. ARM ...................... 6.507 03/01/25 1,197,725
5,000 Federal National Mortgage Assoc. .......................... 4.75 11/14/03 5,117,645
3,380 Federal National Mortgage Assoc. .......................... 5.855 07/01/31 3,405,662
2,857 Federal National Mortgage Assoc. .......................... 7.00 01/01/04 2,968,648
453 Federal National Mortgage Assoc. .......................... 9.50 06/01/20 501,405
6,434 Government National Mortgage Assoc. II ARM ................ 5.50 08/20/29 6,499,058
3,292 Government National Mortgage Assoc. II ARM ................ 6.00 07/20/29-
09/20/29 3,339,269
7,389 Government National Mortgage Assoc. II ARM ................ 6.375 06/20/22-
06/20/25 7,535,566
1,621 Government National Mortgage Assoc. II ARM ................ 6.625 10/20/24-
12/20/24 1,673,114
6,723 Government National Mortgage Assoc. II ARM ................ 6.75 08/20/22 6,920,393
----------
Total U.S. Government Agency Mortgage Backed-Securities
(Cost $48,657,810)................................................................. 49,362,070
----------
Collateralized Mortgage Obligations (14.9%)
U.S. Government Agencies
3 Federal Home Loan Mortgage Corp. 1370 K (PAC IO) .......... 1089.16 09/15/22 58,178
7,297 Federal Home Loan Mortgage Corp. G 21 M ................... 6.50 10/25/23 7,175,207
5,000 Federal National Mortgage Assoc. G96-1 PJ (PAC) ........... 7.50 11/17/25 5,308,985
----------
Total Collateralized Mortgage Obligations
(Cost $12,567,453)................................................................. 12,542,370
----------
Short-Term Investments (25.7%)
Commercial Paper (a) (7.1%)
Finance/Rental/Leasing (2.0%)
1,700 Paccar Financial Corp. .................................... 1.80 07/22/02 1,692,945
----------
Food: Major Diversified (3.9%)
3,317 Nestle Capital Corp. ...................................... 1.82 05/17/02 3,314,317
----------
Industrial Conglomerates (1.2%)
1,000 General Electric Co. ...................................... 1.82 05/20/02 999,039
----------
Total Commercial Paper (Cost $6,006,386)........................................... 6,006,301
----------
See Notes to Financial Statements
4
Morgan Stanley North American Government Income Trust
Portfolio of Investments [|] April 30, 2002 (unaudited) continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------- ------------ ------------ -------------
U.S. Government Agency (a) (14.2%)
5,000 Federal National Mortgage Assoc. ............................. 1.80 % 07/03/02 $ 4,984,000
3,000 Federal National Mortgage Assoc. ............................. 1.82 06/05/02 2,994,692
4,000 Federal National Mortgage Assoc. ............................. 1.86 08/09/02 3,979,127
-----------
Total U.S. Government Agencies (Cost $11,958,275)....................................... 11,957,819
-----------
Repurchase Agreement (4.4%)
3,676 The Bank of New York (dated 04/30/02; proceeds $3,675,784) (b)
(Cost $3,675,612)............................................. 1.688 05/01/02 3,675,612
-----------
Total Short-Term Investments (Cost $21,640,273)......................................... 21,639,732
-----------
Total Investments (Cost $82,865,536) (c) .................................. 99.2% 83,544,172
Other Assets in Excess of Liabilities ..................................... 0.8 672,036
------ -----------
Net Assets ................................................................ 100.0% $84,216,208
====== ===========
- ------------
ARM Adjustable Rate Mortgage.
IO Interest-only securities.
PAC Planned Amortization Class.
(a) Purchased on a discount basis. The interest rate shown has been
adjusted to reflect a money market equivalent yield.
(b) Collateralized by $3,765,897 U.S. Treasury Bill due 08/01/02 valued at
$3,749,150.
(c) The aggregate cost for federal income tax purposes approximates the
aggregate cost for book purposes. The aggregate gross unrealized
appreciation is $1,079,886 and the aggregate gross unrealized
depreciation is $401,250, resulting in net unrealized appreciation of
$678,636.
See Notes to Financial Statements
5
Morgan Stanley North American Government Income Trust
Financial Statements
Statement of Assets and Liabilities
April 30, 2002 (unaudited)
Assets:
Investments in securities, at value
(cost $82,865,536).......................................... $ 83,544,172
Receivable for:
Interest .................................................. 539,166
Principal paydowns ........................................ 184,856
Shares of beneficial interest sold ........................ 149,585
Prepaid expenses and other assets ........................... 44,039
--------------
Total Assets .............................................. 84,461,818
--------------
Liabilities:
Payable for:
Shares of beneficial interest repurchased ................. 85,385
Distribution fee .......................................... 57,595
Investment management fee ................................. 49,916
Accrued expenses ............................................ 52,714
--------------
Total Liabilities ......................................... 245,610
--------------
Net Assets ................................................ $ 84,216,208
==============
Composition of Net Assets:
Paid-in-capital ............................................. $ 315,740,721
Net unrealized appreciation ................................. 678,636
Dividends in excess of net investment income ................ (101,418)
Accumulated net realized loss ............................... (232,101,731)
--------------
Net Assets ................................................ $ 84,216,208
==============
Net Asset Value Per Share,
9,725,743 shares outstanding (unlimited shares
authorized of $.01 par value) ............................. 8.66
==============
See Notes to Financial Statements
6
Morgan Stanley North American Government Income Trust
Financial Statements continued
Statement of Operations
For the six months ended April 30, 2002 (unaudited)
Net Investment Income:
Interest Income ............................... $ 1,915,144
------------
Expenses ......................................
Distribution fee .............................. 309,489
Investment management fee ..................... 273,996
Transfer agent fees and expenses .............. 87,099
Professional fees ............................. 25,271
Registration fees ............................. 17,688
Shareholder reports and notices ............... 9,726
Trustees' fees and expenses ................... 6,337
Custodian fees ................................ 783
Other ......................................... 5,131
------------
Total Expenses .............................. 735,520
Less: expense offset .......................... (344)
------------
Net Expenses ................................ 735,176
------------
Net Investment Income ....................... 1,179,968
------------
Net Realized and Unrealized Loss:
Net realized loss ............................. (23)
Net change in unrealized appreciation ......... (1,097,552)
------------
Net Loss .................................... (1,097,575)
------------
Net Increase .................................. $ 82,393
============
See Notes to Financial Statements
7
Morgan Stanley North American Government Income Trust
Financial Statements continued
Statement of Changes in Net Assets
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
APRIL 30, 2002 OCTOBER 31, 2001
---------------- -----------------
(unaudited)
Increase (Decrease) in Net Assets:
Operations:
Net investment income ................................................................. $ 1,179,968 $ 4,099,129
Net realized loss ..................................................................... (23) -
Net change in unrealized appreciation/depreciation .................................... (1,097,552) 2,295,697
------------ ------------
Net Increase ........................................................................ 82,393 6,394,826
Dividends to shareholders from net investment income .................................. (1,601,776) (4,171,176)
Net decrease from transactions in shares of beneficial interest ....................... (4,875,683) (3,307,860)
------------ ------------
Net Decrease ........................................................................ (6,395,066) (1,084,210)
Net Assets:
Beginning of period ................................................................... 90,611,274 91,695,484
------------ ------------
End of Period
(Including dividends in excess of net investment income of $101,418 and accumulated
undistributed net investment income of $329,619, respectively)......................... $ 84,216,208 $ 90,611,274
============ ============
See Notes to Financial Statements
8
Morgan Stanley North American Government Income Trust
Notes to Financial Statements [|] April 30, 2002 (unaudited)
1. Organization and Accounting Policies
Morgan Stanley North American Government Income Trust (the "Fund") is
registered under the Investment Company Act of 1940, as amended (the "Act"), as
a non-diversified, open-end management investment company. The Fund's
investment objective is to earn a high level of income while maintaining
relatively low volatility of principal. The Fund was organized as a
Massachusetts business trust on February 19, 1992 and commenced operations on
July 31, 1992.
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.
The following is a summary of significant accounting policies:
A. Valuation of Investments - (1) portfolio securities for which
over-the-counter market quotations are readily available are valued at the
latest available bid price prior to the time of valuation; (2) when market
quotations are not readily available, including circumstances under which it is
determined by Morgan Stanley Investment Advisors Inc. (the "Investment
Manager") or TCW Investment Management Company (the "Sub-Advisor") that sale or
bid prices are not reflective of a security's market value, portfolio
securities are valued at their fair value as determined in good faith under
procedures established by and under the general supervision of the Trustees
(valuation of debt securities for which market quotations are not readily
available may be based upon current market prices of securities which are
comparable in coupon, rating and maturity or an appropriate matrix utilizing
similar factors); and (3) 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.
The Fund amortizes premiums and accretes discounts based on the respective life
of the securities. Interest income is accrued daily.
C. Foreign Currency Translation - The books and records of the Fund are
maintained in U.S. dollars as follows: (1) the foreign currency market value of
investment securities, other assets and liabilities and forward foreign
currency contracts ("forward contracts") are translated at the exchange rates
prevailing at the end of the period; and (2) purchases, sales, income and
expenses are translated at the exchange rates prevailing on the respective
dates of such transactions. The resultant exchange gains and losses are
included in the Statement of Operations as realized and unrealized gain/loss on
foreign exchange
9
Morgan Stanley North American Government Income Trust
Notes to Financial Statements [|] April 30, 2002 (unaudited) continued
transactions. Pursuant to U.S. federal income tax regulations, certain foreign
exchange gains/losses included in realized and unrealized gain/loss are
included in or are a reduction of ordinary income for federal income tax
purposes. The Fund does not isolate that portion of the results of operations
arising as a result of changes in the foreign exchange rates from the changes
in the market prices of the securities.
D. Forward Foreign Currency Contracts - The Fund may enter into forward
contracts which are valued daily at the appropriate exchange rates. The
resultant unrealized exchange gains and losses are included in the Statement of
Operations as unrealized foreign currency gain or loss. The Fund records
realized gains or losses on delivery of the currency or at the time the forward
contract is extinguished (compensated) by entering into a closing transaction
prior to delivery.
E. Dollar Rolls - The Fund may enter into dollar rolls in which the Fund sells
securities for delivery and simultaneously contracts to repurchase
substantially similar securities at the current sales price on a specified
future date. The difference between the current sales price and the lower
forward price for the future purchase (often referred to as the "drop") is
amortized over the life of the dollar roll.
F. Federal Income Tax Status - It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute substantially all of its taxable income to its
shareholders. Accordingly, no federal income tax provision is required.
G. Dividends and Distributions to Shareholders - The Fund records dividends and
distributions to its shareholders on the ex-dividend date. 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 financial reporting purposes but not for tax purposes are reported as
dividends in excess of net investment income or distributions in excess of net
realized capital gains. To the extent they exceed net investment income and net
realized capital gains for tax purposes, they are reported as distributions of
paid-in-capital.
2. Investment Management and Sub-Advisory Agreements
Pursuant to an Investment Management Agreement, the Fund pays the Investment
Manager a management 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: 0.65% to the portion of the daily net assets not
exceeding $500 million and 0.60% to the portion of the daily net assets
exceeding $500 million.
10
Morgan Stanley North American Government Income Trust
Notes to Financial Statements [|] April 30, 2002 (unaudited) continued
Under a Sub-Advisory Agreement between the Investment Manager and the
Sub-Advisor, the Sub-Advisor provides the Fund with investment advice and
portfolio management relating to the Fund's investments in securities, subject
to the overall supervision of the Investment Manager. As compensation for its
services provided pursuant to the Sub-Advisory Agreement, the Investment
Manager pays the Sub-Advisor compensation equal to 40% of its monthly
compensation
3. Plan of Distribution
Morgan Stanley Distributors Inc. (the "Distributor"), an affiliate of the
Investment Manager, is the distributor of the Fund's shares and, in accordance
with a Plan of Distribution (the "Plan") pursuant to Rule 12b-1 under the Act,
finances certain expenses in connection with the distribution of shares of the
Fund.
The Fund is authorized to reimburse the Distributor for specific expenses the
Distributor incurs or plans to incur in promoting the distribution of the
Fund's shares. The amount of each monthly reimbursement payment may in no event
exceed an amount equal to a payment at the annual rate of 0.75% of the Fund's
average daily net assets during the month. Expenses incurred pursuant to the
Plan in any fiscal year in excess of 0.75% of the Fund's average daily net
assets will not be reimbursed by the Fund through payments accrued in any
subsequent fiscal year. For the six months ended April 30, 2002, the
distribution fee was accrued at the annual rate of 0.73%.
4. Security Transactions and Transactions with Affiliates
The purchases and proceeds from sales/prepayments of portfolio securities,
excluding short-term investments, for the six months ended April 30, 2002 were
as follows:
SALES/
PURCHASES PREPAYMENTS
------------- --------------
U.S. Government Agencies . ......... $9,662,950 $14,981,766
Morgan Stanley Trust, an affiliate of the Investment Manager and Distributor,
is the Fund's transfer agent. At April 30, 2002, the Fund had transfer agent
fees and expenses payable of approximately $17,100.
11
Morgan Stanley North American Government Income Trust
Notes to Financial Statements [|] April 30, 2002 (unaudited) continued
5. Shares of Beneficial Interest
Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
APRIL 30, 2002 OCTOBER 31, 2001
-------------------------------- ----------------------------------
(unaudited)
SHARES AMOUNT SHARES AMOUNT
--------------- ---------------- ---------------- -----------------
Sold ............................... 2,206,049 $ 19,265,074 13,631,877 $ 119,393,140
Reinvestment of dividends. ......... 139,508 1,211,606 359,700 3,137,960
Repurchased ........................ (2,898,637) (25,352,363) (14,370,369) (125,838,960)
---------- ------------- ----------- --------------
Net decrease ....................... (553,080) $ (4,875,683) (378,792) $ (3,307,860)
========== ============= =========== ==============
6. Federal Income Tax Status
At October 31, 2001, the Fund had a net capital loss carryover of approximately
$232,102,000, to offset future capital gains to the extent provided by
regulations, available through October 31 of the following years:
AMOUNT IN THOUSANDS
- --------------------------------------------------------------------------------
2002 2003 2004 2005 2006 2007 2008
- ------------ ----------- ---------- --------- ------ --------- -----
$ 52,983 $160,560 $14,716 $2,013 $152 $1,657 $21
========= ======== ======= ====== ==== ====== ===
7. Reverse Repurchase and Dollar Roll Agreements
Reverse repurchase and dollar roll agreements involve the risk that the market
value of the securities the Fund is obligated to repurchase under the agreement
may decline below the repurchase price. In the event the buyer of securities
under a reverse repurchase or dollar roll agreement files for bankruptcy or
becomes insolvent, the Fund's use of proceeds of the agreement may be
restricted pending a determination by the other party, its trustee or receiver,
whether to enforce the Fund's obligation to repurchase the securities.
Reverse repurchase agreements are collateralized by Fund securities with a
market value in excess of the Fund's obligation under the contract.
At April 30, 2002, there were no outstanding reverse repurchase or dollar roll
agreements.
8. Expense Offset
The expense offset represents a reduction of the custodian fees for earnings on
cash balances maintained by the Fund.
12
Morgan Stanley North American Government Income Trust
Notes to Financial Statements [|] April 30, 2002 (unaudited) continued
9. Purposes of and Risks Relating to Certain Financial Instruments
The Fund may enter into forward contracts to facilitate settlement of foreign
currency denominated portfolio transactions or to manage foreign currency
exposure associated with foreign currency denominated securities.
Forward contracts involve elements of market risk in excess of the amounts
reflected in the Statement of Assets and Liabilities. The Fund bears the risk
of an unfavorable change in the foreign exchange rates underlying the forward
contracts. Risks may also arise upon entering into these contracts from the
potential inability of the counterparties to meet the terms of their contracts.
At April 30, 2002, there were no outstanding forward contracts.
10. Change in Accounting Policy
Effective November 1, 2001, the Fund has adopted the provisions of the AICPA
Audit and Accounting Guide for Investment Companies, as revised, related to
premiums and discounts on debt securities. The cumulative effect of this
accounting change had no impact on the net assets of the Fund, but resulted in
a $9,229 decrease in the cost of securities and a corresponding decrease in
undistributed net investment income based on securities held as October 31,
2001.
The effect of this change for the six months ended April 30, 2002 was to
decrease net investment income by $112,719 and increase unrealized appreciation
by $112,719. The statement of changes in net assets and the financial
highlights for prior periods have not been restated to reflect this change.
11. Fund Merger
On April 25, 2002, the Trustees of the Fund and Morgan Stanley Limited Duration
Fund ("Limited Duration") approved a plan of reorganization whereby the Fund
would be merged into Limited Duration. The plan of reorganization is subject to
the consent of the Fund's shareholders at a special meeting to be held on
September 24, 2002. If approved, the assets of the Fund would be combined with
the assets of Limited Duration and shareholders of the Fund would become
shareholders of Limited Duration, receiving shares of Limited Duration equal to
the value of their holdings in the Fund.
13
Morgan Stanley North American Government Income Trust
Financial Highlights
Selected ratios and per share data for a share of beneficial interest
outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED OCTOBER 31
MONTHS ENDED -----------------------------------------------------------------------
APRIL 30, 2002 2001 2000 1999 1998 1997
-------------- ------------- ------------- ---------------- ------------- ------------
(unaudited)
Selected Per Share Data:
Net asset value, beginning of period ........ $ 8.82 $ 8.60 $ 8.50 $ 8.60 $ 8.59 $ 8.39
--------- --------- --------- --------- --------- -------
Income (loss) from investment operations:
Net investment income ...................... 0.12 0.40 0.40 0.44 0.49 0.44
Net realized and unrealized gain (loss) .... (0.12) 0.22 0.06 (0.09) (0.05) 0.19
----------- --------- --------- --------- --------- -------
Total income from investment operations ..... 0.00 0.62 0.46 0.35 0.44 0.63
----------- --------- --------- --------- --------- -------
Less dividends and distributions from:
Net investment income ...................... (0.16) (0.40) (0.36) (0.38) (0.43) (0.43)
Paid-in-capital ............................ - - - (0.07) - -
----------- --------- --------- --------- --------- --------
Total dividends and distributions ........... (0.16) (0.40) (0.36) (0.45) (0.43) (0.43)
----------- --------- --------- --------- --------- --------
Net asset value, end of period .............. $ 8.66 $ 8.82 $ 8.60 $ 8.50 $ 8.60 $ 8.59
=========== ========= ========= ========= ========= ========
Total Return+ ............................... 0.07%(1) 7.43% 5.55% 4.30% 5.13% 7.80%
Ratios to Average Net Assets:
Expenses (before expense offset) ............ 1.74%(2) 1.80%(3) 1.76%(3) 1.81%(3) 1.69%(3) 1.65 %
Net investment income ....................... 2.80%(2)(4) 4.51% 4.58% 5.11% 5.52% 5.18%
Supplemental Data:
Net assets, end of period, in thousands ..... $ 84,216 $ 90,611 $ 91,695 $ 120,303 $ 150,441 $212,040
Portfolio turnover rate ..................... 14%(1) 19% - 43% 8% -
- ------------
+ Calculated based on the net asset value as of the last business day of the
period.
(1) Not annualized.
(2) Annualized.
(3) Does not reflect the effect of expense offset of 0.01%
(4) Effective November 1, 2001, the Fund has adopted the provisions of the
AICPA Audit and Accounting Guide for Investment Companies, as revised,
related to premiums and discounts on debt securities. The effect of this
change for the six months ended April 30, 2002 was to decrease net
investment income per share by $0.01, decrease net realized and unrealized
gain or loss per share by $ 0.01 and decrease the ratio of net investment
income to average net assets by 0.27%. The Financial Highlights data
presented in this table for prior periods has not been restated to reflect
this change.
See Notes to Financial Statements
14
Trustees
Michael Bozic
Charles A. Fiumefreddo
Edwin J. Garn
Wayne E. Hedien
James F. Higgins
Dr. Manuel H. Johnson
Michael E. Nugent
Philip J. Purcell
John L. Schroeder
Officers
Charles A. Fiumefreddo
Chairman and Chief Executive Officer
Mitchell M. Merin, President
Barry Fink
Vice President, Secretary and General Counsel
Philip A. Barach, Vice President
Jeffrey E. Gundlach, Vice President
Frederick H. Horton, Vice President
Thomas F. Caloia, Treasurer
Transfer Agent
Morgan Stanley Trust
Harborside Financial Center - Plaza Two
Jersey City, New Jersey 07311
Independent Auditors
Deloitte & Touche LLP
Two World Financial Center
New York, New York 10281
Investment Manager
Morgan Stanley Investment Advisors Inc.
1221 Avenue of the Americas
New York, New York 10020
Sub-Advisor
TCW Investment Management Company
865 South Figueroa Street, Suite 1800
Los Angeles, California 90017
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 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. 37946RPT
[MORGAN STANLEY LOGO]
Morgan Stanley
North American
Government
Income Trust
Semiannual Report
April 30, 2002
Morgan Stanley North American Government Income Trust
LETTER TO THE SHAREHOLDERS o OCTOBER 31, 2001
Dear Shareholder:
Just as the U.S. economy appeared to be rebounding from its slowest period of
growth in a decade, the September 11th terrorist attacks brought economic
activity temporarily to a halt. The Federal Reserve Bank's commitment to
stabilizing the financial markets was swiftly demonstrated by a 50-basis-point
rate cut and an unprecedented increase in temporary reserves. At the time, many
analysts correctly predicted that the U.S. economy would suffer a recession as
a result of these attacks. Indeed, much of the data on the economy since the
terrorist attacks has been weak. Consumer confidence and spending have declined
while layoffs and unemployment have risen. Some analysts have expressed concern
about the effectiveness of monetary policy in an environment of plunging
business and consumer confidence, but most economists are forecasting one of
the smallest recessions since World War II and expect the economy to recover by
early to mid year in 2002.
Fixed-Income Market Overview
The pronounced slowdown in the U.S. economy has led the Federal Reserve to
implement 10 rate cuts in the last 10 months. The federal funds rate currently
stands at 2.00 percent, its lowest level since September 1961. Equity market
losses and, more recently, the terrorist attacks and concerns about the war in
Afghanistan have also driven U.S. Treasury yields lower. Yields on three- and
six-month Treasuries have fallen approximately 400 basis points over the past
12 months, and the two-year Treasury is down 349 basis points. The rate
declines in the longer maturities have been less pronounced but remain
significant. The yield on the 10-year Treasury fell 152 basis points since last
October to close at 4.23 percent on October 31, 2001, while the yield on the
30-year Treasury fell 91 basis points to 4.87 percent.
The U.S. Treasury Department's surprise announcement that it would no longer
issue long bonds led to substantial declines in the yields of long Treasury
bonds on the final day of October. Mortgage rates have not fallen as much or as
fast as Treasury rates, but mortgage rates have hit record lows. As a result,
refinancing activity in the mortgage sector has soared to record highs and is
expected to remain high as long as rates stay close to current levels. In spite
of the sharp increase in prepayment risk, the demand for mortgage products has
been strong. As overall credit conditions have softened, investors have found
value in mortgages' high credit quality and liquidity. Discount securities,
well-structured collateralized mortgage obligations (CMOs) and other
call-protected assets performed well as interest rates fell.
Performance and Portfolio
For the 12-month period ended October 31, 2001, Morgan Stanley North American
Government Income Trust posted a total return of 7.43 percent, compared to
12.42 percent for the Lehman Brothers Short (1-5) U.S. Government Index.
According to TCW Investment Management Company (TCW), the Fund's sub-advisor,
the Fund's underperformance relative to its benchmark was due primarily to its
shorter duration. During the period under review, short assets underperformed
longer-term issues.
Morgan Stanley North American Government Income Trust
LETTER TO THE SHAREHOLDERS o OCTOBER 31, 2001 continued
As of October 31, 2001, 100 percent of the Fund's portfolio was invested in the
United States. TCW continues to emphasize high-quality mortgage-backed
securities, including various types of AAA-rated CMOs, pass-through securities
and adjustable-rate mortgages (ARMs).
The Fund is currently on the sidelines with respect to investing in both the
Mexican and Canadian markets. TCW continues to monitor these markets for
investment opportunities that are attractive relative to those in the United
States.
Looking Ahead
Although the mortgage sector is in the midst of the largest refinancing wave on
record, TCW believes that several favorable trends support a positive outlook
on performance in the coming months. Spreads between mortgages and Treasuries
are still above historic norms, enhancing expected returns in both rising and
falling interest-rate environments. Additionally, the steeper yield curve
rewards investors with wider spreads relative to Treasuries as the average
lives of mortgage securities shorten due to prepayments. According to TCW,
demand for mortgage products, particularly from the banking industry, is
expected to remain high and CMO issuance has been reported at record levels.
The sub-advisor's investment strategy continues to emphasize call protection as
a means of reducing exposure to prepayment rate and reinvestment rate risk. As
always, the vast majority of the Fund's holdings have been issued by the U.S.
government and its agencies and instrumentalities. These factors underly TCW's
positive outlook for the mortgage sector over the next few months.
We appreciate your ongoing support of Morgan Stanley North American Government
Income Trust and look forward to continuing to serve your investment needs and
objectives.
Very truly yours,
/s/ Charles A. Fiumefreddo /s/ Mitchell M. Merin
Charles A. Fiumefreddo Mitchell M. Merin
Chairman of the Board President
2
Morgan Stanley North American Government Income Trust
RESULTS OF SPECIAL MEETING
On June 26, 2001, a special meeting of shareholders of the Fund was held for
the purpose of voting on the following proposal:
Approval of a new Sub-Advisory Agreement between Morgan Stanley Investment
Advisors Inc. and TCW Investment Management Company, a wholly owned
subsidiary of The TCW Group, Inc., in connection with the proposed
acquisition of a controlling interest in The TCW Group, Inc. by Societe
Generale Asset Management, S.A., a wholly owned subsidiary of Societe
Generale, S.A:
For ............. 6,364,726
Against ......... 183,171
Abstain ......... 454,167
3
Morgan Stanley North American Government Income Trust
FUND PERFORMANCE o OCTOBER 31, 2001
[GRAPHIC OMITTED]
MORGAN STANLEY NORTH AMERICAN GOVERNMENT INCOME TRUST
FUND PERFORMANCE OCTOBER 31, 2001
GROWTH OF $10,000
Date Total Lehman
- ------------------------------------------------------------------------------
July 31, 1992 $10,000 $10,000
October 31, 1992 $10,128 $10,120
January 31, 1993 $10,455 $10,357
April 30, 1993 $10,734 $10,594
July 31, 1993 $10,977 $10,691
October 31, 1993 $11,075 $10,879
January 31, 1994 $11,272 $10,989
April 30, 1994 $10,694 $10,711
July 31, 1994 $10,727 $10,856
October 31, 1994 $10,515 $10,846
January 31, 1995 $9,478 $10,979
April 30, 1995 $9,962 $11,343
July 31, 1995 $10,356 $11,697
October 31, 1995 $10,684 $11,957
January 31, 1996 $11,043 $12,294
April 30, 1996 $10,616 $12,164
July 31, 1996 $10,969 $12,322
October 31, 1996 $11,366 $12,658
January 31, 1997 $11,418 $12,803
April 30, 1997 $11,535 $12,911
July 31, 1997 $12,075 $13,293
October 31, 1997 $12,253 $13,524
January 31, 1998 $12,420 $13,808
April 30, 1998 $12,543 $13,920
July 31, 1998 $12,845 $14,143
October 31, 1998 $12,881 $14,679
January 31, 1999 $13,180 $14,759
April 30, 1999 $13,326 $14,779
July 31, 1999 $13,364 $14,796
October 31, 1999 $13,435 $14,978
January 31, 2000 $13,452 $14,954
April 30, 2000 $13,644 $15,206
July 31, 2000 $13,887 $15,557
October 31, 2000 $14,182 $15,929
January 31, 2001 $14,639 $16,570
April 30, 2001 $14,807 $16,839
July 31, 2001 $14,977 $17,227
October 31, 2001 $15,236 (2) $17,906
------ Fund ----Lehman (3)
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE RETURNS. INVESTMENT RETURN AND
PRINCIPAL VALUE WILL FLUCTUATE. WHEN YOU SELL FUND SHARES, THEY MAY BE WORTH
LESS THAN THEIR ORIGINAL COST.
Average Annual Total Returns
- -----------------------------
PERIOD ENDED 10/31/01
- ---------------------------
1 Year 7.43%(1)
5 Years 6.03%(1)
Since Inception (7/31/92) 4.66%(1)
- ------------
(1) Figure shown assumes reinvestment of all distributions. There is no sales
charge.
(2) Closing value assuming a complete redemption on October 31, 2001.
(3) The Lehman Brothers U.S. Government Index (1-5 Year) measures the
performance of all U.S. government agency and Treasury securities with
maturities of one to five years. The Index does not include any expenses,
fees or charges. The Index is unmanaged and should not be considered an
investment.
4
Morgan Stanley North American Government Income Trust
PORTFOLIO OF INVESTMENTS o OCTOBER 31, 2001
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------------------
U.S. Government Agency Mortgage-Backed Securities (59.7%)
$ 5,000 Federal Farm Credit Bank ................................... 6.25 % 12/02/02 $5,215,915
5,000 Federal Home Loan Mortgage Corp. ........................... 4.50 08/15/04 5,169,575
1,467 Federal Home Loan Mortgage Corp. ARM ....................... 7.035 03/01/25 1,503,383
4,087 Federal National Mortgage Assoc. ........................... 5.876 07/01/31 4,158,695
4,743 Federal National Mortgage Assoc. ........................... 7.00 01/01/04 5,012,770
464 Federal National Mortgage Assoc. ........................... 9.50 06/01/20 516,803
8,760 Government National Mortgage Assoc. II ARM ................. 6.375 06/20/22-
06/20/25 8,973,913
8,218 Government National Mortgage Assoc. II ARM ................. 6.50 08/20/29 8,375,144
4,261 Government National Mortgage Assoc. II ARM ................. 7.00 07/20/29-
09/20/29 4,356,565
2,164 Government National Mortgage Assoc. II ARM ................. 7.625 10/20/24-
12/20/24 2,225,930
8,341 Government National Mortgage Assoc. II ARM ................. 7.75 08/20/22 8,581,233
----------
Total U.S. Government Agency Mortgage Backed-Securities
(Cost $52,830,255) .................................................................. 54,089,926
----------
Collateralized Mortgage Obligations (16.0%)
U.S. Government Agencies
5 Federal Home Loan Mortgage Corp. 1370 K (PAC IO) ........... 1,089.16 09/15/22 79,763
8,186 Federal Home Loan Mortgage Corp. G 21 M .................... 6.50 10/25/23 8,648,329
404 Federal National Mortgage Assoc. 1993-167 M (PAC) .......... 6.00 09/25/23 404,279
5,000 Federal National Mortgage Assoc. G96-1 PJ (PAC) ............ 7.50 11/17/25 5,345,300
----------
Total Collateralized Mortgage Obligations (Cost $13,970,383)......................... 14,477,671
----------
Short-Term Investments (24.6%)
Commercial Paper (a) (21.8%)
Finance/Rental/Leasing (18.5%)
12,000 International Lease Finance Corp. .......................... 2.48 11/05/01 11,996,693
4,800 International Lease Finance Corp. .......................... 2.50 11/06/01 4,798,333
----------
16,795,026
----------
Insurance (3.3%)
3,000 American General Corp. ..................................... 2.47 11/06/01 2,998,971
----------
Total Commercial Paper (Cost $19,793,997)............................................ 19,793,997
----------
See Notes to Financial Statements
5
Morgan Stanley North American Government Income Trust
PORTFOLIO OF INVESTMENTS o OCTOBER 31, 2001 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------- ---------- ---------- ---------------
Repurchase Agreement (2.8%)
$ 2,557 The Bank of New York (dated 10/31/01; proceeds
$2,557,353) (b) (Cost $2,557,175)................. 2.5 % 11/01/01 $ 2,557,175
-----------
Total Short-Term Investments (Cost $22,351,172)......................... 22,351,172
-----------
Total Investments (Cost $89,151,810) (c).......... 100.3 % 90,918,769
Liabilities in Excess of Other Assets ............ (0.3) (307,495)
-----------
Net Assets ....................................... 100.0 % $90,611,274
===========
- ------------
ARM Adjustable Rate Mortgage.
IO Interest-only securities.
PAC Planned Amortization Class.
(a) Purchased on a discount basis. The interest rate shown has been
adjusted to reflect a money market equivalent yield.
(b) Collateralized by $1,896,866 U.S. Treasury Bond 7.875% due 02/15/21
valued at $2,608,323.
(c) The aggregate cost for federal income tax purposes approximates the
aggregate cost for book purposes. The aggregate gross unrealized
appreciation is $2,228,467 and the aggregate gross unrealized
depreciation is $461,508, resulting in net unrealized appreciation
of $1,766,959.
See Notes to Financial Statements
6
Morgan Stanley North American Government Income Trust
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
October 31, 2001
Assets:
Investments in securities, at value
(cost $89,151,810) ............................... $ 90,918,769
Receivable for:
Interest ...................................... 513,178
Shares of beneficial interest sold ............ 80,037
Principal paydowns ............................ 56,078
Prepaid expenses ................................... 15,229
------------
Total Assets .................................... 91,583,291
------------
Liabilities:
Payable for:
Shares of beneficial interest repurchased ..... 736,504
Distribution fee .............................. 59,057
Investment management fee ..................... 51,183
Payable to bank .................................... 68,845
Accrued expenses ................................... 56,428
------------
Total Liabilities ............................... 972,017
------------
Net Assets ...................................... $ 90,611,274
============
Composition of Net Assets:
Paid-in-capital .................................... $320,616,404
Net unrealized appreciation ........................ 1,766,959
Accumulated undistributed net investment
income ........................................... 329,619
Accumulated net realized loss ...................... (232,101,708)
------------
Net Assets ...................................... $ 90,611,274
============
Net Asset Value Per Share,
10,278,823 shares outstanding (unlimited
shares authorized of $.01 par value) .......... $ 8.82
============
Statement of Operations
For the year ended October 31, 2001
Net Investment Income:
Interest Income ............................... $5,715,195
----------
Expenses
Distribution fee .............................. 663,568
Investment management fee ..................... 587,228
Transfer agent fees and expenses .............. 180,881
Professional fees ............................. 68,090
Shareholder reports and notices ............... 50,430
Registration fees ............................. 40,483
Custodian fees ................................ 14,262
Trustees' fees and expenses ................... 12,511
Other ......................................... 11,976
----------
Total Expenses ............................. 1,629,429
Less: expense offset .......................... (13,363)
----------
Net Expenses ............................... 1,616,066
----------
Net Investment Income ...................... 4,099,129
----------
Net change in unrealized depreciation ......... 2,295,697
----------
Net Increase .................................. $6,394,826
==========
See Notes to Financial Statements
7
Morgan Stanley North American Government Income Trust
FINANCIAL STATEMENTS continued
Statement of Changes in Net Assets
FOR THE YEAR FOR THE YEAR
ENDED ENDED
OCTOBER 31, 2001 OCTOBER 31, 2000
------------------ -----------------
Increase (Decrease) in Net Assets:
Operations:
Net investment income ....................................................... $ 4,099,129 $ 4,837,596
Net realized gain ........................................................... - 792,094
Net change in unrealized depreciation ....................................... 2,295,697 (109,419)
------------ -------------
Net Increase .............................................................. 6,394,826 5,520,271
Dividends to shareholders from net investment income ........................ (4,171,176) (4,457,000)
Net decrease from transactions in shares of beneficial interest ............. (3,307,860) (29,670,526)
------------ -------------
Net Decrease .............................................................. (1,084,210) (28,607,255)
Net Assets:
Beginning of period ......................................................... 91,695,484 120,302,739
------------ -------------
End of Period
(Including accumulated undistributed net investment income of $329,619 and
$504,364, respectively)...................................................... $ 90,611,274 $ 91,695,484
============ =============
See Notes to Financial Statements
8
Morgan Stanley North American Government Income Trust
NOTES TO FINANCIAL STATEMENTS o October 31, 2001
1. Organization and Accounting Policies
Morgan Stanley North American Government Income Trust (the "Fund"), formerly
Morgan Stanley Dean Witter North American Government Income Trust, is
registered under the Investment Company Act of 1940, as amended (the "Act"), as
a non-diversified, open-end management investment company. The Fund's
investment objective is to earn a high level of income while maintaining
relatively low volatility of principal. The Fund was organized as a
Massachusetts business trust on February 19, 1992 and commenced operations on
July 31, 1992.
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.
The following is a summary of significant accounting policies:
A. Valuation of Investments - (1) portfolio securities for which
over-the-counter market quotations are readily available are valued at the
latest available bid price prior to the time of valuation; (2) when market
quotations are not readily available, including circumstances under which it is
determined by Morgan Stanley Investment Advisors Inc. (the "Investment
Manager"), formerly Morgan Stanley Dean Witter Advisors Inc., or TCW Investment
Management Company (the "Sub-Advisor") that sale or bid prices are not
reflective of a security's market value, portfolio securities are valued at
their fair value as determined in good faith under procedures established by
and under the general supervision of the Trustees (valuation of debt securities
for which market quotations are not readily available may be based upon current
market prices of securities which are comparable in coupon, rating and maturity
or an appropriate matrix utilizing similar factors); and (3) 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.
The Fund amortizes premiums and accretes discounts based on the respective life
of the securities. Interest income is accrued daily.
C. Foreign Currency Translation - The books and records of the Fund are
maintained in U.S. dollars as follows: (1) the foreign currency market value of
investment securities, other assets and liabilities and forward foreign
currency contracts ("forward contracts") are translated at the exchange rates
prevailing at the end of the period; and (2) purchases, sales, income and
expenses are translated at the exchange rates prevailing on the respective
dates of such transactions. The resultant exchange gains and losses are
9
Morgan Stanley North American Government Income Trust
NOTES TO FINANCIAL STATEMENTS o October 31, 2001 continued
included in the Statement of Operations as realized and unrealized gain/loss on
foreign exchange transactions. Pursuant to U.S. federal income tax regulations,
certain foreign exchange gains/losses included in realized and unrealized
gain/loss are included in or are a reduction of ordinary income for federal
income tax purposes. The Fund does not isolate that portion of the results of
operations arising as a result of changes in the foreign exchange rates from
the changes in the market prices of the securities.
D. Forward Foreign Currency Contracts - The Fund may enter into forward
contracts which are valued daily at the appropriate exchange rates. The
resultant unrealized exchange gains and losses are included in the Statement of
Operations as unrealized foreign currency gain or loss. The Fund records
realized gains or losses on delivery of the currency or at the time the forward
contract is extinguished (compensated) by entering into a closing transaction
prior to delivery.
E. Dollar Rolls - The Fund may enter into dollar rolls in which the Fund sells
securities for delivery and simultaneously contracts to repurchase
substantially similar securities at the current sales price on a specified
future date. The difference between the current sales price and the lower
forward price for the future purchase (often referred to as the "drop") is
amortized over the life of the dollar roll.
F. Federal Income Tax Status - It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute substantially all of its taxable income to its
shareholders. Accordingly, no federal income tax provision is required.
G. Dividends and Distributions to Shareholders - The Fund records dividends and
distributions to its shareholders on the ex-dividend date. 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.
2. Investment Management and Sub-Advisory Agreements
Pursuant to an Investment Management Agreement, the Fund pays the Investment
Manager a management 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: 0.65% to the portion of the daily net assets not
exceeding $500 million and 0.60% to the portion of the daily net assets
exceeding $500 million.
10
Morgan Stanley North American Government Income Trust
NOTES TO FINANCIAL STATEMENTS o October 31, 2001 continued
Under a Sub-Advisory Agreement between the Investment Manager and the
Sub-Advisor, the Sub-Advisor provides the Fund with investment advice and
portfolio management relating to the Fund's investments in securities, subject
to the overall supervision of the Investment Manager. As compensation for its
services provided pursuant to the Sub-Advisory Agreement, the Investment
Manager pays the Sub-Advisor compensation equal to 40% of its monthly
compensation.
3. Plan of Distribution
Morgan Stanley Distributors Inc. (the "Distributor"), an affiliate of the
Investment Manager, is the distributor of the Fund's shares and, in accordance
with a Plan of Distribution (the "Plan") pursuant to Rule 12b-1 under the Act,
finances certain expenses in connection with the distribution of shares of the
Fund.
The Fund is authorized to reimburse the Distributor for specific expenses the
Distributor incurs or plans to incur in promoting the distribution of the
Fund's shares. The amount of each monthly reimbursement payment may in no event
exceed an amount equal to a payment at the annual rate of 0.75% of the Fund's
average daily net assets during the month. Expenses incurred pursuant to the
Plan in any fiscal year in excess of 0.75% of the Fund's average daily net
assets will not be reimbursed by the Fund through payments accrued in any
subsequent fiscal year. For the year ended October 31, 2001, the distribution
fee was accrued at the annual rate of 0.73%.
4. Security Transactions and Transactions with Affiliates
The purchases and proceeds from prepayments of portfolio securities, excluding
short-term investments, for the year ended October 31, 2001 were as follows:
PURCHASES PREPAYMENTS
-------------- --------------
U.S. Government Agencies . . . . . . . . . . . . . . . . . . . . . . . ........ $14,444,850 $31,100,601
Private Issue CMOs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. - 1,781,743
Morgan Stanley Trust, an affiliate of the Investment Manager and Distributor,
is the Fund's transfer agent. At October 31, 2001, the Fund had transfer agent
fees and expenses payable of approximately $8,100.
11
Morgan Stanley North American Government Income Trust
NOTES TO FINANCIAL STATEMENTS o October 31, 2001 continued
5. Shares of Beneficial Interest
Transactions in shares of beneficial interest were as follows:
FOR THE YEAR FOR THE YEAR
ENDED ENDED
OCTOBER 31, 2001 OCTOBER 31, 2000
---------------------------------- ----------------------------------
SHARES AMOUNT SHARES AMOUNT
---------------- ----------------- ---------------- -----------------
Sold .............................. 13,631,877 $ 119,393,140 27,659,513 $ 235,059,575
Reinvestment of dividends ......... 359,700 3,137,960 390,253 3,309,760
Repurchased ....................... (14,370,369) (125,838,960) (31,548,244) (268,039,861)
----------- -------------- ----------- --------------
Net decrease ...................... (378,792) $ (3,307,860) (3,498,478) $ (29,670,526)
=========== ============== =========== ==============
6. Federal Income Tax Status
During the year ended October 31, 2001, the Fund utilized approximately
$103,000 of its net capital loss carryover. At October 31, 2001, the Fund had a
net capital loss carryover of approximately $232,102,000, to offset future
capital gains to the extent provided by regulations, available through October
31 of the following years:
AMOUNT IN THOUSANDS
- --------------------------------------------------------------------------------
2002 2003 2004 2005 2006 2007 2008
- ------------ ----------- ---------- --------- ------ --------- -----
$ 52,983 $160,560 $14,716 $2,013 $152 $1,657 $21
========= ======== ======= ====== ==== ====== ===
As of October 31, 2001, the Fund had permanent book/tax differences
attributable to reclassifications of net gains on paydowns. To reflect
reclassifications arising from these differences, accumulated undistributed net
investment income was charged $102,698 and accumulated net realized loss was
credited $102,698.
7. Reverse Repurchase and Dollar Roll Agreements
Reverse repurchase and dollar roll agreements involve the risk that the market
value of the securities the Fund is obligated to repurchase under the agreement
may decline below the repurchase price. In the event the buyer of securities
under a reverse repurchase or dollar roll agreement files for bankruptcy or
becomes insolvent, the Fund's use of proceeds of the agreement may be
restricted pending a determination by the other party, its trustee or receiver,
whether to enforce the Fund's obligation to repurchase the securities.
Reverse repurchase agreements are collateralized by Fund securities with a
market value in excess of the Fund's obligation under the contract.
At October 31, 2001, there were no outstanding reverse repurchase or dollar
roll agreements.
12
Morgan Stanley North American Government Income Trust
NOTES TO FINANCIAL STATEMENTS o OCTOBER 31, 2001 continued
8. Expense Offset
The expense offset represents a reduction of the custodian fees for earnings on
cash balances maintained by the Fund.
9. Purposes of and Risks Relating to Certain Financial Instruments
The Fund may enter into forward contracts to facilitate settlement of foreign
currency denominated portfolio transactions or to manage foreign currency
exposure associated with foreign currency denominated securities.
Forward contracts involve elements of market risk in excess of the amounts
reflected in the Statement of Assets and Liabilities. The Fund bears the risk
of an unfavorable change in the foreign exchange rates underlying the forward
contracts. Risks may also arise upon entering into these contracts from the
potential inability of the counterparties to meet the terms of their contracts.
At October 31, 2001, there were no outstanding forward contracts.
10. Change in Accounting Policy
Effective November 1, 2001, the Fund will adopt the provisions of the AICPA
Audit and Accounting Guide for Investment Companies, as revised, related to
premiums and discounts on debt securities. The cumulative effect of this
accounting change will have no impact on the net assets of the Fund, but will
result in an adjustment to the cost of securities and a corresponding
adjustment to undistributed net investment income based on securities held as
of October 31, 2001.
13
Morgan Stanley North American Government Income Trust
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of beneficial interest
outstanding throughout each period:
FOR THE YEAR ENDED OCTOBER 31
----------------------------------
2001 2000
----------------- ----------------
Selected Per Share Data:
Net asset value, beginning of period ......... $8.60 $8.50
----- -----
Income (loss) from investment operations:
Net investment income ....................... 0.40 0.40
Net realized and unrealized gain (loss) ..... 0.22 0.06
----- -----
Total income from investment operations ...... 0.62 0.46
----- -----
Less dividends and distributions from:
Net investment income ....................... (0.40) (0.36)
Paid-in-capital ............................. - -
----- -----
Total dividends and distributions ............ (0.40) (0.36)
----- -----
Net asset value, end of period ............... $8.82 $8.60
===== =====
Total Return+ ................................ 7.43% 5.55%
Ratios to Average Net Assets:
Expenses (before expense offset) ............. 1.80%(1) 1.76%(1)
Net investment income ........................ 4.51% 4.58%
Supplemental Data:
Net assets, end of period, in thousands ...... $90,611 $91,695
Portfolio turnover rate ...................... 19% -
FOR THE YEAR ENDED OCTOBER 31
----------------------------------------------------
1999 1998 1997
----------------- ------------------ ---------------
Selected Per Share Data:
Net asset value, beginning of period ......... $8.60 $8.59 $8.39
----- ----- ------
Income (loss) from investment operations:
Net investment income ....................... 0.44 0.49 0.44
Net realized and unrealized gain (loss) ..... (0.09) (0.05) 0.19
----- ----- ------
Total income from investment operations ...... 0.35 0.44 0.63
----- ----- ------
Less dividends and distributions from:
Net investment income ....................... (0.38) (0.43) (0.43)
Paid-in-capital ............................. (0.07) - -
----- ----- -----
Total dividends and distributions ............ (0.45) (0.43) (0.43)
----- ----- -----
Net asset value, end of period ............... $8.50 $8.60 $8.59
===== ===== =====
Total Return+ ................................ 4.30% 5.13% 7.80%
Ratios to Average Net Assets:
Expenses (before expense offset) ............. 1.81%(1) 1.69%(1) 1.65%
Net investment income ........................ 5.11% 5.52% 5.18%
Supplemental Data:
Net assets, end of period, in thousands ...... $120,303 $150,441 $212,040
Portfolio turnover rate ...................... 43% 8% -
- ------------
+ Calculated based on the net asset value as of the last business day of the
period.
(1) Does not reflect the effect of expense offset of 0.01%.
See Notes to Financial Statements
14
Morgan Stanley North American Government Income Trust
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Trustees of
Morgan Stanley North American Government Income Trust:
We have audited the accompanying statement of assets and liabilities of Morgan
Stanley North American Government Income Trust (the "Fund"), formerly Morgan
Stanley Dean Witter North American Government Income Trust, including the
portfolio of investments, as of October 31, 2001, and the related statement of
operations for the year then ended, the statements of changes in net assets for
each of the two years in the period then ended, and the financial highlights
for each of the five years in the period then ended. These financial statements
and financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements and financial highlights are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. Our procedures
included confirmation of securities owned as of October 31, 2001, by
correspondence with the custodian. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Morgan Stanley North American Government Income Trust as of October 31, 2001,
the results of its operations for the year then ended, the changes in its net
assets for each of the two years in the period then ended, and the financial
highlights for each of the five years in the period then ended, in conformity
with accounting principles generally accepted in the United States of America.
Deloitte & Touche LLP
New York, New York
December 11, 2001
2001 Federal Tax Notice (unaudited)
Of the Fund's ordinary income dividends paid during the fiscal year ended
October 31, 2001, 3.08% was attributable to qualifying Federal
obligations. Please consult your tax advisor to determine if any portion
of the dividends you received is exempt from state income tax.
15
TRUSTEES
Michael Bozic
Charles A. Fiumefreddo
Edwin J. Garn
Wayne E. Hedien
James F. Higgins
Dr. Manuel H. Johnson
Michael E. Nugent
Philip J. Purcell
John L. Schroeder
OFFICERS
Charles A. Fiumefreddo
Chairman and Chief Executive Officer
Mitchell M. Merin
President
Barry Fink
Vice President, Secretary and General Counsel
Philip A. Barach
Vice President
Jeffrey E. Gundlach
Vice President
Frederick H. Horton
Vice President
Thomas F. Caloia
Treasurer
TRANSFER AGENT
Morgan Stanley Trust
Harborside Financial Center - Plaza Two
Jersey City, New Jersey 07311
INDEPENDENT AUDITORS
Deloitte & Touche LLP
Two World Financial Center
New York, New York 10281
INVESTMENT MANAGER
Morgan Stanley Investment Advisors Inc.
1221 Avenue of the Americas
New York, New York 10020
SUB-ADVISOR
TCW Investment Management Company
865 South Figueroa Street, Suite 1800
Los Angeles, California 90017
This report is submitted for the general information of shareholders of the
Fund. For more detailed information about the Fund, its officers and trustees,
fees, expenses and other pertinent information, please see the prospectus of
the Fund.
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
MorganStanley
[GRAPHIC OMITTED]
Morgan Stanley
North American
Government
Income Trust
Annual Report
October 31, 2001
MORGAN STANLEY LIMITED DURATION FUND
PART B
STATEMENT OF ADDITIONAL INFORMATION
This Statement of Additional Information relates to the shares of Morgan
Stanley Limited Duration Fund ("Limited Duration") to be issued pursuant to an
Agreement and Plan of Reorganization, dated April 25, 2002, between Limited
Duration and Morgan Stanley North American Government Income Trust ("North
American") in connection with the acquisition by Limited Duration of
substantially all of the assets, subject to stated liabilities, of North
American. This Statement of Additional Information does not constitute a
prospectus. This Statement of Additional Information does not include all
information that a shareholder should consider before voting on the proposals
contained in the Proxy Statement and Prospectus, and, therefore, should be read
in conjunction with the related Proxy Statement and Prospectus, dated July ,
2002. A copy of the Proxy Statement and Prospectus may be obtained without
charge by mailing a written request to Limited Duration, c/o Morgan Stanley
Trust, Harborside Financial Center, Plaza Two, Jersey City, NJ 07311 or by
calling (800) 869-NEWS (TOLL FREE). Please retain this document for future
reference.
The date of this Statement of Additional Information is July , 2002.
B-1
TABLE OF CONTENTS
PAGE
-----
INTRODUCTION ........................................... B-3
ADDITIONAL INFORMATION ABOUT LIMITED DURATION .......... B-3
FINANCIAL STATEMENTS ................................... B-4
B-2
INTRODUCTION
This Statement of Additional Information is intended to supplement the
information provided in the Proxy Statement and Prospectus dated July , 2002
(the "Proxy Statement and Prospectus"). The Proxy Statement and Prospectus has
been sent to North American shareholders in connection with the solicitation of
proxies by the Board of Trustees of North American to be voted at the Special
Meeting of shareholders of Capital Growth to be held on September 24, 2002.
This Statement of Additional Information incorporates by reference the
Statement of Additional Information of Limited Duration dated June 28, 2002 and
the Statement of Additional Information of North American dated December 31,
2001.
ADDITIONAL INFORMATION ABOUT LIMITED DURATION
INVESTMENT OBJECTIVES AND POLICIES
For additional information about Limited Duration's investment objectives
and policies, see "Description of the Fund and Its Investments and Risks" in
Limited Duration's Statement of Additional Information.
MANAGEMENT
For additional information about the Board of Trustees, officers and
management personnel of Limited Duration, see "Management of the Fund" and
"Investment Management and Other Services" in Limited Duration's Statement of
Additional Information.
INVESTMENT ADVISORY AND OTHER SERVICES
For additional information about Limited Duration's investment manager,
see "Investment Management and Other Services" in Limited Duration's Statement
of Additional Information. For additional information about Limited Duration's
independent auditors, see "Investment Management and Other Services" in Limited
Duration's Statement of Additional Information. For additional information
about other services provided to Limited Duration, see "Investment Management
and Other Services" in Limited Duration's Statement of Additional Information.
PORTFOLIO TRANSACTIONS AND BROKERAGE
For additional information about brokerage allocation practices, see
"Brokerage Allocation and Other Practices" in Limited Duration's Statement of
Additional Information.
DESCRIPTION OF FUND SHARES
For additional information about the voting rights and other
characteristics of the shares of Limited Duration, see "Capital Stock and Other
Securities" in Limited Duration's Statement of Additional Information.
PURCHASE, REDEMPTION AND PRICING OF SHARES
For additional information about the purchase and redemption of Limited
Duration's shares and the determination of net asset value, see "Purchase,
Redemption and Pricing of Shares" in Limited Duration's Statement of Additional
Information.
DIVIDENDS, DISTRIBUTIONS AND TAX STATUS
For additional information about Limited Duration's policies regarding
dividends and distributions and tax matters affecting Limited Duration and its
shareholders, see "Taxation of the Fund and Shareholders" in Limited Duration's
Statement of Additional Information.
B-3
DISTRIBUTION OF SHARES
For additional information about Limited Duration's distributor and the
distribution agreement between Limited Duration and its distributor, see
"Investment Management and Other Services" and "Underwriters" in Limited
Duration's Statement of Additional Information.
PERFORMANCE DATA
For additional information about Limited Duration's performance, see
"Calculation of Performance Data" in Limited Duration's Statement of Additional
Information.
FINANCIAL STATEMENTS
Limited Duration's most recent audited financial statements are set forth
in Limited Duration's Annual Report for the fiscal year ended April 30, 2002. A
copy of the Annual Report accompanies, and is incorporated by reference in, the
Proxy Statement and Prospectus. North American's most recent audited financial
statements are set forth in North American's Annual Report for the fiscal year
ended October 31, 2001, and its unaudited financial statements are set forth in
its Semi-Annual Report for the six-month period ended April 30, 2002, both of
which are incorporated by reference in the Proxy Statement and Prospectus.
B-4
MORGAN STANLEY LIMITED DURATION FUND
PRO FORMA PORTFOLIO OF INVESTMENTS AS OF APRIL 30, 2002
(UNAUDITED)
MORGAN STANLEY
LIMITED DURATION FUND
-------------------------
PRINCIPAL
AMOUNT
COUPON MATURITY IN
RATE DATE THOUSANDS VALUE
---------- ---------- ----------- -------------
CORPORATE BONDS (17.9%)
Aerospace & Defense (0.4%)
Lockheed Martin Corp. ................ 7.25% 05/15/06 $ 475 $ 505,789
Raytheon Co. ......................... 8.20 03/01/06 390 424,271
Raytheon Co. ......................... 6.75 08/15/07 55 57,024
-----------
987,084
-----------
Airlines (0.1%)
Southwest Airlines Co. ............... 5.496 11/01/06 130 129,894
-----------
Auto Parts: O.E.M. (0.3%)
Delphi Automotive Systems Corp. 6.125 05/01/04 405 414,539
Johnson Controls, Inc ................ 5.00 11/15/06 385 377,791
-----------
792,330
-----------
Broadcasting (0.8%)
Clear Channel Communications
Corp.** ............................. 7.25 09/15/03 2,000 2,050,068
-----------
Cable/Satellite TV (1.0%)
Comcast Cable ........................ 6.375 01/30/06 530 531,759
Cox Enterprises Inc. -- 144A* ** ..... 6.625 06/14/02 1,000 1,002,798
Rogers Cablesystems, Ltd. ............ 9.625 08/01/02 800 802,000
TCI Communications, Inc. ............. 8.00 08/01/05 215 226,678
-----------
2,563,235
-----------
Department Stores (0.3%)
Federated Dept Stores ................ 8.50 06/15/03 495 519,221
May Dept Stores Co. .................. 6.875 11/01/05 130 137,974
-----------
657,195
-----------
Discount Stores (0.1%)
Target Corp. ......................... 7.50 02/15/05 310 334,166
-----------
Drugstore Chains (0.2%)
CVS Corp. ............................ 5.625 03/15/06 455 456,574
-----------
Electric Utilities (0.2%)
Progress Energy Inc. ................. 6.75 03/01/06 525 544,046
-----------
Environmental Services (0.3%)
WMX Technologies Inc. ................ 7.00 10/15/06 660 676,641
-----------
Finance/Rental/Leasing (1.7%)
American General Finance Corp. ....... 5.875 07/14/06 740 751,335
Ford Motor Credit Co. ................ 6.875 02/01/06 1,090 1,104,187
Ford Motor Credit Co. ................ 6.50 01/25/07 200 198,701
Household Finance Corp. .............. 6.50 01/24/06 875 897,343
Household Finance Corp. .............. 5.75 01/30/07 290 285,856
MBNA America Bank N.A. ............... 7.75 09/15/05 75 80,491
MBNA America Bank N.A. ............... 6.50 06/20/06 445 453,776
MORGAN STANLEY
NORTH AMERICAN
GOVERNMENT
INCOME TRUST COMBINED
------------------------ -------------------------
PRINCIPAL PRINCIPAL
AMOUNT AMOUNT
IN IN
THOUSANDS VALUE THOUSANDS VALUE
----------- ------------ ----------- -------------
CORPORATE BONDS (17.9%)
Aerospace & Defense (0.4%)
Lockheed Martin Corp. ................ -- $ 475 $ 505,789
--
Raytheon Co. ......................... -- -- 390 424,271
Raytheon Co. ......................... -- -- 55 57,024
-----------
-- 987,084
---------- -----------
Airlines (0.1%)
Southwest Airlines Co. ............... -- -- 130 129,894
---------- -----------
Auto Parts: O.E.M. (0.3%)
Delphi Automotive Systems Corp. -- -- 405 414,539
Johnson Controls, Inc ................ -- -- 385 377,791
---------- -----------
-- 792,330
---------- -----------
Broadcasting (0.8%)
Clear Channel Communications
Corp.** ............................. -- -- 2,000 2,050,068
---------- -----------
Cable/Satellite TV (1.0%)
Comcast Cable ........................ -- -- 530 531,759
Cox Enterprises Inc. -- 144A* ** ..... -- -- 1,000 1,002,798
Rogers Cablesystems, Ltd. ............ -- -- 800 802,000
TCI Communications, Inc. ............. -- -- 215 226,678
---------- -----------
-- 2,563,235
---------- -----------
Department Stores (0.3%)
Federated Dept Stores ................ -- -- 495 519,221
May Dept Stores Co. .................. -- -- 130 137,974
---------- -----------
-- 657,195
---------- -----------
Discount Stores (0.1%)
Target Corp. ......................... -- -- 310 334,166
---------- -----------
Drugstore Chains (0.2%)
CVS Corp. ............................ -- -- 455 456,574
---------- -----------
Electric Utilities (0.2%)
Progress Energy Inc. ................. -- -- 525 544,046
---------- -----------
Environmental Services (0.3%)
WMX Technologies Inc. ................ -- -- 660 676,641
---------- -----------
Finance/Rental/Leasing (1.7%)
American General Finance Corp. ....... -- -- 740 751,335
Ford Motor Credit Co. ................ -- -- 1,090 1,104,187
Ford Motor Credit Co. ................ -- -- 200 198,701
Household Finance Corp. .............. -- -- 875 897,343
Household Finance Corp. .............. -- -- 290 285,856
MBNA America Bank N.A. ............... -- -- 75 80,491
MBNA America Bank N.A. ............... -- -- 445 453,776
1
MORGAN STANLEY LIMITED DURATION FUND
PRO FORMA PORTFOLIO OF INVESTMENTS AS OF APRIL 30, 2002
(UNAUDITED)
MORGAN STANLEY
LIMITED DURATION FUND
-------------------------
PRINCIPAL
AMOUNT
COUPON MATURITY IN
RATE DATE THOUSANDS VALUE
------------ ---------- ----------- -------------
Prime Property Funding II --
144A* .............................. 6.80 % 08/15/02 $ 145 $ 146,420
Prime Property Funding II --
144A* .............................. 7.00 08/15/04 220 227,604
-----------
4,145,713
-----------
Financial Conglomerates (1.1%)
General Electric Capital Corp.**..... 5.375 03/15/07 1,305 1,314,725
General Motors Acceptance
Corp. .............................. 7.50 07/15/05 395 419,642
J.P. Morgan Chase & Co. ............. 5.35 03/01/07 765 759,505
Tyco Capital Corp. .................. 5.625 05/17/04 160 154,383
Tyco Capital Corp. .................. 6.50 02/07/06 85 80,547
-----------
2,728,802
-----------
Financial Publishing/Services (0.1%)
Reed Elsevier Capital ............... 6.125 08/01/06 200 205,400
-----------
Food Retail (0.5%)
Kroger Co. .......................... 7.375 03/01/05 735 781,967
Safeway Inc. ........................ 6.15 03/01/06 350 359,729
-----------
1,141,696
-----------
Food: Meat/Fish/Dairy (0.1%)
ConAgra Foods, Inc. ................. 6.00 09/15/06 270 275,235
-----------
Foreign Government Obligations
(0.5%)
Quebec Province (Canada)** .......... 5.50 04/11/06 1,025 1,047,893
United Mexican States (Mexico) ...... 8.625 03/12/08 290 316,825
-----------
1,364,718
-----------
Forest Products (0.3%)
Weyerhauser Company -- 144A* ........ 5.50 03/15/05 815 824,839
-----------
Gas Distributors (0.7%)
CMS Panhandle Holding Co. ........... 6.125 03/15/04 530 541,469
Consolidated Natural Gas Co. ........ 5.375 11/01/06 520 512,063
Nisource Finance Corp. .............. 7.625 11/15/05 375 376,635
Ras Laffan Liquefied Natural Gas
Co. Ltd. -- 144A* (Qatar) .......... 7.628 09/15/06 397 415,914
-----------
1,846,081
-----------
Home Building (0.1%)
Centex Corp. ........................ 9.75 06/15/05 240 268,545
-----------
MORGAN STANLEY
NORTH AMERICAN
GOVERNMENT
INCOME TRUST COMBINED
------------------------ -------------------------
PRINCIPAL PRINCIPAL
AMOUNT AMOUNT
IN IN
THOUSANDS VALUE THOUSANDS VALUE
----------- ------------ ----------- -------------
Prime Property Funding II --
144A* .............................. -- $ 145 $ 146,420
--
Prime Property Funding II --
144A* .............................. -- -- 220 227,604
----------- -----------
-- 4,145,713
----------- -----------
Financial Conglomerates (1.1%)
General Electric Capital Corp.**..... -- -- 1,305 1,314,725
General Motors Acceptance
Corp. .............................. -- -- 395 419,642
J.P. Morgan Chase & Co. ............. -- -- 765 759,505
Tyco Capital Corp. .................. -- -- 160 154,383
Tyco Capital Corp. .................. -- -- 85 80,547
----------- -----------
-- 2,728,802
----------- -----------
Financial Publishing/Services (0.1%)
Reed Elsevier Capital ............... -- -- 200 205,400
----------- -----------
Food Retail (0.5%)
Kroger Co. .......................... -- -- 735 781,967
Safeway Inc. ........................ -- -- 350 359,729
----------- -----------
-- 1,141,696
----------- -----------
Food: Meat/Fish/Dairy (0.1%)
ConAgra Foods, Inc. ................. -- -- 270 275,235
----------- -----------
Foreign Government Obligations
(0.5%)
Quebec Province (Canada)** .......... -- -- 1,025 1,047,893
United Mexican States (Mexico) ...... -- -- 290 316,825
----------- -----------
-- 1,364,718
----------- -----------
Forest Products (0.3%)
Weyerhauser Company -- 144A* ........ -- -- 815 824,839
----------- -----------
Gas Distributors (0.7%)
CMS Panhandle Holding Co. ........... -- -- 530 541,469
Consolidated Natural Gas Co. ........ -- -- 520 512,063
Nisource Finance Corp. .............. -- -- 375 376,635
Ras Laffan Liquefied Natural Gas
Co. Ltd. -- 144A* (Qatar) .......... -- -- 397 415,914
----------- -----------
-- 1,846,081
----------- -----------
Home Building (0.1%)
Centex Corp. ........................ -- -- 240 268,545
----------- -----------
2
MORGAN STANLEY LIMITED DURATION FUND
PRO FORMA PORTFOLIO OF INVESTMENTS AS OF APRIL 30, 2002
(UNAUDITED)
MORGAN STANLEY
LIMITED DURATION FUND
-------------------------
PRINCIPAL
AMOUNT
COUPON MATURITY IN
RATE DATE THOUSANDS VALUE
------------ ---------- ----------- -------------
Home Furnishings (0.1%)
Mohawk Industries, Inc. .............. 6.50 % 04/15/07 $ 195 $ 198,914
-----------
Home Improvement Chains (0.2%)
Lowe's Co., Inc. ..................... 7.50 12/15/05 565 614,067
-----------
Hospital/Nursing Management (0.2%)
Tenet Healthcare Corp. ............... 5.375 11/15/06 525 517,200
-----------
Hotels/Resorts/Cruiselines (0.4%)
Hyatt Equities LLC -- 144A* .......... 9.25 05/15/05 280 294,991
Marriott International Inc.
(Ser D) ............................. 8.125 04/01/05 435 467,388
Starwood Hotels Resorts .............. 7.375 05/01/07 295 296,844
-----------
1,059,223
-----------
Industrial Conglomerates (0.4%)
Honeywell International, Inc. ........ 5.125 11/01/06 600 592,918
Tyco International Group S.A.
(Luxembourg) ........................ 6.375 02/15/06 565 476,052
-----------
1,068,970
-----------
Insurance Brokers (0.2%)
Marsh & McLennan Companies,
Inc. ................................ 5.375 03/15/07 600 604,051
-----------
Integrated Oil (0.2%)
Conoco Inc. .......................... 5.90 04/15/04 585 604,940
-----------
Investment Banks/Brokers (0.9%)
Credit Suisse F/B USA, Inc. ** ....... 5.75 04/15/07 805 808,501
Goldman Sachs Group, Inc. ............ 7.625 08/17/05 595 643,678
Lehman Brothers Holdings,
Inc. ** ............................. 6.25 05/15/06 730 752,114
-----------
2,204,293
-----------
Investment Managers (0.4%)
TIAA Global Markets -- 144A* ......... 5.00 03/01/07 1,045 1,035,635
-----------
Life/Health Insurance (1.2%)
Equitable Life Assurance Corp. --
144A* ............................... 6.95 12/01/05 250 264,763
John Hancock Global Fund --
144A* ............................... 5.625 06/27/06 585 588,892
Metropolitan Life Insurance Co. --
144A* ............................... 6.30 11/01/03 625 645,853
Monumental Global Funding II --
144A* ............................... 6.05 01/19/06 330 340,970
MORGAN STANLEY
NORTH AMERICAN
GOVERNMENT
INCOME TRUST COMBINED
------------------------ -------------------------
PRINCIPAL PRINCIPAL
AMOUNT AMOUNT
IN IN
THOUSANDS VALUE THOUSANDS VALUE
----------- ------------ ----------- -------------
Home Furnishings (0.1%)
Mohawk Industries, Inc. .............. -- -- $ 195 $ 198,914
----------- -----------
Home Improvement Chains (0.2%)
Lowe's Co., Inc. ..................... -- -- 565 614,067
----------- -----------
Hospital/Nursing Management (0.2%)
Tenet Healthcare Corp. ............... -- -- 525 517,200
----------- -----------
Hotels/Resorts/Cruiselines (0.4%)
Hyatt Equities LLC -- 144A* .......... -- -- 280 294,991
Marriott International Inc.
(Ser D) ............................. -- -- 435 467,388
Starwood Hotels Resorts .............. -- -- 295 296,844
----------- -----------
-- -- 1,059,223
----------- -----------
Industrial Conglomerates (0.4%)
Honeywell International, Inc. ........ -- -- 600 592,918
Tyco International Group S.A.
(Luxembourg) ........................ -- -- 565 476,052
----------- -----------
-- -- 1,068,970
----------- -----------
Insurance Brokers (0.2%)
Marsh & McLennan Companies,
Inc. ................................ -- -- 600 604,051
----------- -----------
Integrated Oil (0.2%)
Conoco Inc. .......................... -- -- 585 604,940
----------- -----------
Investment Banks/Brokers (0.9%)
Credit Suisse F/B USA, Inc. ** ....... -- -- 805 808,501
Goldman Sachs Group, Inc. ............ -- -- 595 643,678
Lehman Brothers Holdings,
Inc. ** ............................. -- -- 730 752,114
----------- -----------
-- 2,204,293
----------- -----------
Investment Managers (0.4%)
TIAA Global Markets -- 144A* ......... -- -- 1,045 1,035,635
----------- -----------
Life/Health Insurance (1.2%)
Equitable Life Assurance Corp. --
144A* ............................... -- -- 250 264,763
John Hancock Global Fund --
144A* ............................... -- -- 585 588,892
Metropolitan Life Insurance Co. --
144A* ............................... -- -- 625 645,853
Monumental Global Funding II --
144A* ............................... -- -- 330 340,970
3
MORGAN STANLEY LIMITED DURATION FUND
PRO FORMA PORTFOLIO OF INVESTMENTS AS OF APRIL 30, 2002
(UNAUDITED)
MORGAN STANLEY
LIMITED DURATION FUND
-------------------------
PRINCIPAL
AMOUNT
COUPON MATURITY IN
RATE DATE THOUSANDS VALUE
------------ ---------- ----------- -------------
Nationwide Mutual Insurance --
144A* ............................... 6.50 % 02/15/04 $ 650 $ 673,085
Prudential Insurance Co. -- 144A*..... 6.375 07/23/06 495 510,021
-----------
3,023,584
-----------
Major Banks (0.8%)
First Union Corp. ** ................. 8.00 11/15/02 2,000 2,057,384
-----------
Major Telecommunications (0.9%)
AT&T Corp. -- 144A* .................. 6.50 11/15/06 615 589,232
Sprint Capital Corp. ................. 6.00 01/15/07 455 416,210
Telus Corp. (Canada) ................. 7.50 06/01/07 595 605,226
WorldCom, Inc. ....................... 7.875 05/15/03 675 506,250
WorldCom, Inc. ....................... 6.50 05/15/04 340 200,600
-----------
2,317,518
-----------
Managed Health Care (0.5%)
Aetna, Inc. .......................... 7.375 03/01/06 475 482,786
UnitedHealth Group Inc. .............. 7.50 11/15/05 275 298,786
Wellpoint Health Network Inc. ........ 6.375 06/15/06 410 423,100
-----------
1,204,672
-----------
Media Conglomerates (0.3%)
AOL Time Warner, Inc. ................ 6.125 04/15/06 635 621,658
-----------
Motor Vehicles (0.2%)
DaimierChrysler NA Holding ........... 6.40 05/15/06 470 480,105
-----------
Multi-Line Insurance (0.7%)
AIG SunAmerica Global Finance
VI -- 144A* ......................... 5.20 05/10/04 465 476,787
Farmers Insurance Exchange --
144A* ............................... 8.50 08/01/04 500 524,110
Hartford Financial Services
Group, Inc. ** ...................... 7.75 06/15/05 600 651,928
-----------
1,652,825
-----------
Oil & Gas Pipelines (0.2%)
Williams Companies, Inc. ............. 6.50 08/01/06 415 402,776
-----------
Oil & Gas Production (0.1%)
Pemex Master Trust -- 144A* .......... 7.875 02/01/09 300 308,625
-----------
Railroads (0.3%)
Norfolk Southern Corp. ** ............ 7.875 02/15/04 300 318,613
Union Pacific Corp. .................. 5.84 05/25/04 470 483,400
-----------
802,013
-----------
MORGAN STANLEY
NORTH AMERICAN
GOVERNMENT
INCOME TRUST COMBINED
------------------------ -------------------------
PRINCIPAL PRINCIPAL
AMOUNT AMOUNT
IN IN
THOUSANDS VALUE THOUSANDS VALUE
----------- ------------ ----------- -------------
Nationwide Mutual Insurance --
144A* ............................... -- -- $ 650 $ 673,085
Prudential Insurance Co. -- 144A*..... -- -- 495 510,021
----------- -----------
-- 3,023,584
----------- -----------
Major Banks (0.8%)
First Union Corp. ** ................. -- -- 2,000 2,057,384
----------- -----------
Major Telecommunications (0.9%)
AT&T Corp. -- 144A* .................. -- -- 615 589,232
Sprint Capital Corp. ................. -- -- 455 416,210
Telus Corp. (Canada) ................. -- -- 595 605,226
WorldCom, Inc. ....................... -- -- 675 506,250
WorldCom, Inc. ....................... -- -- 340 200,600
----------- -----------
-- 2,317,518
----------- -----------
Managed Health Care (0.5%)
Aetna, Inc. .......................... -- -- 475 482,786
UnitedHealth Group Inc. .............. -- -- 275 298,786
Wellpoint Health Network Inc. ........ -- -- 410 423,100
----------- -----------
-- 1,204,672
----------- -----------
Media Conglomerates (0.3%)
AOL Time Warner, Inc. ................ -- -- 635 621,658
----------- -----------
Motor Vehicles (0.2%)
DaimierChrysler NA Holding ........... -- -- 470 480,105
----------- -----------
Multi-Line Insurance (0.7%)
AIG SunAmerica Global Finance
VI -- 144A* ......................... -- -- 465 476,787
Farmers Insurance Exchange --
144A* ............................... -- -- 500 524,110
Hartford Financial Services
Group, Inc. ** ...................... -- -- 600 651,928
----------- -----------
-- 1,652,825
----------- -----------
Oil & Gas Pipelines (0.2%)
Williams Companies, Inc. ............. -- -- 415 402,776
----------- -----------
Oil & Gas Production (0.1%)
Pemex Master Trust -- 144A* .......... -- -- 300 308,625
----------- -----------
Railroads (0.3%)
Norfolk Southern Corp. ** ............ -- -- 300 318,613
Union Pacific Corp. .................. -- -- 470 483,400
----------- -----------
-- 802,013
----------- -----------
4
MORGAN STANLEY LIMITED DURATION FUND
PRO FORMA PORTFOLIO OF INVESTMENTS AS OF APRIL 30, 2002
(UNAUDITED)
MORGAN STANLEY
LIMITED DURATION FUND
--------------------------
PRINCIPAL
AMOUNT
COUPON MATURITY IN
RATE DATE THOUSANDS VALUE
---------- ---------------- ----------- --------------
Real Estate Investment Trusts (0.4%)
EOP Operating LP ..................... 8.375% 03/15/06 $ 415 $ 450,866
Simon Property Group LP .............. 6.375 11/15/07 555 555,862
------------
1,006,728
------------
Specialty Telecommunications (0.2%)
Qwest Capital Funding Inc. ........... 7.75 08/15/06 490 379,792
------------
Wireless Telecommunications (0.3%)
AT&T Wireless Services, Inc. ......... 7.35 03/01/06 595 594,735
------------
TOTAL CORPORATE BONDS
(Cost $44,983,467, $0 and
$44,983,467, respectively)........... 44,751,970
------------
U.S. GOVERNMENT & AGENCY
OBLIGATIONS (55.2%)
MORTGAGE PASS-THROUGH SECURITIES
(39.0%)
Federal Farm Credit Bank ............. 6.25 12/02/02 -- --
Federal Home Loan Mortgage
Corp. ............................... 4.50 08/15/04 -- --
Federal Home Loan Mortgage
Corp. ARM ........................... 6.507 03/01/25 -- --
Federal Home Loan Mortgage 08/01/02-
Corp. PC Gold ....................... 6.00 09/01/03 2,153 2,196,961
Federal Home Loan Mortgage 07/01/02-
Corp. PC Gold ....................... 6.50 09/01/02 176 179,874
Federal Home Loan Mortgage
Corp. PC Gold ....................... 7.50 *** 15,050 15,703,734
Federal Home Loan Mortgage
Corp. ............................... 6.00 *** 15,500 15,713,125
Federal Home Loan Mortgage
Corp. ............................... 7.00 *** 7,000 7,216,563
Federal National Mortgage
Assoc. .............................. 4.75 11/14/03 -- --
Federal National Mortgage
Assoc. .............................. 5.855 07/01/31 -- --
Federal National Mortgage 08/01/02-
Assoc. .............................. 6.00 12/01/02 237 240,688
Federal National Mortgage
Assoc. .............................. 6.50 *** 7,000 7,052,500
Federal National Mortgage
Assoc. .............................. 7.00 01/04/04 -- --
Federal National Mortgage
Assoc. .............................. 9.50 06/01/20 -- --
Government National Mortgage
Assoc. II ARM ....................... 5.50 08/20/29 -- --
Government National Mortgage 07/20/29-
Assoc. II ARM ....................... 6.00 09/20/29 -- --
MORGAN STANLEY
NORTH AMERICAN
GOVERNMENT
INCOME TRUST COMBINED
------------------------- --------------------------
PRINCIPAL PRINCIPAL
AMOUNT AMOUNT
IN IN
THOUSANDS VALUE THOUSANDS VALUE
----------- ------------- ----------- --------------
Real Estate Investment Trusts (0.4%)
EOP Operating LP ..................... -- -- $ 415 $ 450,866
Simon Property Group LP .............. -- -- 555 555,862
-------- ------------
-- 1,006,728
-------- ------------
Specialty Telecommunications (0.2%)
Qwest Capital Funding Inc. ........... -- -- 490 379,792
-------- ------------
Wireless Telecommunications (0.3%)
AT&T Wireless Services, Inc. ......... -- -- 595 594,735
-------- ------------
TOTAL CORPORATE BONDS
(Cost $44,983,467, $0 and
$44,983,467, respectively)........... -- -- 44,751,970
-------- ------------
U.S. GOVERNMENT & AGENCY
OBLIGATIONS (55.2%)
MORTGAGE PASS-THROUGH SECURITIES
(39.0%)
Federal Farm Credit Bank ............. $5,000 $5,116,615 5,000 5,116,615
Federal Home Loan Mortgage
Corp. ............................... 5,000 5,086,970 5,000 5,086,970
Federal Home Loan Mortgage
Corp. ARM ........................... 1,169 1,197,725 1,169 1,197,725
Federal Home Loan Mortgage
Corp. PC Gold ....................... -- -- 2,153 2,196,961
Federal Home Loan Mortgage
Corp. PC Gold ....................... -- -- 176 179,874
Federal Home Loan Mortgage
Corp. PC Gold ....................... -- -- 15,050 15,703,734
Federal Home Loan Mortgage
Corp. ............................... -- -- 15,500 15,713,125
Federal Home Loan Mortgage
Corp. ............................... -- -- 7,000 7,216,563
Federal National Mortgage
Assoc. .............................. 5,000 5,117,645 5,000 5,117,645
Federal National Mortgage
Assoc. .............................. 3,380 3,405,662 3,380 3,405,662
Federal National Mortgage
Assoc. .............................. -- -- 237 240,688
Federal National Mortgage
Assoc. .............................. -- -- 7,000 7,052,500
Federal National Mortgage
Assoc. .............................. 2,857 2,968,648 2,857 2,968,648
Federal National Mortgage
Assoc. .............................. 453 501,405 453 501,405
Government National Mortgage
Assoc. II ARM ....................... 6,434 6,499,058 6,434 6,499,058
Government National Mortgage
Assoc. II ARM ....................... 3,292 3,339,269 3,292 3,339,269
5
MORGAN STANLEY LIMITED DURATION FUND
PRO FORMA PORTFOLIO OF INVESTMENTS AS OF APRIL 30, 2002
(UNAUDITED)
MORGAN STANLEY
LIMITED DURATION FUND
--------------------------
PRINCIPAL
AMOUNT
COUPON MATURITY IN
RATE DATE THOUSANDS VALUE
------------ ---------- ----------- --------------
Government National Mortgage 06/20/22-
Assoc. II ARM ...................... 6.375% 06/20/25 -- --
Government National Mortgage 10/20/24-
Assoc. II ARM ...................... 6.625 12/20/24 -- --
Government National Mortgage
Assoc. II ARM ...................... 6.75 08/20/22 -- --
-----------
TOTAL MORTGAGE PASS-THROUGH
SECURITIES
(Cost $47,501,306, $48,657,810,
and $96,159,116, respectively)....... $48,303,445
-----------
U.S. GOVERNMENT OBLIGATIONS (16.2%)
U.S. Treasury Notes**
(Cost $41,254,699, $0, and 6.75- 11/15/04-
41,254,699, respectively) .......... 7.875 05/15/05 $37,225 40,687,991
-----------
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost $88,756,005, $48,657,810,
and 137,413,815, respectively) ..... 88,991,436
-----------
COLLATERALIZED MORTGAGE
OBLIGATIONS (5.6%)
U.S. Government Agencies
Federal Home Loan Mortgage
Corp. 1370 K (PAC IO) .............. 1,089.16 09/15/22 -- --
Federal Home Loan Mortgage
Corp. G 21 M ....................... 6.50 10/25/23 -- --
Federal Home Loan Mortgage
Corp. .............................. 6.50 03/15/29 489 499,507
Federal Home Loan Mortgage
Corp. CMO 214 ...................... 6.60 03/15/29 1,059 1,089,587
Federal National Mortgage Assoc.
G96-1 PJ (PAC) ..................... 7.50 11/17/25 -- --
-----------
TOTAL COLLATERALIZED MORTGAGE
OBLIGATIONS
(Cost $1,587,547, $12,567,453 and
$14,155,000, respectively)........... 1,589,094
-----------
ASSET BACKED SECURITIES (8.3%)
Finance/Rental/Leasing
American Express Credit Account
Master Trust 2001-2 A .............. 6.40 04/15/05 1,000 1,016,085
CIT Marine Trust 1999-A AL .......... 5.80 04/15/10 135 138,555
Capital Auto Receivables Asset
Trust 2002-2A ...................... 4.50 10/15/07 1,200 1,206,000
Chase Credit Card Master Trust
2001-4 A ........................... 5.50 11/17/08 875 900,117
Chase Manhattan Auto Owner
Trust .............................. 4.24 09/15/08 1,100 1,093,984
MORGAN STANLEY
NORTH AMERICAN
GOVERNMENT
INCOME TRUST COMBINED
------------------------- ---------------------------
PRINCIPAL PRINCIPAL
AMOUNT AMOUNT
IN IN
THOUSANDS VALUE THOUSANDS VALUE
----------- ------------- ----------- ---------------
Government National Mortgage
Assoc. II ARM ...................... $7,389 $ 7,535,566 $ 7,389 $ 7,535,566
Government National Mortgage
Assoc. II ARM ...................... 1,621 1,673,114 1,621 1,673,114
Government National Mortgage
Assoc. II ARM ...................... 6,723 6,920,393 6,723 6,920,393
----------- -------------
TOTAL MORTGAGE PASS-THROUGH
SECURITIES
(Cost $47,501,306, $48,657,810,
and $96,159,116, respectively)....... 49,362,070 97,665,515
----------- -------------
U.S. GOVERNMENT OBLIGATIONS (16.2%)
U.S. Treasury Notes**
(Cost $41,254,699, $0, and
41,254,699, respectively) .......... -- -- 37,225 40,687,991
----------- -------------
TOTAL U.S. GOVERNMENT & AGENCY
OBLIGATIONS
(Cost $88,756,005, $48,657,810,
and 137,413,815, respectively) ..... 49,362,070 138,353,506
----------- -------------
COLLATERALIZED MORTGAGE
OBLIGATIONS (5.6%)
U.S. Government Agencies
Federal Home Loan Mortgage
Corp. 1370 K (PAC IO) .............. 3 58,178 3 58,178
Federal Home Loan Mortgage
Corp. G 21 M ....................... 7,297 7,175,207 7,297 7,175,207
Federal Home Loan Mortgage
Corp. .............................. -- -- 489 499,507
Federal Home Loan Mortgage
Corp. CMO 214 ...................... -- -- 1,059 1,089,587
Federal National Mortgage Assoc.
G96-1 PJ (PAC) ..................... 5,000 5,308,985 5,000 5,308,985
----------- -------------
TOTAL COLLATERALIZED MORTGAGE
OBLIGATIONS
(Cost $1,587,547, $12,567,453 and
$14,155,000, respectively)........... 12,542,370 14,131,464
----------- -------------
ASSET BACKED SECURITIES (8.3%)
Finance/Rental/Leasing
American Express Credit Account
Master Trust 2001-2 A .............. -- -- 1,000 1,016,085
CIT Marine Trust 1999-A AL .......... -- -- 135 138,555
Capital Auto Receivables Asset
Trust 2002-2A ...................... -- -- 1,200 1,206,000
Chase Credit Card Master Trust
2001-4 A ........................... -- -- 875 900,117
Chase Manhattan Auto Owner
Trust .............................. -- -- 1,100 1,093,984
6
MORGAN STANLEY LIMITED DURATION FUND
PRO FORMA PORTFOLIO OF INVESTMENTS AS OF APRIL 30, 2002
(UNAUDITED)
MORGAN STANLEY
LIMITED DURATION FUND
--------------------------
PRINCIPAL
AMOUNT
COUPON MATURITY IN
RATE DATE THOUSANDS VALUE
-------------- ---------- ----------- --------------
Connecticut RRB Special Purpose
Trust CL&P-1 .................... 5.36 % 03/30/07 $ 500 $ 516,241
Daimler-Benz Vehicle Trust
1998-A A4 ....................... 5.22 12/22/03 257 257,394
Daimler Chrysler Auto Trust 4.49- 09/06/04-
2000-C A3 ....................... 6.82 10/06/08 2,200 2,234,616
First Security Auto Owner Trust
1999-1 A4 ....................... 5.74 06/15/04 283 286,192
Ford Credit Auto Owner Trust 4.14- 6/15/04-
2002-B .......................... 6.74 12/15/05 1,307 1,331,131
Harley Davidson Motorcycle Trust
2002-1 .......................... 4.50 01/15/10 1,200 1,197,671
Honda Auto Receivables Owner 2.76- 02/18/04-
Trust 2001-3 A2 ................. 6.62 10/17/05 1,991 2,005,493
Household Automotive Trust
2001-3 A3 ....................... 3.68 04/17/06 1,325 1,327,572
MBNA Master Card Trust
1997-J A ........................ 1.98 02/15/07 1,200 1,202,307
MMCA Automobile Trust
2000-1 A3 ....................... 7.00 06/15/04 492 501,369
National City Auto Trust 2002-A... 4.04 07/15/06 1,100 1,109,393
Nissan Auto Receivables Owner 3.58- 09/15/03-
Trust 2002-A A3 ................. 7.01 02/15/07 2,098 2,133,228
Nissan Auto Receivables Owner
Trust 2002 B 4.60 09/17/07 900 909,931
Nordstrom Private Label Credit
Card Master Trust -- 144A*
2000-C A3 ....................... 4.82 04/15/10 650 645,437
Peco Energy Transition Trust
1999-A A2 ....................... 5.63 03/01/05 259 263,588
Premier Auto Trust 1999-2 A4 ..... 5.59 02/09/04 391 396,279
Residential Funding Mortgage
Securities Trust 2000-HI4 AI2 ... 7.39 04/25/11 82 81,860
Toyota Auto Receivables Owner
Trust 1999-A A3 ................. 6.15 08/16/04 134 134,303
------------
TOTAL ASSET BACKED SECURITIES
(Cost $20,834,777, $0, and
$20,834,777, respectively)....... 20,888,746
------------
MORGAN STANLEY
NORTH AMERICAN
GOVERNMENT
INCOME TRUST COMBINED
------------------------ --------------------------
PRINCIPAL PRINCIPAL
AMOUNT AMOUNT
IN IN
THOUSANDS VALUE THOUSANDS VALUE
----------- ------------ ----------- --------------
Connecticut RRB Special Purpose
Trust CL&P-1 .................... -- $ 500 $ 516,241
--
Daimler-Benz Vehicle Trust
1998-A A4 ....................... -- -- 257 257,394
Daimler Chrysler Auto Trust
2000-C A3 ....................... -- -- 2,200 2,234,616
First Security Auto Owner Trust
1999-1 A4 ....................... -- -- 283 286,192
Ford Credit Auto Owner Trust
2002-B .......................... -- -- 1,307 1,331,131
Harley Davidson Motorcycle Trust
2002-1 .......................... -- -- 1,200 1,197,671
Honda Auto Receivables Owner
Trust 2001-3 A2 ................. -- -- 1,991 2,005,493
Household Automotive Trust
2001-3 A3 ....................... -- -- 1,325 1,327,572
MBNA Master Card Trust
1997-J A ........................ -- -- 1,200 1,202,307
MMCA Automobile Trust
2000-1 A3 ....................... -- -- 492 501,369
National City Auto Trust 2002-A... -- -- 1,100 1,109,393
Nissan Auto Receivables Owner
Trust 2002-A A3 ................. -- -- 2,098 2,133,228
Nissan Auto Receivables Owner
Trust 2002 B -- -- 900 909,931
Nordstrom Private Label Credit
Card Master Trust -- 144A*
2000-C A3 ....................... -- -- 650 645,437
Peco Energy Transition Trust
1999-A A2 ....................... -- -- 259 263,588
Premier Auto Trust 1999-2 A4 ..... -- -- 391 396,279
Residential Funding Mortgage
Securities Trust 2000-HI4 AI2 ... -- -- 82 81,860
Toyota Auto Receivables Owner
Trust 1999-A A3 ................. -- -- 134 134,303
----------- ------------
TOTAL ASSET BACKED SECURITIES
(Cost $20,834,777, $0, and
$20,834,777, respectively)....... -- 20,888,746
----------- ------------
7
MORGAN STANLEY LIMITED DURATION FUND
PRO FORMA PORTFOLIO OF INVESTMENTS AS OF APRIL 30, 2002
(UNAUDITED)
MORGAN STANLEY
LIMITED DURATION FUND
--------------------------
PRINCIPAL
AMOUNT
COUPON MATURITY IN
RATE DATE THOUSANDS VALUE
-------------- ---------- ----------- --------------
SHORT-TERM INVESTMENTS (29.9%)
COMMERCIAL PAPER (2.4%) (A)
Finance/Rental/Leasing (0.7%)
Paccar Financial Corp. ................. 1.80 % 07/22/02 -- --
Food: Major Diversified (1.3%)
Nestle Capital Corp. ................... 1.82 05/17/02 -- --
Industrial Conglomerates (0.4%)
General Electric Co. ................... 1.82 05/20/02 -- --
-----------
TOTAL COMMERCIAL PAPER
(Cost $0, $6,006,386 and
$6,006,386, respectively).............. --
-----------
U.S. GOVERNMENT & AGENCY OBLIGATIONS (A)
(20.9%)
1.73- 05/03/02-
Federal Home Loan Banks ................ 1.86 06/26/02 $15,000 $14,978,207
1.67- 05/31/02-
Federal Home Mortgage Corp. ............ 3.58 07/03/02 20,000 19,949,381
Federal National Mortgage
Assoc. ................................ 1.80 07/03/02 -- --
Federal National Mortgage
Assoc. ................................ 1.82 06/05/02 -- --
Federal National Mortgage
Assoc. ................................ 1.86 08/09/02 -- --
Federal National Mortgage
Assoc. ................................ 1.77 06/05/02 5,000 4,991,396
U.S. Treasury Bill ** .................. 1.88 10/17/02 550 545,146
-----------
TOTAL U.S. GOVERNMENT & AGENCY
OBLIGATIONS
(Cost $40,464,129, $11,958,275 and
$52,422,404, respectively)............. 40,464,130
-----------
REPURCHASE AGREEMENTS (6.6%)
Joint repurchase agreement
account (dated 04/30/02;
proceeds $12,912,683) (b) ............. 1.905 05/01/02 12,912 12,912,000
-----------
The Bank of New York (dated
04/30/02; proceeds $3,675,784) (c)..... 1.688 05/01/02 -- --
-----------
TOTAL REPURCHASE AGREEMENTS
(Cost $12,912,000, $3,675,612 and
$16,587,612, respectively)............. 12,912,000
-----------
TOTAL SHORT-TERM INVESTMENTS
(Cost $53,376,129, $21,640,273 and
$75,016,402, respectively)............. 53,376,130
-----------
MORGAN STANLEY
NORTH AMERICAN
GOVERNMENT
INCOME TRUST COMBINED
------------------------- -------------------------
PRINCIPAL PRINCIPAL
AMOUNT AMOUNT
IN IN
THOUSANDS VALUE THOUSANDS VALUE
----------- ------------- ----------- -------------
SHORT-TERM INVESTMENTS (29.9%)
COMMERCIAL PAPER (2.4%) (A)
Finance/Rental/Leasing (0.7%)
Paccar Financial Corp. ................. $1,700 $ 1,692,945 $ 1,700 $ 1,692,945
Food: Major Diversified (1.3%)
Nestle Capital Corp. ................... 3,317 3,314,317 3,317 3,314,317
Industrial Conglomerates (0.4%)
General Electric Co. ................... 1,000 999,039 1,000 999,039
----------- -----------
TOTAL COMMERCIAL PAPER
(Cost $0, $6,006,386 and
$6,006,386, respectively).............. 6,006,301 6,006,301
----------- -----------
U.S. GOVERNMENT & AGENCY OBLIGATIONS (A)
(20.9%)
Federal Home Loan Banks ................ -- -- 15,000 14,978,207
Federal Home Mortgage Corp. ............ -- -- 20,000 19,949,381
Federal National Mortgage
Assoc. ................................ 5,000 4,984,000 5,000 4,984,000
Federal National Mortgage
Assoc. ................................ 3,000 2,994,692 3,000 2,994,692
Federal National Mortgage
Assoc. ................................ 4,000 3,979,127 4,000 3,979,127
Federal National Mortgage
Assoc. ................................ -- -- 5,000 4,991,396
U.S. Treasury Bill ** .................. -- -- 550 545,146
----------- -----------
TOTAL U.S. GOVERNMENT & AGENCY
OBLIGATIONS
(Cost $40,464,129, $11,958,275 and
$52,422,404, respectively)............. 11,957,819 52,421,949
----------- -----------
REPURCHASE AGREEMENTS (6.6%)
Joint repurchase agreement
account (dated 04/30/02;
proceeds $12,912,683) (b) ............. -- -- 12,912 12,912,000
----------- -----------
The Bank of New York (dated
04/30/02; proceeds $3,675,784) (c)..... 3,676 3,675,612 3,676 3,675,612
----------- -----------
TOTAL REPURCHASE AGREEMENTS
(Cost $12,912,000, $3,675,612 and
$16,587,612, respectively)............. 3,675,612 16,587,612
----------- -----------
TOTAL SHORT-TERM INVESTMENTS
(Cost $53,376,129, $21,640,273 and
$75,016,402, respectively)............. 21,639,732 75,015,862
----------- -----------
8
MORGAN STANLEY LIMITED DURATION FUND
PRO FORMA PORTFOLIO OF INVESTMENTS AS OF APRIL 30, 2002
(UNAUDITED)
MORGAN STANLEY
NORTH AMERICAN
MORGAN STANLEY GOVERNMENT
LIMITED DURATION FUND INCOME TRUST COMBINED
----------------------- --------------- ---------------
VALUE VALUE VALUE
----------------------- --------------- ---------------
TOTAL INVESTMENTS
(Cost $209,537,925, $82,865,536 and $292,403,461,
respectively) (d) .............................. $ 209,597,376 $83,544,172 116.9% $ 293,141,548
OTHER ASSETS AND LIABILITIES .................... (42,966,540) 672,036 (16.9) (42,294,504)
------------- ----------- ----- -------------
NET ASSETS ...................................... $ 166,630,836 $84,216,208 100.0% $ 250,847,044
============= =========== ===== =============
Note: The percentages indicated are based on the holdings and net assets of the
combined entity.
- ----------
ARM Adjustable Rate Mortgage.
IO Interest-only securities.
PAC Planned Amortization Class.
* Resale is restricted to qualified institutional investors.
** Some or all of these securities have been segregated in connection with
securities purchased on a forward commitment basis and/or futures
contracts.
*** Security purchased on a forward commitment with an approximate principal
amount and no definite maturity date; the actual principal amount and
maturity date will be determined upon settlement.
(a) Purchased on a discount basis. The interest rate shown has been
adjusted to reflect a money market equivalent yield.
(b) Collateralized by federal agency and U.S. Treasury obligations.
(c) Collateralized by $3,765,897 U.S. Treasury Bill due 08/01/02 valued
at $3,749,150.
(d) The aggregate cost for federal income tax purposes approximates the
aggregate cost for book purposes.
GROSS GROSS NET
UNREALIZED UNREALIZED UNREALIZED
APPRECIATION DEPRECIATION APPRECIATION
-------------- -------------- -------------
Morgan Stanley Limited Duration ......... $1,038,758 $ 979,307 $ 59,451
Morgan Stanley North American ........... 1,079,886 401,250 678,636
---------- ---------- --------
Combined ................................ $2,118,644 $1,380,557 $738,087
========== ========== ========
Long (Short) Futures Contracts Open at April 30, 2002 for Limited Duration:
DESCRIPTION, UNDERLYING UNREALIZED
NUMBER OF DELIVERY MONTH, FACE AMOUNT APPRECIATION/
CONTRACTS LONG/SHORT AND YEAR AT VALUE DEPRECIATION
- ----------- ----------------------------- ------------------------------- ---------------- --------------
35 Long U.S. Treasury Notes/June 2002 $ 3,711,641 $ 2,386
25 Long U.S. Treasury Notes/June 2002 5,227,735 9,822
15 Long U.S. Treasury Bonds/June 2002 1,534,688 10,253
289 Short U.S. Treasury Notes/June 2002 (30,507,563) (87,844)
---------
Net unrealized depreciation $ (65,383)
=========
See Notes to Pro Forma Financial Statements.
9
MORGAN STANLEY LIMITED DURATION FUND
PRO FORMA FINANCIAL STATEMENTS
STATEMENT OF ASSETS AND LIABILITIES
APRIL 30, 2002 (UNAUDITED)
MORGAN STANLEY
NORTH AMERICAN
MORGAN STANLEY GOVERNMENT PRO FORMA
LIMITED DURATION INCOME TRUST ADJUSTMENTS COMBINED
------------------ ----------------- ------------------- -----------------
ASSETS:
Investments in securities, at value (cost
$209,537,925, $82,865,536 and $292,403,461,
respectively) ....................................... $209,597,376 $ 83,544,172 -- $ 293,141,548
Receivable for:
Investments sold .................................... 7,096,651 -- -- 7,096,651
Interest ............................................ 1,924,399 539,166 -- 2,463,565
Principal paydowns .................................. -- 184,856 -- 184,856
Shares of beneficial interest sold .................. 1,254,240 149,585 -- 1,403,825
Prepaid expenses and other assets .................... 49,720 44,039 -- 93,759
------------ -------------- -------- --------------
TOTAL ASSETS ........................................ 219,922,386 84,461,818 -- 304,384,204
------------ -------------- -------- --------------
LIABILITIES:
Payable for:
Investments purchased ............................... 52,421,690 -- -- 52,421,690
Shares of beneficial interest repurchased ........... 618,706 85,385 -- 704,091
Investment management fee ........................... 104,081 49,916 -- 153,997
Dividends to shareholders ........................... 72,585 -- -- 72,585
Distribution fee .................................... -- 57,595 -- 57,595
Variation margin .................................... 22,858 -- -- 22,858
Accrued expenses and other payables .................. 51,630 52,714 -- 104,344
------------ -------------- -------- --------------
TOTAL LIABILITIES ................................... 53,291,550 245,610 -- 53,537,160
------------ -------------- -------- --------------
NET ASSETS .......................................... $166,630,836 $ 84,216,208 -- $ 250,847,044
============ ============== ======== ==============
COMPOSITION OF NET ASSETS:
Paid-in-capital ...................................... $169,378,542 $ 315,740,721 -- $ 485,119,263
Net unrealized appreciation (depreciation) ........... (5,932) 678,636 -- 672,704
Dividends in excess of net investment income ......... (572,326) (101,418) -- (673,744)
Accumulated net realized loss ........................ (2,169,448) (232,101,731) -- (234,271,179)
------------ -------------- -- --------------
NET ASSETS .......................................... $166,630,836 $ 84,216,208 -- $ 250,847,044
============ ============== ======== ==============
SHARES OUTSTANDING .................................. 17,379,848 9,725,743 (944,074)(1) 26,161,517
============ ============== ======== ==============
NET ASSET VALUE PER SHARE ........................... $ 9.59 $ 8.66 $ 9.59
- ----------
(1) Represents the difference between total additional shares to be issued
(see Note 2) and current Morgan Stanley North American Government Income
Trust shares outstanding.
See Notes to Pro Forma Financial Statements
10
MORGAN STANLEY LIMITED DURATION FUND
PRO FORMA FINANCIAL STATEMENTS
STATEMENT OF OPERATIONS
FOR THE TWELVE MONTHS ENDED APRIL 30, 2002 (UNAUDITED)
MORGAN STANLEY
MORGAN STANLEY NORTH AMERICAN PRO FORMA
LIMITED GOVERNMENT ADJUSTMENTS
DURATION INCOME TRUST (NOTE 3) COMBINED
---------------- ---------------- -------------------- --------------
NET INVESTMENT INCOME:
INTEREST INCOME .................................. $6,403,612 $4,678,973 -- $11,082,585
---------- ---------- ----------- -----------
EXPENSES..........................................
Distribution fee ................................. -- 662,605 $ (662,605)(1) --
Investment management fee ........................ 945,845 568,485 43,730 (1) 1,558,060
Transfer agent fees and expenses ................. 87,612 185,471 -- (3) 273,083
Registration fees ................................ 60,080 47,849 (17,688)(2) 90,241
Professional fees ................................ 67,821 61,864 (61,864)(2) 67,821
(3)
Shareholder reports and notices .................. 52,247 35,903 (14,361)(2) 73,789
(3)
Custodian fees ................................... 16,560 10,528 -- 27,088
Trustees' fees and expenses ...................... 12,192 12,748 (12,748)(2) 12,192
Other ............................................ 7,233 11,907 (610)(2) 18,530
---------- ---------- ----------- -----------
TOTAL EXPENSES .................................. 1,249,590 1,597,360 (726,146) 2,120,804
Less: amounts waived/reimbursed .................. (168,625) -- -- (168,625)
Less: expense offset ............................. -- (344) -- (344)
---------- ---------- ----------- -----------
NET EXPENSES .................................... 1,080,965 1,597,016 (726,146) 1,951,835
---------- ---------- ----------- -----------
NET INVESTMENT INCOME ........................... 5,322,647 3,081,957 726,146 9,130,750
---------- ---------- ----------- -----------
NET REALIZED AND UNREALIZED GAIN
(LOSS):
Net realized gain (loss) on:
Investments ...................................... 3,861,264 (28) -- 3,861,236
Futures contracts ................................ (287,415) -- -- (287,415)
---------- ---------- ----------- -----------
NET GAIN (LOSS) ................................. 3,573,849 (28) -- 3,573,821
---------- ---------- ----------- -----------
Net change in unrealized appreciation/depreciation
on:
Investments ..................................... (852,647) 1,185,325 -- 332,678
Futures contracts ............................... (65,383) -- -- (65,383)
---------- ---------- ----------- -----------
NET APPRECIATION (DEPRECIATION) ................. (918,030) 1,185,325 -- 267,295
---------- ---------- ----------- -----------
NET GAIN ........................................ 2,655,819 1,185,297 -- 3,841,116
---------- ---------- ----------- -----------
NET INCREASE ..................................... $7,978,466 $4,267,254 $ 726,146 $12,971,866
========== ========== =========== ===========
- ----------
(1) Reflects adjustment to investment management fees and plan of
distribution fees based on the surviving Fund's fee schedule.
(2) Reflects elimination of duplicate services or fees.
(3) Solicitation costs in connection with the reorganization, which will be
borne by Morgan Stanley North American
Government Income Trust approximates $ .
See Notes to Pro Forma Financial Statements
11
MORGAN STANLEY LIMITED DURATION FUND
NOTES TO PRO FORMA FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF COMBINATION -- The Pro Forma Statement of Assets and Liabilities,
including the Portfolio of Investments, at April 30, 2002 and the related
Statement of Operations ("Pro Forma Statements") for the twelve months ended
April 30, 2002, reflect the accounts of Morgan Stanley Limited Duration Fund
("Limited Duration") and Morgan Stanley North American Government Income Trust
("North American").
The Pro Forma Statements give effect to the proposed transfer of all assets and
liabilities of North American in exchange for shares in Limited Duration. The
Pro Forma Statements should be read in conjunction with the historical
financial statements of each Fund included in its Statement of Additional
Information.
2. SHARES OF BENEFICIAL INTEREST -- The pro forma net asset value per share
assumes the issuance of additional shares of Limited which would have been
issued on April 30, 2002 in connection with the proposed reorganization.
Shareholders of North American would become shareholders of Limited Duration
receiving shares of Limited equal to the value of their holdings in North
American. The amount of additional shares assumed to be issued was calculated
based on the April 30, 2002 net assets of North American and the April 30, 2002
net asset value per share of Limited Duration as follows:
NET ASSET VALUE
NET ASSETS PER SHARE
ADDITIONAL SHARES ISSUED NORTH AMERICAN LIMITED
- -------------------------- ---------------- ----------------
8,781,669 $84,216,208 $ 9.59
3. PRO FORMA OPERATIONS -- The Pro Forma Statement of Operations assumes
similar rates of gross investment income for the investments of each Fund.
Accordingly, the combined gross investment income is equal to the sum of each
Fund's gross investment income. Certain expenses have been adjusted to reflect
the expected expenses of the combined entity. The pro-forma investment
management fees and distribution fees of the combined Fund are based on the fee
schedule in effect for Limited Duration at the combined level of average net
assets for the twelve months ended April 30, 2002. The Pro Forma Statement of
Operations does not include the effect of any realized gains or losses, or
transaction fees incurred in connection with the realignment of the portfolio.
12
STATEMENT OF ADDITIONAL INFORMATION MORGAN STANLEY
JUNE 28, 2002 LIMITED
DURATION FUND
- --------------------------------------------------------------------------------
This STATEMENT OF ADDITIONAL INFORMATION is not a prospectus. The PROSPECTUS
dated June 28, 2002 for the Morgan Stanley Limited Duration Fund may be obtained
without charge from the Fund at its address or telephone number listed below or
from Morgan Stanley DW Inc. at any of its branch offices.
Morgan Stanley
Limited Duration Fund
1221 Avenue of the Americas
New York, New York 10020
(800) 869-NEWS
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
I. Fund History................................................ 4
II. Description of the Fund and Its Investments and Risks....... 4
A. Classification........................................... 4
B. Investment Strategies and Risks.......................... 4
C. Fund Policies/Investment Restrictions.................... 14
III. Management of the Fund...................................... 15
A. Board of Trustees........................................ 15
B. Management Information................................... 16
C. Compensation............................................. 21
IV. Control Persons and Principal Holders of Securities......... 23
V. Investment Management and Other Services.................... 23
A. Investment Manager....................................... 23
B. Principal Underwriter.................................... 24
C. Services Provided by the Investment Manager.............. 24
D. Dealer Reallowances...................................... 25
E. Rule 12b-1 Plan.......................................... 25
F. Other Service Providers.................................. 26
G. Codes of Ethics.......................................... 26
VI. Brokerage Allocation and Other Practices.................... 26
A. Brokerage Transactions................................... 26
B. Commissions.............................................. 27
C. Brokerage Selection...................................... 27
D. Directed Brokerage....................................... 28
E. Regular Broker-Dealers................................... 28
VII. Capital Stock and Other Securities.......................... 28
VIII. Purchase, Redemption and Pricing of Shares.................. 29
A. Purchase/Redemption of Shares............................ 29
B. Offering Price........................................... 30
IX. Taxation of the Fund and Shareholders....................... 31
X. Underwriters................................................ 33
XI. Calculation of Performance Data............................. 33
XII. Financial Statements........................................ 34
2
GLOSSARY OF SELECTED DEFINED TERMS
The terms defined in this glossary are frequently used in this STATEMENT OF
ADDITIONAL INFORMATION (other terms used occasionally are defined in the text of
the document).
"CUSTODIAN"--The Bank of New York.
"DISTRIBUTOR"--Morgan Stanley Distributors Inc., a wholly-owned broker-dealer
subsidiary of Morgan Stanley.
"FINANCIAL ADVISORS"--Morgan Stanley authorized financial services
representatives.
"FUND"--Morgan Stanley Limited Duration Fund, a registered open-end investment
company.
"INDEPENDENT TRUSTEES"--Trustees who are not "interested persons" (as defined by
the Investment Company Act) of the Fund.
"INVESTMENT MANAGER"--Morgan Stanley Investment Advisors Inc., a wholly-owned
investment advisor subsidiary of Morgan Stanley.
"MORGAN STANLEY"--A preeminent global financial services firm.
"MORGAN STANLEY & CO."--Morgan Stanley & Co. Incorporated, a wholly-owned
broker-dealer subsidiary of Morgan Stanley.
"MORGAN STANLEY DW"--Morgan Stanley DW Inc., a wholly-owned broker-dealer
subsidiary of Morgan Stanley.
"MORGAN STANLEY FUNDS"--Registered investment companies for which the Investment
Manager serves as the investment advisor and that hold themselves out to
investors as related companies for investment and investor services.
"MORGAN STANLEY SERVICES"--Morgan Stanley Services Company Inc., a wholly-owned
fund services subsidiary of the Investment Manager.
"TRANSFER AGENT"--Morgan Stanley Trust, a wholly-owned transfer agent subsidiary
of Morgan Stanley.
"TRUSTEES"--The Board of Trustees of the Fund.
3
I. FUND HISTORY
- --------------------------------------------------------------------------------
The Fund was organized as a Massachusetts business trust, under a
Declaration of Trust, on October 22, 1993, with the name Dean Witter Short-Term
Bond Fund. Effective June 22, 1998, the Fund's name was changed to Morgan
Stanley Dean Witter Short-Term Bond Fund. Effective June 18, 2001, the Fund's
name was changed to Morgan Stanley Short-Term Bond Fund. Effective December 27,
2001, the Fund's name was changed to Morgan Stanley Limited Duration Fund.
II. DESCRIPTION OF THE FUND AND ITS INVESTMENTS AND RISKS
- --------------------------------------------------------------------------------
A. CLASSIFICATION
The Fund is an open-end, diversified management investment company whose
investment objective is to provide investors with a high level of current
income, consistent with the preservation of capital.
B. INVESTMENT STRATEGIES AND RISKS
The following discussion of the Fund's investment strategies and risks
should be read with the sections of the Fund's PROSPECTUS titled "Principal
Investment Strategies," "Principal Risks," "Additional Investment Strategy
Information" and "Additional Risk Information."
COLLATERALIZED MORTGAGE OBLIGATIONS. The Fund may invest in
CMOs --collateralized mortgage obligations. CMOs are debt obligations
collateralized by mortgage loans or mortgage pass-through securities
(collectively "Mortgage Assets"). Payments of principal and interest on the
Mortgage Assets and any reinvestment income are used to make payments on the
CMOs. CMOs are issued in multiple classes. Each class has a specific fixed or
floating coupon rate and a stated maturity or final distribution date. The
principal and interest on the Mortgage Assets may be allocated among the classes
in a number of different ways. Certain classes will, as a result of the
collection, have more predictable cash flows than others. As a general matter,
the more predictable the cash flow, the lower the yield relative to other
Mortgage Assets. The less predictable the cash flow, the higher the yield and
the greater the risk. The Fund may invest in any class of CMO.
Certain mortgage-backed securities in which the Fund may invest (e.g.,
certain classes of CMOs) may increase or decrease in value substantially with
changes in interest rates and/or the rate of prepayment. In addition, if the
collateral securing CMOs or any third party guarantees are insufficient to make
payments, the Fund could sustain a loss.
STRIPPED MORTGAGE-BACKED SECURITIES. In addition, the Fund may invest up to
15% of its net assets in stripped mortgage-backed securities, which are usually
structured in two classes. One class entitles the holder to receive all or most
of the interest but little or none of the principal of a pool of Mortgage Assets
(the interest-only or "IO" Class), while the other class entitles the holder to
receive all or most of the principal but little or none of the interest (the
principal-only or "PO" Class). IOs tend to decrease in value substantially if
interest rates decline and prepayment rates become more rapid. POs tend to
decrease in value substantially if interest rates increase and the rate of
prepayment decreases.
INVERSE FLOATERS. The Fund may invest up to 10% of its assets in inverse
floaters. An inverse floater has a coupon rate that moves in the direction
opposite to that of a designated interest rate index. Like most other
fixed-income securities, the value of inverse floaters will decrease as interest
rates increase. They are more volatile, however, than most other fixed-income
securities because the coupon rate on an inverse floater typically changes at a
multiple of the change in the relevant index rate. Thus, any rise in the index
rate (as a consequence of an increase in interest rates) causes a
correspondingly greater drop in the coupon rate of an inverse floater while a
drop in the index rate causes a correspondingly greater increase in the coupon
of an inverse floater. Some inverse floaters may also increase or decrease
substantially because of changes in the rate of prepayments.
CONVERTIBLE SECURITIES. The Fund may invest in fixed-income securities
which are convertible into common stock. Convertible securities rank senior to
common stocks in a corporation's capital structure and, therefore, entail less
risk than the corporation's common stock. The value of a convertible security
4
is a function of its "investment value" (its value as if it did not have a
conversion privilege), and its "conversion value" (the security's worth if it
were to be exchanged for the underlying security, at market value, pursuant to
its conversion privilege).
To the extent that a convertible security's investment value is greater than
its conversion value, its price will be primarily a reflection of such
investment value and its price will be likely to increase when interest rates
fall and decrease when interest rates rise, as with a fixed-income security (the
credit standing of the issuer and other factors may also have an effect on the
convertible security's value). If the conversion value exceeds the investment
value, the price of the convertible security will rise above its investment
value and, in addition, will sell at some premium over its conversion value.
(This premium represents the price investors are willing to pay for the
privilege of purchasing a fixed-income security with a possibility of capital
appreciation due to the conversion privilege.) At such times the price of the
convertible security will tend to fluctuate directly with the price of the
underlying equity security. Convertible securities may be purchased by the Fund
at varying price levels above their investment values and/or their conversion
values in keeping with the Fund's objective.
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS. The Fund may enter into
forward foreign currency exchange contracts ("forward contracts") as a hedge
against fluctuations in future foreign exchange rates. The Fund may conduct its
foreign currency exchange transactions either on a spot (i.e., cash) basis at
the spot rate prevailing in the foreign currency exchange market, or through
entering into forward contracts to purchase or sell foreign currencies. A
forward contract involves an obligation to purchase or sell a specific currency
at a future date, which may be any fixed number of days from the date of the
contract agreed upon by the parties, at a price set at the time of the contract.
These contracts are traded in the interbank market conducted directly between
currency traders (usually large, commercial and investment banks) and their
customers. Forward contracts only will be entered into with United States banks
and their foreign branches, insurance companies and other dealers whose assets
total $1 billion or more, or foreign banks whose assets total $1 billion or
more. A forward contract generally has no deposit requirement, and no
commissions are charged at any stage for trades.
The Fund may enter into forward contracts under various circumstances. The
typical use of a forward contract is to "lock in" the price of a security in
U.S. dollars or some other foreign currency which the Fund is holding in its
portfolio. By entering into a forward contract for the purchase or sale, for a
fixed amount of dollars or other currency, of the amount of foreign currency
involved in the underlying security transactions, the Fund may be able to
protect itself against a possible loss resulting from an adverse change in the
relationship between the U.S. dollar or other currency which is being used for
the security purchase and the foreign currency in which the security is
denominated during the period between the date on which the security is
purchased or sold and the date on which payment is made or received.
The Investment Manager also may from time to time utilize forward contracts
to hedge a foreign security held in the portfolio or a security which pays out
principal tied to an exchange rate between the U.S. dollar and a foreign
currency, against a decline in value of the applicable foreign currency. They
also may be used to lock in the current exchange rate of the currency in which
those securities anticipated to be purchased are denominated. At times, the Fund
may enter into "cross-currency" hedging transactions involving currencies other
than those in which securities are held or proposed to be purchased are
denominated.
The Fund will not enter into forward currency contracts or maintain a net
exposure to these contracts where the consummation of the contracts would
obligate the Fund to deliver an amount of foreign currency in excess of the
value of the Fund's portfolio securities.
When required by law, the Fund will cause its custodian bank to earmark
cash, U.S. government securities or other appropriate liquid portfolio
securities in an amount equal to the value of the Fund's total assets committed
to the consummation of forward contracts entered into under the circumstances
set forth above. If the value of the securities so earmarked declines,
additional cash or securities will be earmarked on a daily basis so that the
value of such securities will equal the amount of the Fund's commitments with
respect to such contracts.
5
Although the Fund values its assets daily in terms of U.S. dollars, it does
not intend to convert its holdings of foreign currencies into U.S. dollars on a
daily basis. It will, however, do so from time to time, and investors should be
aware of the costs of currency conversion. Although foreign exchange dealers do
not charge a fee for conversion, they do realize a profit based on the spread
between the prices at which they are buying and selling various currencies.
Thus, a dealer may offer to sell a foreign currency to the Fund at one rate,
while offering a lesser rate of exchange should the Fund desire to resell that
currency to the dealer.
The Fund may be limited in its ability to enter into hedging transactions
involving forward contracts by the Internal Revenue Code requirements relating
to qualification as a regulated investment company.
Forward currency contracts may limit gains on portfolio securities that
could otherwise be realized had they not been utilized and could result in
losses. The contracts also may increase the Fund's volatility and may involve a
significant amount of risk relative to the investment of cash.
OPTION AND FUTURES TRANSACTIONS. The Fund may engage in transactions in
listed and OTC options. Listed options are issued or guaranteed by the exchange
on which they are traded or by a clearing corporation such as the Options
Clearing Corporation ("OCC"). Ownership of a listed call option gives the Fund
the right to buy from the OCC (in the U.S.) or other clearing corporation or
exchange, the underlying security or currency covered by the option at the
stated exercise price (the price per unit of the underlying security) by filing
an exercise notice prior to the expiration date of the option. The writer
(seller) of the option would then have the obligation to sell to the OCC (in the
U.S.) or other clearing corporation or exchange, the underlying security or
currency at that exercise price prior to the expiration date of the option,
regardless of its then current market price. Ownership of a listed put option
would give the Fund the right to sell the underlying security or currency to the
OCC (in the U.S.) or other clearing corporation or exchange, at the stated
exercise price. Upon notice of exercise of the put option, the writer of the put
would have the obligation to purchase the underlying security or currency from
the OCC (in the U.S.) or other clearing corporation or exchange, at the exercise
price.
COVERED CALL WRITING. The Fund is permitted to write covered call options
on portfolio securities and on the U.S. dollar and foreign currencies in which
they are denominated, without limit.
The Fund will receive from the purchaser, in return for a call it has
written, a "premium;" i.e., the price of the option. Receipt of these premiums
may better enable the Fund to earn a higher level of current income than it
would earn from holding the underlying securities (or currencies) alone.
Moreover, the premium received will offset a portion of the potential loss
incurred by the Fund if the securities (or currencies) underlying the option
decline in value.
The Fund may be required, at any time during the option period, to deliver
the underlying security (or currency) against payment of the exercise price on
any calls it has written. This obligation is terminated upon the expiration of
the option period or at such earlier time when the writer effects a closing
purchase transaction. A closing purchase transaction is accomplished by
purchasing an option of the same series as the option previously written.
However, once the Fund has been assigned an exercise notice, the Fund will be
unable to effect a closing purchase transaction.
A call option is "covered" if the Fund owns the underlying security subject
to the option or has an absolute and immediate right to acquire that security
without additional cash consideration (or for additional consideration (in cash,
Treasury bills or other liquid portfolio securities) held in a segregated
account on the Fund's books) upon conversion or exchange of other securities
held in its portfolio. A call option is also covered if the Fund holds a call on
the same security as the call written where the exercise price of the call held
is (i) equal to or less than the exercise price of the call written or (ii)
greater than the exercise price of the call written if the difference is
maintained by the Fund in cash, Treasury bills or other liquid portfolio
securities in a segregated account on the Fund's books.
Options written by the Fund normally have expiration dates of from up to
eighteen months from the date written. The exercise price of a call option may
be below, equal to or above the current market value of the underlying security
at the time the option is written.
6
COVERED PUT WRITING. A writer of a covered put option incurs an obligation
to buy the security underlying the option from the purchaser of the put, at the
option's exercise price at any time during the option period, at the purchaser's
election. Through the writing of a put option, the Fund would receive income
from the premium paid by purchasers. The potential gain on a covered put option
is limited to the premium received on the option (less the commissions paid on
the transaction). During the option period, the Fund may be required, at any
time, to make payment of the exercise price against delivery of the underlying
security (or currency). A put option is "covered" if the Fund maintains cash,
Treasury bills or other liquid portfolio securities with a value equal to the
exercise price in a segregated account on the Fund's books, or holds a put on
the same security as the put written where the exercise price of the put held is
equal to or greater than the exercise price of the put written. The aggregate
value of the obligations underlying puts may not exceed 50% of the Fund's
assets. The operation of and limitations on covered put options in other
respects are substantially identical to those of call options.
PURCHASING CALL AND PUT OPTIONS. The Fund may purchase listed and OTC call
and put options in amounts equaling up to 5% of its total assets. The purchase
of a call option would enable the Fund, in return for the premium paid to lock
in a purchase price for a security or currency during the term of the option.
The purchase of a put option would enable the Fund, in return for a premium
paid, to lock in a price at which it may sell a security or currency during the
term of the option.
OPTIONS ON FOREIGN CURRENCIES. The Fund may purchase and write options on
foreign currencies for purposes similar to those involved with investing in
forward foreign currency exchange contracts.
OTC OPTIONS. OTC options are purchased from or sold (written) to dealers or
financial institutions which have entered into direct agreements with the Fund.
With OTC options, such variables as expiration date, exercise price and premium
will be agreed upon between the Fund and the transacting dealer, without the
intermediation of a third party such as the OCC. The Fund will engage in OTC
option transactions only with member banks of the Federal Reserve Bank System or
primary dealers in U.S. government securities or with affiliates of such banks
or dealers.
RISKS OF OPTIONS TRANSACTIONS. The successful use of options depends on the
ability of the Investment Manager to forecast correctly interest rates, currency
exchange rates and/or market movements. If the market value of the portfolio
securities (or the currencies in which they are denominated) upon which call
options have been written increases, the Fund may receive a lower total return
from the portion of its portfolio upon which calls have been written than it
would have had such calls not been written. During the option period, the
covered call writer has, in return for the premium on the option, given up the
opportunity for capital appreciation above the exercise price should the market
price of the underlying security (or the value of its denominated currency)
increase, but has retained the risk of loss should the price of the underlying
security (or the value of its denominated currency) decline. The covered put
writer also retains the risk of loss should the market value of the underlying
security decline below the exercise price of the option less the premium
received on the sale of the option. In both cases, the writer has no control
over the time when it may be required to fulfill its obligation as a writer of
the option. Prior to exercise or expiration, an option position can only be
terminated by entering into a closing purchase or sale transaction. Once an
option writer has received an exercise notice, it cannot effect a closing
purchase transaction in order to terminate its obligation under the option and
must deliver or receive the underlying securities at the exercise price.
The Fund's ability to close out its position as a writer of an option is
dependent upon the existence of a liquid secondary market on option exchanges.
There is no assurance that such a market will exist, particularly in the case of
OTC options.
In the event of the bankruptcy of a broker through which the Fund engages in
transactions in options, the Fund could experience delays and/or losses in
liquidating open positions purchased or sold through the broker and/or incur a
loss of all or part of its margin deposits with the broker. In the case of OTC
options, if the transacting dealer fails to make or take delivery of the
securities underlying an option it has written, in accordance with the terms of
that option, due to insolvency or otherwise, the Fund would lose the premium
paid for the option as well as any anticipated benefit of the transaction.
7
Each of the exchanges has established limitations governing the maximum
number of call or put options on the same underlying security which may be
written by a single investor, whether acting alone or in concert with others
(regardless of whether such options are written on the same or different
exchanges or are held or written on one or more accounts or through one or more
brokers). An exchange may order the liquidation of positions found to be in
violation of these limits and it may impose other sanctions or restrictions.
These position limits may restrict the number of listed options which the Fund
may write.
The hours of trading for options may not conform to the hours during which
the underlying securities are traded. To the extent that the option markets
close before the markets for the underlying securities, significant price and
rate movements can take place in the underlying markets that cannot be reflected
in the option markets.
The markets in foreign currency options are relatively new and the Fund's
ability to establish and close out positions on such options is subject to the
maintenance of a liquid secondary market. There can be no assurance that a
liquid secondary market will exist for a particular option at any specific time.
The value of a foreign currency option depends upon the value of the
underlying currency relative to the U.S. dollar. As a result, the price of the
option position may vary with changes in the value of either or both currencies
and have no relationship to the investment merits of a foreign security. Because
foreign currency transactions occurring in the interbank market involve
substantially larger amounts than those that may be involved in the use of
foreign currency options, investors may be disadvantaged by having to deal in an
odd lot market (generally consisting of transactions of less than $1 million)
for the underlying foreign currencies at prices that are less favorable than for
round lots.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis. Quotation
information available is generally representative of very large transactions in
the interbank market and thus may not reflect relatively smaller transactions
(i.e., less than $1 million) where rates may be less favorable. The interbank
market in foreign currencies is a global, around-the-clock market. To the extent
that the U.S. options markets are closed while the markets for the underlying
currencies remain open, significant price and rate movements may take place in
the underlying markets that are not reflected in the options market.
FUTURES CONTRACTS. The Fund may purchase and sell interest rate and index
futures contracts that are traded on U.S. and foreign commodity exchanges on
such underlying securities as U.S. Treasury bonds, notes, bills and GNMA
Certificates and/or any foreign government fixed-income security and on such
indexes of U.S. and foreign securities as may exist or come into existence.
A futures contract purchaser incurs an obligation to take delivery of a
specified amount of the obligation underlying the contract at a specified time
in the future for a specified price. A seller of a futures contract incurs an
obligation to deliver the specified amount of the underlying obligation at a
specified time in return for an agreed upon price. The purchase of a futures
contract enables the Fund, during the term of the contract, to lock in a price
at which it may purchase a security and protect against a rise in prices pending
purchase of portfolio securities. The sale of a futures contract enables the
Fund to lock in a price at which it may sell a security and protect against
declines in the value of portfolio securities.
Although most futures contracts call for actual delivery or acceptance of
securities, the contracts usually are closed out before the settlement date
without the making or taking of delivery. Index futures contracts provide for
the delivery of an amount of cash equal to a specified dollar amount times the
difference between the index value at the open or close of the last trading day
of the contract and the futures contract price. A futures contract sale is
closed out by effecting a futures contract purchase for the same aggregate
amount of the specific type of security and the same delivery date. If the sale
price exceeds the offsetting purchase price, the seller would be paid the
difference and would realize a gain. If the offsetting purchase price exceeds
the sale price, the seller would pay the difference and would realize a loss.
Similarly, a futures contract purchase is closed out by effecting a futures
contract sale for the same aggregate amount of the specific type of security and
the same delivery date. If the offsetting
8
sale price exceeds the purchase price, the purchaser would realize a gain,
whereas if the purchase price exceeds the offsetting sale price, the purchaser
would realize a loss. There is no assurance that the Fund will be able to enter
into a closing transaction.
MARGIN. If the Fund enters into a futures contract, it is initially
required to deposit an "initial margin" of cash, U.S. government securities or
other liquid portfolio securities ranging from approximately 2% to 5% of the
contract amount. Initial margin requirements are established by the exchanges on
which futures contracts trade and may, from time to time, change. In addition,
brokers may establish margin deposit requirements in excess of those required by
the exchanges.
Initial margin in futures transactions is different from margin in
securities transactions in that initial margin does not involve the borrowing of
funds by a broker's client but is, rather, a good faith deposit on the futures
contract which will be returned to the Fund upon the proper termination of the
futures contract. The margin deposits made are marked to market daily and the
Fund may be required to make subsequent deposits of cash, U.S. government
securities or other liquid portfolio securities, called "variation margin,"
which are reflective of price fluctuations in the futures contract.
OPTIONS ON FUTURES CONTRACTS. The Fund may purchase and write call and put
options on futures contracts and enter into closing transactions with respect to
such options to terminate an existing position. An option on a futures contract
gives the purchaser the right (in return for the premium paid), and the writer
the obligation, to assume a position in a futures contract (a long position if
the option is a call and a short position if the option is a put) at a specified
exercise price at any time during the term of the option. Upon exercise of the
option, the delivery of the futures position by the writer of the option to the
holder of the option is accompanied by delivery of the accumulated balance in
the writer's futures margin account, which represents the amount by which the
market price of the futures contract at the time of exercise exceeds, in the
case of a call, or is less than, in the case of a put, the exercise price of the
option on the futures contract.
The writer of an option on a futures contract is required to deposit initial
and variation margin pursuant to requirements similar to those applicable to
futures contracts. Premiums received from the writing of an option on a futures
contract are included in initial margin deposits.
LIMITATIONS ON FUTURES CONTRACTS AND OPTIONS ON FUTURES. The Fund may not
enter into futures contracts or purchase related options thereon if, immediately
thereafter, the amount committed to margin plus the amount paid for premiums for
unexpired options on futures contracts exceeds 5% of the value of the Fund's
total assets, after taking into account unrealized gains and unrealized losses
on such contracts it has entered into, provided, however, that in the case of an
option that is in-the-money (the exercise price of the call (put) option is less
(more) than the market price of the underlying security) at the time of
purchase, the in-the-money amount may be excluded in calculating the 5%.
However, there is no overall limitation on the percentage of the Fund's net
assets which may be subject to a hedge position.
RISKS OF TRANSACTIONS IN FUTURES CONTRACTS AND RELATED OPTIONS. The prices
of securities and indexes subject to futures contracts (and thereby the futures
contract prices) may correlate imperfectly with the behavior of the cash prices
of the Fund's portfolio securities. Also, prices of futures contracts may not
move in tandem with the changes in prevailing interest rates, market movements
and/or currency exchange rates against which the Fund seeks a hedge. A
correlation may also be distorted (a) temporarily, by short-term traders'
seeking to profit from the difference between a contract or security price
objective and their cost of borrowed funds; (b) by investors in futures
contracts electing to close out their contracts through offsetting transactions
rather than meet margin deposit requirements; (c) by investors in futures
contracts opting to make or take delivery of underlying securities rather than
engage in closing transactions, thereby reducing liquidity of the futures
market; and (d) temporarily, by speculators who view the deposit requirements in
the futures markets as less onerous than margin requirements in the cash market.
Due to the possibility of price distortion in the futures market and because of
the possible imperfect correlation between movements in the prices of securities
and movements in the prices of futures contracts, a correct forecast of interest
rate and/or market movement trends by the Investment Manager may still not
result in a successful hedging transaction.
9
There is no assurance that a liquid secondary market will exist for futures
contracts and related options in which the Fund may invest. In the event a
liquid market does not exist, it may not be possible to close out a futures
position and, in the event of adverse price movements, the Fund would continue
to be required to make daily cash payments of variation margin. The absence of a
liquid market in futures contracts might cause the Fund to make or take delivery
of the underlying securities at a time when it may be disadvantageous to do so.
Exchanges also limit the amount by which the price of a futures contract may
move on any day. If the price moves equal the daily limit on successive days,
then it may prove impossible to liquidate a futures position until the daily
limit moves have ceased. In the event of adverse price movements, the Fund would
continue to be required to make daily cash payments of variation margin on open
futures positions. In these situations, if the Fund has insufficient cash, it
may have to sell portfolio securities to meet daily variation margin
requirements at a time when it may be disadvantageous to do so. In addition, the
Fund may be required to take or make delivery of the instruments underlying
interest rate futures contracts it holds at a time when it is disadvantageous to
do so. The inability to close out options and futures positions could also have
an adverse impact on the Fund's ability to effectively hedge its portfolio.
Futures contracts and options thereon which are purchased or sold on foreign
commodities exchanges may have greater price volatility than their U.S.
counterparts. Furthermore, foreign commodities exchanges may be less regulated
and under less governmental scrutiny than U.S. exchanges. Brokerage commissions,
clearing costs and other transaction costs may be higher on foreign exchanges.
Greater margin requirements may limit the Fund's ability to enter into certain
commodity transactions on foreign exchanges. Moreover, differences in clearance
and delivery requirements on foreign exchanges may occasion delays in the
settlement of the Fund's transactions effected on foreign exchanges.
In the event of the bankruptcy of a broker through which the Fund engages in
transactions in futures or options thereon, the Fund could experience delays
and/or losses in liquidating open positions purchased or sold through the broker
and/or incur a loss of all or part of its margin deposits with the broker.
If the Fund maintains a short position in a futures contract or has sold a
call option in a futures contract, it will cover this position by holding, in a
segregated account maintained on the books of the Fund, cash, U.S. government
securities or other liquid portfolio securities equal in value (when added to
any initial or variation margin on deposit) to the market value of the
securities underlying the futures contract or the exercise price of the option.
Such a position may also be covered by owning the securities underlying the
futures contract (in the case of a stock index futures contract a portfolio of
securities substantially replicating the relevant index), or by holding a call
option permitting the Fund to purchase the same contract at a price no higher
than the price at which the short position was established.
In addition, if the Fund holds a long position in a futures contract or has
sold a put option on a futures contract, it will hold cash, U.S. government
securities or other liquid portfolio securities equal to the purchase price of
the contract or the exercise price of the put option (less the amount of initial
or variation margin on deposit) in a segregated account maintained on the books
of the Fund. Alternatively, the Fund could cover its long position by purchasing
a put option on the same futures contract with an exercise price as high or
higher than the price of the contract held by the Fund.
MONEY MARKET SECURITIES. In addition to the short term fixed-income
securities in which the Fund may otherwise invest, the Fund may invest in
various money market securities for cash management purposes or when assuming a
temporary defensive position, which among others may include commercial paper,
bank acceptances, bank obligations, corporate debt securities, certificates of
deposit, U.S. government securities, obligations of savings institutions and
repurchase agreements. Such securities are limited to:
10
U.S. GOVERNMENT SECURITIES. Obligations issued or guaranteed as to
principal and interest by the United States Government or its agencies (such as
the Export-Import Bank of the United States, Federal Housing Administration and
Government National Mortgage Association) or its instrumentalities (such as the
Federal Home Loan Bank), including Treasury bills, notes and bonds;
BANK OBLIGATIONS. Obligations (including certificates of deposit, time
deposits and bankers' acceptances) of banks subject to regulation by the U.S.
government and having total assets of $1 billion or more, and instruments
secured by such obligations, not including obligations of foreign branches of
domestic banks except to the extent below;
EURODOLLAR CERTIFICATES OF DEPOSIT. Eurodollar certificates of deposit
issued by foreign branches of domestic banks having total assets of $1 billion
or more;
OBLIGATIONS OF SAVINGS INSTITUTIONS. Certificates of deposit of savings
banks and savings and loan associations, having total assets of $1 billion or
more;
FULLY INSURED CERTIFICATES OF DEPOSIT. Certificates of deposits of banks
and savings institutions, having total assets of less than $1 billion, if the
principal amount of the obligation is federally insured by the Bank Insurance
Fund or the Savings Association Insurance Fund (each of which is administered by
the FDIC), limited to $100,000 principal amount per certificate and to 10% or
less of the Fund's total assets in all such obligations and in all illiquid
assets, in the aggregate;
COMMERCIAL PAPER. Commercial paper rated within the two highest grades by
Standard & Poor's Corporation ("S&P") or by Moody's Investors Service, Inc.
("Moody's") or, if not rated, issued by a company having an outstanding debt
issue rated at least AA by S&P or Aa by Moody's; and
REPURCHASE AGREEMENTS. The Fund may invest in repurchase agreements. When
cash may be available for only a few days, it may be invested by the Fund in
repurchase agreements until such time as it may otherwise be invested or used
for payments of obligations of the Fund. These agreements, which may be viewed
as a type of secured lending by the Fund, typically involve the acquisition by
the Fund of debt securities from a selling financial institution such as a bank,
savings and loan association or broker-dealer. The agreement provides that the
Fund will sell back to the institution, and that the institution will
repurchase, the underlying security serving as collateral at a specified price
and at a fixed time in the future, usually not more than seven days from the
date of purchase. The collateral will be marked-to-market daily to determine
that the value of the collateral, as specified in the agreement, does not
decrease below the purchase price plus accrued interest. If such decrease
occurs, additional collateral will be requested and, when received, added to the
account to maintain full collateralization. The Fund will accrue interest from
the institution until the time when the repurchase is to occur. Although this
date is deemed by the Fund to be the maturity date of a repurchase agreement,
the maturities of securities subject to repurchase agreements are not subject to
any limits.
While repurchase agreements involve certain risks not associated with direct
investments in debt securities, the Fund follows procedures approved by the
Trustees designed to minimize such risks. These procedures include effecting
repurchase transactions only with large, well-capitalized and well-established
financial institutions whose financial condition will be continually monitored
by the Investment Manager. In addition, as described above, the value of the
collateral underlying the repurchase agreement will be at least equal to the
repurchase price, including any accrued interest earned on the repurchase
agreement. In the event of a default or bankruptcy by a selling financial
institution, the Fund will seek to liquidate such collateral. However, the
exercising of the Fund's right to liquidate such collateral could involve
certain costs or delays and, to the extent that proceeds from any sale upon a
default of the obligation to repurchase were less than the repurchase price, the
Fund could suffer a loss. It is the current policy of the Fund not to invest in
repurchase agreements that do not mature within seven days if any such
investment, together with any other illiquid assets held by the Fund, amounts to
more than 15% of its net assets.
ZERO COUPON TREASURY SECURITIES. A portion of the U.S. government
securities purchased by the Fund may be "zero coupon" Treasury securities. These
are U.S. Treasury bills, notes and bonds which
11
have been stripped of their unmatured interest coupons and receipts or which are
certificates representing interests in such stripped debt obligations and
coupons. Such securities are purchased at a discount from their face amount,
giving the purchaser the right to receive their full value at maturity. A zero
coupon security pays no interest to its holder during its life. Its value to an
investor consists of the difference between its face value at the time of
maturity and the price for which it was acquired, which is generally an amount
significantly less than its face value (sometimes referred to as a "deep
discount" price).
The interest earned on such securities is, implicitly, automatically
compounded and paid out at maturity. While such compounding at a constant rate
eliminates the risk of receiving lower yields upon reinvestment of interest if
prevailing interest rates decline, the owner of a zero coupon security will be
unable to participate in higher yields upon reinvestment of interest received if
prevailing interest rates rise. For this reason, zero coupon securities are
subject to substantially greater market price fluctuations during periods of
changing prevailing interest rates than are comparable debt securities which
make current distributions of interest. Current federal tax law requires that a
holder (such as the Fund) of a zero coupon security accrue a portion of the
discount at which the security was purchased as income each year even though the
Fund receives no interest payments in cash on the security during the year.
INVESTMENT COMPANIES. Any Fund investment in an investment company is
subject to the underlying risk of that investment company's portfolio
securities. For example, if the investment company held common stocks, the Fund
also would be exposed to the risk of investing in common stocks. As a
shareholder in an investment company, the Fund would bear its ratable share of
that entity's expenses, including its advisory and administration fees. At the
same time, the Fund would continue to pay its own investment management fees and
other expenses. As a result, the Fund and its shareholders, in effect, will be
absorbing duplicate levels of fees with respect to investments in other
investment companies.
REVERSE REPURCHASE AGREEMENTS AND DOLLAR ROLLS. The Fund may use reverse
repurchase agreements and dollar rolls as part of its investment strategy.
Reverse repurchase agreements and dollar rolls are speculative techniques
involving leverage and are considered borrowings by the Fund.
Reverse repurchase agreements involve sales by the Fund of assets
concurrently with an agreement by the Fund to repurchase the same assets at a
later date at a fixed price. Reverse repurchase agreements involve the risk that
the market value of the securities the Fund is obligated to purchase under the
agreement may decline below the repurchase price. In the event the buyer of
securities under a reverse repurchase agreement files for bankruptcy or becomes
insolvent, the Fund's use of the proceeds of the agreement may be restricted
pending a determination by the other party, or its trustee or receiver, whether
to enforce the Fund's obligation to repurchase the securities.
Dollar rolls involve the Fund selling securities for delivery in the current
month and simultaneously contracting to repurchase substantially similar (same
type and coupon) securities on a specified future date. During the roll period,
the Fund will forgo principal and interest paid on the securities. The Fund is
compensated by the difference between the current sales price and the lower
forward price for the future purchase (often referred to as the "drop") as well
as by the interest earned on the cash proceeds of the initial sale.
LENDING PORTFOLIO SECURITIES. The Fund may lend its portfolio securities to
brokers, dealers and other financial institutions, provided that the loans are
callable at any time by the Fund, and are at all times secured by cash or cash
equivalents, which are maintained in a segregated account pursuant to applicable
regulations and that are equal to at least 100% of the market value, determined
daily, of the loaned securities. The advantage of these loans is that the Fund
continues to receive the income on the loaned securities while at the same time
earning interest on the cash amounts deposited as collateral, which will be
invested in short-term obligations. The Fund will not lend more than 10% of the
value of its total assets.
As with any extensions of credit, there are risks of delay in recovery and,
in some cases, even loss of rights in the collateral should the borrower of the
securities fail financially. However, these loans of portfolio securities will
only be made to firms deemed by the Fund's management to be creditworthy and
12
when the income which can be earned from such loans justifies the attendant
risks. Upon termination of the loan, the borrower is required to return the
securities to the Fund. Any gain or loss in the market price during the loan
period would inure to the Fund.
When voting or consent rights which accompany loaned securities pass to the
borrower, the Fund will follow the policy of calling the loaned securities, to
be delivered within one day after notice, to permit the exercise of the rights
if the matters involved would have a material effect on the Fund's investment in
the loaned securities. The Fund will pay reasonable finder's, administrative and
custodial fees in connection with a loan of its securities.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES AND FORWARD COMMITMENTS. From
time to time the Fund may purchase securities on a when-issued or delayed
delivery basis or may purchase or sell securities on a forward commitment basis.
When these transactions are negotiated, the price is fixed at the time of the
commitment, but delivery and payment can take place a month or more after the
date of commitment. While the Fund will only purchase securities on a
when-issued, delayed delivery or forward commitment basis with the intention of
acquiring the securities, the Fund may sell the securities before the settlement
date, if it is deemed advisable. The securities so purchased or sold are subject
to market fluctuation and no interest or dividends accrue to the purchaser prior
to the settlement date.
At the time the Fund makes the commitment to purchase or sell securities on
a when-issued, delayed delivery or forward commitment basis, it will record the
transaction and thereafter reflect the value, each day, of such security
purchased, or if a sale, the proceeds to be received, in determining its net
asset value. At the time of delivery of the securities, their value may be more
or less than the purchase or sale price. An increase in the percentage of the
Fund's assets committed to the purchase of securities on a when-issued, delayed
delivery or forward commitment basis may increase the volatility of its net
asset value. The Fund will also establish a segregated account on the Fund's
books in which it will continually maintain cash or cash equivalents or other
liquid portfolio securities equal in value to commitments to purchase securities
on a when-issued, delayed delivery or forward commitment basis.
WHEN, AS AND IF ISSUED SECURITIES. The Fund may purchase securities on a
"when, as and if issued" basis under which the issuance of the security depends
upon the occurrence of a subsequent event, such as approval of a merger,
corporate reorganization or debt restructuring. The commitment for the purchase
of any such security will not be recognized in the portfolio of the Fund until
the Investment Manager determines that issuance of the security is probable. At
that time, the Fund will record the transaction and, in determining its net
asset value, will reflect the value of the security daily. At that time, the
Fund will also establish a segregated account on the Fund's books in which it
will maintain cash or cash equivalents or other liquid portfolio securities
equal in value to recognized commitments for such securities.
With respect to 75% of the Fund's total assets, the value of the Fund's
commitments to purchase the securities of any one issuer, together with the
value of all securities of such issuer owned by the Fund, may not exceed 5% of
the value of the Fund's total assets at the time the initial commitment to
purchase such securities is made. An increase in the percentage of the Fund's
net assets committed to the purchase of securities on a "when, as and if issued"
basis may increase the volatility of its net asset value. The Fund may also sell
securities on a "when, as and if issued" basis provided that the issuance of the
security will result automatically from the exchange or conversion of a security
owned by the Fund at the time of sale.
PRIVATE PLACEMENTS. The Fund may invest up to 15% of its net assets in
securities which are subject to restrictions on resale because they have not
been registered under the Securities Act of 1933 (the "Securities Act"), or
which are otherwise not readily marketable. (Securities eligible for resale
pursuant to Rule 144A under the Securities Act, and determined to be liquid
pursuant to the procedures discussed in the following paragraph, are not subject
to the foregoing restriction.) These securities are generally referred to as
private placements or restricted securities. Limitations on the resale of these
securities may have an adverse effect on their marketability, and may prevent
the Fund from disposing of them promptly at reasonable prices. The Fund may have
to bear the expense of registering the securities for resale and the risk of
substantial delays in effecting the registration.
13
Rule 144A permits the Fund to sell restricted securities to qualified
institutional buyers without limitation. The Investment Manager, pursuant to
procedures adopted by the Trustees, will make a determination as to the
liquidity of each restricted security purchased by the Fund. If a restricted
security is determined to be "liquid," the security will not be included within
the category "illiquid securities," which may not exceed 15% of the Fund's net
assets. However, investing in Rule 144A securities could have the effect of
increasing the level of Fund illiquidity to the extent the Fund, at a particular
point in time, may be unable to find qualified institutional buyers interested
in purchasing such securities.
WARRANTS AND SUBSCRIPTION RIGHTS. The Fund may acquire warrants and
subscription rights attached to other securities. A warrant is, in effect, an
option to purchase equity securities at a specific price, generally valid for a
specific period of time, and has no voting rights, pays no dividends and has no
rights with respect to the corporation issuing it.
A subscription right is a privilege granted to existing shareholders of a
corporation to subscribe to shares of a new issue of common stock before it is
offered to the public. A subscription right normally has a life of two to four
weeks and a subscription price lower than the current market value of the common
stock.
C. FUND POLICIES/INVESTMENT RESTRICTIONS
The investment objectives, policies and restrictions listed below have been
adopted by the Fund as fundamental policies. Under the Investment Company Act of
1940, as amended (the "Investment Company Act"), a fundamental policy may not be
changed without the vote of a majority of the outstanding voting securities of
the Fund. The Investment Company Act defines a majority as the lesser of
(a) 67% or more of the shares present at a meeting of shareholders, if the
holders of 50% of the outstanding shares of the Fund are present or represented
by proxy; or (b) more than 50% of the outstanding shares of the Fund. For
purposes of the following restrictions: (i) all percentage limitations apply
immediately after a purchase or initial investment; and (ii) any subsequent
change in any applicable percentage resulting from market fluctuations or other
changes in total or net assets does not require elimination of any security from
the portfolio.
The Fund will:
1. Seek to provide a high level of current income, consistent with the
preservation of capital.
The Fund may not:
1. As to 75% of its total assets, invest more than 5% of the value of
its total assets in the securities of any one issuer (other than obligations
issued, or guaranteed by, the United States government, its agencies or
instrumentalities).
2. As to 75% of its total assets, purchase more than 10% of all
outstanding voting securities or any class of securities of any one issuer.
3. Invest 25% or more of the value of its total assets in securities
of issuers in any one industry. This restriction does not apply to
obligations issued or guaranteed by the United States government or its
agencies or instrumentalities.
4. Invest more than 5% of the value of its total assets in securities
of issuers having a record, together with predecessors, of less then three
years of continuous operation. This restriction shall not apply to
mortgage-backed securities or asset-backed securities or to any obligation
of the United States government, its agencies or instrumentalities.
5. Purchase or sell real estate or interests therein, although the
Fund may purchase securities of issuers which engage in real estate
operations and securities secured by real estate or interests therein.
14
6. Purchase oil, gas or other mineral leases, rights or royalty
contracts or exploration or development programs, except that the Fund may
invest in the securities of companies which operate, invest in, or sponsor
such programs.
7. With the exception of reverse repurchase agreements and dollar
rolls, borrow money, except that the Fund may borrow from a bank for
temporary or emergency purposes in amounts not exceeding 5% (taken at the
lower of cost or current value) of its total assets (not including the
amount borrowed).
8. Pledge its assets or assign or otherwise encumber them except to
secure permitted borrowings. For the purpose of this restriction, collateral
arrangements with respect to the writing of options and collateral
arrangements with respect to initial or variation margin for futures are not
deemed to be pledges of assets.
9. Issue senior securities as defined in the Investment Company Act,
except insofar as the Fund may be deemed to have issued a senior security by
reason of (a) entering into any repurchase or reverse repurchase agreement
or dollar roll; (b) purchasing any securities on a when-issued or delayed
delivery basis; (c) purchasing or selling futures contracts, forward foreign
exchange contracts or options; (d) borrowing money; or (e) lending portfolio
securities.
10. Make loans of money or securities, except: (a) by the purchase of
publicly distributed debt obligations in which the Fund may invest
consistent with its investment objectives and policies; (b) by investment in
repurchase agreements; or (c) by lending portfolio securities.
11. Make short sales of securities.
12. Purchase securities on margin, except for such short-term loans as
are necessary for the clearance of portfolio securities. The deposit or
payment by the Fund of initial or variation margin in connection with
futures contracts or related options thereon is not considered the purchase
of a security on margin.
13. Engage in the underwriting of securities, except insofar as the
Fund may be deemed an underwriter under the Securities Act in disposing of a
portfolio security.
14. Invest for purposes of exercising control or management of any
other issuer.
15. Purchase securities of other investment companies, except in
connection with a merger, consolidation, reorganization or acquisition of
assets or in accordance with the provisions of Section 12(d) of the
Investment Company Act and any Rules promulgated thereunder.
16. Purchase or sell commodities or commodities contracts except that
the Fund may purchase or sell futures contracts or options on futures.
Notwithstanding any other investment policy or restriction, the Fund may
seek to achieve its investment objective by investing all or substantially all
of its assets in another investment company having substantially the same
investment objective and policies as the Fund.
PORTFOLIO TURNOVER
For the fiscal years ended April 30, 2002 and 2001, the Fund's portfolio
turnover rates were 327% and 133%, respectively. This variation resulted from
the portfolio manager's response to varying market conditions during these
periods.
III. MANAGEMENT OF THE FUND
- --------------------------------------------------------------------------------
A. BOARD OF TRUSTEES
The Board of Trustees of the Fund oversees the management of the Fund but
does not itself manage the Fund. The Trustees review various services provided
by or under the direction of the Investment Manager to ensure that the Fund's
general investment policies and programs are properly carried out. The Trustees
also conduct their review to ensure that administrative services are provided to
the Fund in a satisfactory manner.
15
Under state law, the duties of the Trustees are generally characterized as a
duty of loyalty and a duty of care. The duty of loyalty requires a Trustee to
exercise his or her powers in the interest of the Fund and not the Trustee's own
interest or the interest of another person or organization. A Trustee satisfies
his or her duty of care by acting in good faith with the care of an ordinarily
prudent person and in a manner the Trustee reasonably believes to be in the best
interest of the Fund and its shareholders.
B. MANAGEMENT INFORMATION
TRUSTEES AND OFFICERS. The Board of the Fund consists of nine
(9) Trustees. These same individuals also serve as directors or trustees for all
of the Morgan Stanley Funds. Six Trustees (67% of the total number) have no
affiliation or business connection with the Investment Manager or any of its
affiliated persons and do not own any stock or other securities issued by the
Investment Manager's parent company, Morgan Stanley. These are the
"non-interested" or "independent" Trustees. The other three Trustees (the
"management Trustees") are affiliated with the Investment Manager.
The Independent Trustees of the Fund, their term of office and length of
time served, their principal business occupations during the past five years,
the number of portfolios in the Fund Complex (defined below) overseen by each
Independent Trustee (as of December 31, 2001) and other directorships, if any,
held by the Trustee, are shown below. The Fund Complex includes all open- and
closed-end funds (including all of their portfolios) advised by Morgan Stanley
Investment Advisors Inc. and any funds that have an investment advisor that is
an affiliated person of Morgan Stanley Investment Advisors Inc. (including, but
not limited to, Morgan Stanley Investment Management Inc., Morgan Stanley
Investments LP and Van Kampen Asset Management Inc.).
NUMBER OF
PORTFOLIOS
IN FUND
POSITION(S) LENGTH OF COMPLEX
NAME, AGE AND ADDRESS OF HELD WITH TIME PRINCIPAL OCCUPATION(S) DURING OVERSEEN
INDEPENDENT TRUSTEE REGISTRANT SERVED* PAST 5 YEARS BY TRUSTEE
- --------------------------- ----------- ----------- -------------------------------------- -----------
Michael Bozic (61) Trustee Trustee Retired; Director or Trustee of the 129
c/o Mayer, Brown, Rowe & since Morgan Stanley Funds and the TCW/DW
Maw April 1994 Term Trusts; formerly Vice Chairman of
Counsel to the Independent Kmart Corporation (December
Trustees 1998-October 2000), Chairman and Chief
1675 Broadway Executive Officer of Levitz Furniture
New York, NY Corporation (November 1995-November
1998) and President and Chief
Executive Officer of Hills Department
Stores (May 1991-July 1995); formerly
variously Chairman, Chief Executive
Officer, President and Chief Operating
Officer (1987-1991) of the Sears
Merchandise Group of Sears, Roebuck &
Co.
Edwin J. Garn (69) Trustee Trustee Director or Trustee of the Morgan 129
c/o Summit Ventures LLC since Stanley Funds and the TCW/DW Term
1 Utah Center January Trusts; formerly United States Senator
201 S. Main Street 1993 (R- Utah)(1974-1992) and Chairman,
Salt Lake City, UT Senate Banking Committee (1980-1986);
formerly Mayor of Salt Lake City, Utah
(1971-1974); formerly Astronaut, Space
Shuttle Discovery (April 12-19, 1985);
Vice Chairman, Huntsman Corporation
(chemical company); member of the Utah
Regional Advisory Board of Pacific
Corp.
NAME, AGE AND ADDRESS OF OTHER DIRECTORSHIPS HELD
INDEPENDENT TRUSTEE BY TRUSTEE
- --------------------------- -------------------------
Michael Bozic (61) Director of Weirton Steel
c/o Mayer, Brown, Rowe & Corporation.
Maw
Counsel to the Independent
Trustees
1675 Broadway
New York, NY
Edwin J. Garn (69) Director of Franklin
c/o Summit Ventures LLC Covey (time management
1 Utah Center systems), BMW Bank of
201 S. Main Street North America, Inc.
Salt Lake City, UT (industrial loan
corporation), United
Space Alliance (joint
venture between Lockheed
Martin and the Boeing
Company) and Nuskin Asia
Pacific (multilevel
marketing); member of the
board of various civic
and charitable
organizations.
- ----------------------------------
* This is the date the Trustee began serving the Morgan Stanley Funds.
16
NUMBER OF
PORTFOLIOS
IN FUND
POSITION(S) LENGTH OF COMPLEX
NAME, AGE AND ADDRESS OF HELD WITH TIME PRINCIPAL OCCUPATION(S) DURING OVERSEEN
INDEPENDENT TRUSTEE REGISTRANT SERVED* PAST 5 YEARS BY TRUSTEE
- --------------------------- ----------- ----------- -------------------------------------- -----------
Wayne E. Hedien (68) Trustee Trustee Retired; Director or Trustee of the 129
c/o Mayer, Brown, Rowe & since Morgan Stanley Funds and the TCW/DW
Maw September Term Trusts; formerly associated with
Counsel to the Independent 1997 the Allstate Companies (1966-1994),
Trustees most recently as Chairman of The
1675 Broadway Allstate Corporation (March
New York, NY 1993-December 1994) and Chairman and
Chief Executive Officer of its
wholly-owned subsidiary, Allstate
Insurance Company (July 1989-December
1994).
Dr. Manuel H. Johnson (53) Trustee Trustee Chairman of the Audit Committee and 129
c/o Johnson Smick since Director or Trustee of the Morgan
International, Inc. July 1991 Stanley Funds and the TCW/DW Term
1133 Connecticut Avenue, Trusts; Senior Partner, Johnson Smick
N.W. International, Inc., a consulting
Washington, D.C. firm; Co- Chairman and a founder of
the Group of Seven Council (G7C), an
international economic commission;
formerly Vice Chairman of the Board of
Governors of the Federal Reserve
System and Assistant Secretary of the
U.S. Treasury.
Michael E. Nugent (66) Trustee Trustee Chairman of the Insurance Committee 207
c/o Triumph Capital, L.P. since and Director or Trustee of the Morgan
237 Park Avenue July 1991 Stanley Funds and the TCW/DW Term
New York, NY Trusts; director/trustee of various
investment companies managed by Morgan
Stanley Investment Management Inc. and
Morgan Stanley Investments LP (since
July 2001); General Partner, Triumph
Capital, L.P., a private investment
partnership; formerly Vice President,
Bankers Trust Company and BT Capital
Corporation (1984-1988).
John L. Schroeder (71) Trustee Trustee Retired; Chairman of the Derivatives 129
c/o Mayer, Brown, Rowe & since Committee and Director or Trustee of
Maw April 1994 the Morgan Stanley Funds and the
Counsel to the Independent TCW/DW Term Trusts; formerly Executive
Trustees Vice President and Chief Investment
1675 Broadway Officer of the Home Insurance Company
New York, NY (August 1991-September 1995).
NAME, AGE AND ADDRESS OF OTHER DIRECTORSHIPS HELD
INDEPENDENT TRUSTEE BY TRUSTEE
- --------------------------- -------------------------
Wayne E. Hedien (68) Director of The PMI Group
c/o Mayer, Brown, Rowe & Inc. (private mortgage
Maw insurance); Trustee and
Counsel to the Independent Vice Chairman of The
Trustees Field Museum of Natural
1675 Broadway History; director of
New York, NY various other business
and charitable
organizations.
Dr. Manuel H. Johnson (53) Director of NVR, Inc.
c/o Johnson Smick (home construction);
International, Inc. Chairman and Trustee of
1133 Connecticut Avenue, the Financial Accounting
N.W. Foundation (oversight
Washington, D.C. organization of the
Financial Accounting
Standards Board).
Michael E. Nugent (66) Director of various
c/o Triumph Capital, L.P. business organizations.
237 Park Avenue
New York, NY
John L. Schroeder (71) Director of Citizens
c/o Mayer, Brown, Rowe & Communications Company
Maw (telecommunications
Counsel to the Independent company).
Trustees
1675 Broadway
New York, NY
- ----------------------------------
* This is the date the Trustee began serving the Morgan Stanley Funds.
17
The management Trustees and executive officers of the Fund, their term of
office and length of time served, their principal business occupations during
the past five years, the number of portfolios in the Fund Complex overseen by
each management Trustee and the other directorships, if any, held by the
Trustee, are shown below.
NUMBER OF
PORTFOLIOS
IN FUND
POSITION(S) LENGTH OF COMPLEX
NAME, AGE AND ADDRESS OF HELD WITH TIME PRINCIPAL OCCUPATION(S) DURING OVERSEEN
MANAGEMENT TRUSTEE REGISTRANT SERVED* PAST 5 YEARS BY TRUSTEE
- --------------------------- ----------- ----------- -------------------------------------- -----------
Charles A. Fiumefreddo (69) Chairman, Trustee Chairman, Director or Trustee and 129
c/o Morgan Stanley Trust Director or since Chief Executive Officer of the Morgan
Harborside Financial Trustee July 1991 Stanley Funds and the TCW/DW Term
Center, and Chief Trusts; formerly Chairman, Chief
Plaza Two, Executive Executive Officer and Director of the
Jersey City, NJ Officer Investment Manager, the Distributor
and Morgan Stanley Services, Executive
Vice President and Director of Morgan
Stanley DW, Chairman and Director of
the Transfer Agent and Director and/or
officer of various Morgan Stanley
subsidiaries (until June 1998).
James F. Higgins (54) Trustee Trustee Director or Trustee of the Morgan 129
c/o Morgan Stanley Trust since June Stanley Funds and the TCW/DW Term
Harborside Financial 2000 Trusts (since June 2000); Senior
Center, Advisor of Morgan Stanley (since
Plaza Two, August 2000); Director of the
Jersey City, NJ Distributor and Dean Witter Realty
Inc.; previously President and Chief
Operating Officer of the Private
Client Group of Morgan Stanley (May
1999-August 2000), President and Chief
Operating Officer of Individual
Securities of Morgan Stanley (February
1997-May 1999).
Philip J. Purcell (58) Trustee Trustee Director or Trustee of the Morgan 129
1585 Broadway since April Stanley Funds and the TCW/DW Term
New York, NY 1994 Trusts; Chairman of the Board of
Directors and Chief Executive Officer
of Morgan Stanley and Morgan Stanley
DW; Director of the Distributor;
Chairman of the Board of Directors and
Chief Executive Officer of Novus
Credit Services Inc.; Director and/or
officer of various Morgan Stanley
subsidiaries.
NAME, AGE AND ADDRESS OF OTHER DIRECTORSHIPS HELD
MANAGEMENT TRUSTEE BY TRUSTEE
- --------------------------- -------------------------
Charles A. Fiumefreddo (69) None
c/o Morgan Stanley Trust
Harborside Financial
Center,
Plaza Two,
Jersey City, NJ
James F. Higgins (54) None
c/o Morgan Stanley Trust
Harborside Financial
Center,
Plaza Two,
Jersey City, NJ
Philip J. Purcell (58) Director of American
1585 Broadway Airlines, Inc. and its
New York, NY parent company, AMR
Corporation.
- ----------------------------------
* This is the date the Trustee began serving the Morgan Stanley funds.
18
POSITION(S)
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF TIME PRINCIPAL OCCUPATION(S) DURING
EXECUTIVE OFFICER REGISTRANT SERVED PAST 5 YEARS
- ---------------------------- ---------------- --------------------- -------------------------------------------------------
Mitchell M. Merin (48) President President since May President and Chief Operating Officer of Morgan Stanley
1221 Avenue of the Americas 1999 Investment Management (since December 1998); President,
New York, NY Director (since April 1997) and Chief Executive Officer
(since June 1998) of the Investment Manager and Morgan
Stanley Services; Chairman, Chief Executive Officer and
Director of the Distributor (since June 1998); Chairman
and Chief Executive Officer (since June 1998) and
Director (since January 1998) of the Transfer Agent;
Director of various Morgan Stanley subsidiaries;
President of the Morgan Stanley Funds and TCW/DW Term
Trusts (since May 1999); Trustee of various Van Kampen
investment companies (since December 1999); previously
Chief Strategic Officer of the Investment Manager and
Morgan Stanley Services and Executive Vice President of
the Distributor (April 1997-June 1998), Vice President
of the Morgan Stanley Funds (May 1997-April 1999), and
Executive Vice President of Morgan Stanley.
Barry Fink (47) Vice President, Vice President, General Counsel (since May 2000) and Managing Director
1221 Avenue of the Americas Secretary and Secretary and General (since December 2000) of Morgan Stanley Investment
New York, NY General Counsel Counsel since Management; Managing Director (since December 2000),
February 1997 and Secretary and General Counsel (since February 1997)
and Director (since July 1998) of the Investment
Manager and Morgan Stanley Services; Assistant
Secretary of Morgan Stanley DW; Vice President,
Secretary and General Counsel of the Morgan Stanley
Funds and TCW/DW Term Trusts (since February 1997);
Vice President and Secretary of the Distributor;
previously, Senior Vice President, Assistant Secretary
and Assistant General Counsel of the Investment Manager
and Morgan Stanley Services.
Thomas F. Caloia (56) Treasurer Since April 1989 First Vice President and Assistant Treasurer of the
c/o Morgan Stanley Trust Investment Manager, the Distributor and Morgan Stanley
Harborside Financial Center, Services; Treasurer of the Morgan Stanley Funds.
Plaza Two,
Jersey City, NJ
David S. Horowitz (28) Vice President Since February 2001 Vice President and Portfolio Manager of the Investment
One Tower Bridge Manager and/or its investment management affiliates for
West Conshohocken, over 5 years.
Pennsylvania
For each Trustee, the dollar range of equity securities beneficially owned
by the Trustee is shown below.
AGGREGATE DOLLAR RANGE OF EQUITY SECURITIES IN
ALL REGISTERED INVESTMENT COMPANIES OVERSEEN
DOLLAR RANGE OF EQUITY SECURITIES IN THE FUND BY TRUSTEE IN FAMILY OF INVESTMENT COMPANIES
NAME OF TRUSTEE (AS OF DECEMBER 31, 2001) (AS OF DECEMBER 31, 2001)
- ------------------------- -------------------------------------------------- -------------------------------------------------
Michael Bozic none over $100,000
Edwin J. Garn none over $100,000
Wayne E. Hedien none over $100,000
Dr. Manuel H. Johnson none over $100,000
Michael E. Nugent $50,001-$100,000 over $100,000
John L. Schroeder none over $100,000
Charles A. Fiumefreddo $10,001-$50,000 over $100,000
James F. Higgins none over $100,000
Philip J. Purcell none over $100,000
19
As to each independent Trustee and his immediate family members, no person
owned beneficially or of record securities in an investment advisor or principal
underwriter of the Fund, or a person (other than a registered investment
company) directly or indirectly controlling, controlled by or under common
control with an investment advisor or principal underwriter of the Fund.
RONALD E. ROBISON, Managing Director, Chief Administrative Officer and
Director of the Investment Manager and Morgan Stanley Services and Chief
Executive Officer and Director of the Transfer Agent, JOSEPH J. MCALINDEN,
Managing Director and Chief Investment Officer of the Investment Manager and
Director of the Transfer Agent, and JONATHAN R. PAGE and JAMES F. WILLISON,
Managing Directors of the Investment Manager, are Vice Presidents of the Fund.
In addition, A. THOMAS SMITH III, Managing Director and General Counsel of
the Investment Manager and Morgan Stanley Services, is a Vice President and
Assistant Secretary of the Fund, LOU ANNE D. MCINNIS, CARSTEN OTTO and RUTH
ROSSI, Executive Directors and Assistant General Counsels of the Investment
Manager and Morgan Stanley Services, MARILYN K. CRANNEY, First Vice President
and Assistant General Counsel of the Investment Manager and Morgan Stanley
Services, and NATASHA KASSIAN and GEORGE SILFEN, Vice Presidents and Assistant
General Counsels of the Investment Manager and Morgan Stanley Services, are
Assistant Secretaries of the Fund.
INDEPENDENT DIRECTORS/TRUSTEES AND THE COMMITTEES. Law and regulation
establish both general guidelines and specific duties for the independent
directors/trustees. The Morgan Stanley Funds seek as independent
directors/trustees individuals of distinction and experience in business and
finance, government service or academia; these are people whose advice and
counsel are in demand by others and for whom there is often competition. To
accept a position on the funds' boards, such individuals may reject other
attractive assignments because the funds make substantial demands on their time.
All of the independent directors/trustees serve as members of the Audit
Committee. In addition, three of the directors/trustees, including two
independent directors/trustees, serve as members of the Derivatives Committee
and the Insurance Committee.
The independent directors/trustees are charged with recommending to the full
board approval of management, advisory and administration contracts, Rule 12b-1
plans and distribution and underwriting agreements; continually reviewing Fund
performance; checking on the pricing of portfolio securities, brokerage
commissions, transfer agent costs and performance, and trading among funds in
the same complex; and approving fidelity bond and related insurance coverage and
allocations, as well as other matters that arise from time to time. The
independent directors/trustees are required to select and nominate individuals
to fill any independent director/trustee vacancy on the board of any fund that
has a Rule 12b-1 plan of distribution. Most of the Morgan Stanley Funds have a
Rule 12b-1 plan.
The Audit Committee is charged with recommending to the full board the
engagement or discharge of the Fund's independent auditors; directing
investigations into matters within the scope of the independent auditors'
duties, including the power to retain outside specialists; reviewing with the
independent auditors the audit plan and results of the auditing engagement;
approving professional services provided by the independent auditors and other
accounting firms prior to the performance of the services; reviewing the
independence of the independent auditors; considering the range of audit and
non-audit fees; reviewing the adequacy of the Fund's system of internal
controls; and preparing and submitting Committee meeting minutes to the full
board. The Audit Committee currently consists of Messrs. Johnson, Bozic, Hedien,
Garn, Nugent and Schroeder. During the Fund's fiscal year ended April 30, 2002,
the Audit Committee held 11 meetings.
The board of each fund has a Derivatives Committee to approve parameters for
and monitor the activities of the Fund with respect to derivative investments,
if any, made by the Fund. The Derivatives Committee currently consists of
Messrs. Schroeder, Fiumefreddo and Johnson. During the Fund's fiscal year ended
April 30, 2002, the Derivatives Committee held 3 meetings.
20
Finally, the board of each fund has formed an Insurance Committee to review
and monitor the insurance coverage maintained by the Fund. The Insurance
Committee currently consists of Messrs. Nugent, Fiumefreddo and Hedien. During
the Fund's fiscal year ended April 30, 2002, the Insurance Committee held 2
meetings.
ADVANTAGES OF HAVING SAME INDIVIDUALS AS INDEPENDENT DIRECTORS/TRUSTEES FOR
ALL MORGAN STANLEY FUNDS. The independent directors/trustees and the funds'
management believe that having the same independent directors/trustees for each
of the Morgan Stanley Funds avoids the duplication of effort that would arise
from having different groups of individuals serving as independent directors/
trustees for each of the funds or even of sub-groups of funds. They believe that
having the same individuals serve as independent directors/trustees of all the
funds tends to increase their knowledge and expertise regarding matters which
affect the Fund complex generally and enhances their ability to negotiate on
behalf of each fund with the Fund's service providers. This arrangement also
precludes the possibility of separate groups of independent directors/trustees
arriving at conflicting decisions regarding operations and management of the
Funds and avoids the cost and confusion that would likely ensue. Finally, having
the same independent directors/trustees serve on all Fund boards enhances the
ability of each Fund to obtain, at modest cost to each separate Fund, the
services of independent directors/ trustees of the caliber, experience and
business acumen of the individuals who serve as independent directors/trustees
of the Morgan Stanley Funds.
TRUSTEE AND OFFICER INDEMNIFICATION. The Fund's Declaration of Trust
provides that no Trustee, officer, employee or agent of the Fund is liable to
the Fund or to a shareholder, nor is any Trustee, officer, employee or agent
liable to any third persons in connection with the affairs of the Fund, except
as such liability may arise from his/her or its own bad faith, willful
misfeasance, gross negligence or reckless disregard of his/her or its duties. It
also provides that all third persons shall look solely to the Fund property for
satisfaction of claims arising in connection with the affairs of the Fund. With
the exceptions stated, the Declaration of Trust provides that a Trustee,
officer, employee or agent is entitled to be indemnified against all liability
in connection with the affairs of the Fund.
C. COMPENSATION
The Fund pays each Independent Trustee an annual fee of $800 plus a per
meeting fee of $50 for meetings of the Board of Trustees, the Independent
Trustees or Committees of the Board of Trustees attended by the Trustee (the
Fund pays the Chairman of the Audit Committee an additional annual fee of $750,
and the Chairmen of the Derivatives and Insurance Committees additional annual
fees of $500). If a Board meeting and a meeting of the Independent Trustees or a
Committee meeting (except an Audit Committee meeting), or a meeting of the
Independent Trustees and/or more than one Committee meeting (except an Audit
Committee meeting), take place on a single day, the Trustees are paid a single
meeting fee by the Fund. The Fund also reimburses such Trustees for travel and
other out-of-pocket expenses incurred by them in connection with attending such
meetings. Trustees and officers of the Fund who are or have been employed by the
Investment Manager or an affiliated company receive no compensation or expense
reimbursement from the Fund for their services as Trustee.
The following table illustrates the compensation that the Fund paid to its
Independent Trustees for the fiscal year ended April 30, 2002.
FUND COMPENSATION
AGGREGATE
COMPENSATION
NAME OF INDEPENDENT TRUSTEE FROM THE FUND
- --------------------------- -------------
Michael Bozic............................................... $1,600
Edwin J. Garn............................................... 1,600
Wayne E. Hedien............................................. 1,600
Dr. Manuel H. Johnson....................................... 2,350
Michael E. Nugent........................................... 2,100
John L. Schroeder........................................... 2,100
21
The following table illustrates the compensation paid to the Fund's
Independent Trustees for the calendar year ended December 31, 2001 for services
to the 97 registered Morgan Stanley Funds (consisting of 129 portfolios) that
were in operation at December 31, 2001. None of the Fund's Independent Trustees
received compensation from any other funds in the Fund Complex, except for
Mr. Nugent who received compensation for service as Director/Trustee to 16 other
registered funds (consisting of 78 portfolios) in the Fund Complex.
CASH COMPENSATION FROM MORGAN STANLEY FUNDS
TOTAL CASH
COMPENSATION
FOR SERVICES TO
97 MORGAN
STANLEY FUNDS
AND OTHER
FUNDS IN THE
NAME OF INDEPENDENT TRUSTEE FUND COMPLEX
- --------------------------- ---------------
Michael Bozic............................................... $150,150
Edwin J. Garn............................................... 150,150
Wayne E. Hedien............................................. 150,150
Dr. Manuel H. Johnson....................................... 219,900
Michael E. Nugent........................................... 228,362
John L. Schroeder........................................... 196,650
As of the date of this STATEMENT OF ADDITIONAL INFORMATION, 52 of the Morgan
Stanley Funds, not including the Fund, have adopted a retirement program under
which an independent director/trustee who retires after serving for at least
five years (or such lesser period as may be determined by the Board) as an
independent director/trustee of any Morgan Stanley Fund that has adopted the
retirement program (each such fund referred to as an "Adopting Fund" and each
such director/trustee referred to as an "Eligible Trustee") is entitled to
retirement payments upon reaching the eligible retirement age (normally, after
attaining age 72). Annual payments are based upon length of service.
Currently, upon retirement, each Eligible Trustee is entitled to receive
from the Adopting Fund, commencing as of his or her retirement date and
continuing for the remainder of his or her life, an annual retirement benefit
(the "Regular Benefit") equal to 30.22% of his or her Eligible Compensation plus
0.5036667% of such Eligible Compensation for each full month of service as an
independent director/ trustee of any Adopting Fund in excess of five years up to
a maximum of 60.44% after ten years of service. The foregoing percentages may be
changed by the Board.(1) "Eligible Compensation" is one-fifth of the total
compensation earned by such Eligible Trustee for service to the Adopting Fund in
the five year period prior to the date of the Eligible Trustee's retirement.
Benefits under the retirement program are accrued as expenses on the books of
the Adopting Funds. Such benefits are not secured or funded by the Adopting
Funds.
- ------------------------
(1) An Eligible Trustee may elect alternative payments of his or her retirement
benefits based upon the combined life expectancy of the Eligible Trustee and
his or her spouse on the date of such Eligible Trustee's retirement. In
addition, the Eligible Trustee may elect that the surviving spouse's
periodic payment of benefits will be equal to a lower percentage of the
periodic amount when both spouses were alive. The amount estimated to be
payable under this method, through the remainder of the later of the lives
of the Eligible Trustee and spouse, will be the actuarial equivalent of the
Regular Benefit.
22
The following table illustrates the retirement benefits accrued to the
Fund's Independent Trustees by the 52 Morgan Stanley Funds (not including the
Fund) for the fiscal year ended December 31, 2001, and the estimated retirement
benefits for the Independent Trustees, to commence upon their retirement, from
the 52 Morgan Stanley Funds as of December 31, 2001. For the calendar year ended
December 31, 2001, no retirement benefits accrued to the Independent Trustees
from any other funds in the Fund Complex.
RETIREMENT BENEFITS FROM ALL MORGAN STANLEY FUNDS
ESTIMATED ESTIMATED ANNUAL
CREDITED RETIREMENT BENEFITS BENEFITS
YEARS ESTIMATED ACCRUED AS UPON RETIREMENT
OF SERVICE AT PERCENTAGE OF EXPENSES FROM ALL
RETIREMENT ELIGIBLE BY ALL ADOPTING
NAME OF INDEPENDENT TRUSTEE (MAXIMUM 10) COMPENSATION ADOPTING FUNDS FUNDS(1)
- --------------------------- ------------- ------------- ------------------- ----------------
Michael Bozic................... 10 60.44% $21,395 $48,443
Edwin J. Garn................... 10 60.44 33,443 49,121
Wayne E. Hedien................. 9 51.37 44,952 41,437
Dr. Manuel H. Johnson........... 10 60.44 22,022 72,014
Michael E. Nugent............... 10 60.44 38,472 64,157
John L. Schroeder............... 8 50.37 68,342 50,640
- ------------------------
(1) Based on current levels of compensation. Amount of annual benefits also
varies depending on the Trustee's elections described in Footnote (1) on
page 22.
IV. CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
- --------------------------------------------------------------------------------
As of June 19, 2002, no person was known to own 5% or more of the
outstanding shares of the Fund.
As of the date of this STATEMENT OF ADDITIONAL INFORMATION, the aggregate
number of shares of beneficial interest of the Fund owned by the Fund's officers
and Trustees as a group was less than 1% of the Fund's shares of beneficial
interest outstanding.
V. INVESTMENT MANAGEMENT AND OTHER SERVICES
- --------------------------------------------------------------------------------
A. INVESTMENT MANAGER
The Investment Manager to the Fund is Morgan Stanley Investment Advisors
Inc., a Delaware corporation, whose address is 1221 Avenue of the Americas, New
York, NY 10020. The Investment Manager is a wholly-owned subsidiary of Morgan
Stanley, a Delaware corporation. Morgan Stanley is a preeminent global financial
services firm that maintains leading market positions in each of its three
primary businesses: securities, asset management and credit services.
Pursuant to an Investment Management Agreement (the "Management Agreement")
with the Investment Manager, the Fund has retained the Investment Manager to
provide administrative services and manage the investment of the Fund's assets,
including the placing of orders for the purchase and sale of portfolio
securities. The Fund pays the Investment Manager monthly compensation calculated
daily by applying the annual rate of 0.70% to the net assets of the Fund
determined as of the close of each business day. The Investment Manager has
undertaken from January 1, 1999 through December 31, 2002 to assume operating
expenses (except for any brokerage fees) and to waive its compensation to the
extent such expenses and compensation exceed 0.80% of the Fund's daily net
assets on an annualized basis. Taking these waivers and assumptions of expenses
into account, for the fiscal years ended April 30, 2000, 2001 and 2002, the fees
payable under the Management Agreement amounted to $920,686, $633,337 and
$777,220, respectively.
23
The Investment Manager has retained its wholly-owned subsidiary, Morgan
Stanley Services, to perform administrative services for the Fund.
In approving the Management Agreement, the Board of Trustees, including the
Independent Trustees, considered the nature, quality and scope of the services
provided by the Investment Manager, the performance, fees and expenses of the
Fund compared to other similar investment companies, the Investment Manager's
expenses in providing the services, the profitability of the Investment Manager
and its affiliated companies and other benefits they derive from their
relationship with the Fund and the extent to which economies of scale are shared
with the Fund. The Independent Trustees met with and reviewed reports from third
parties about the foregoing factors and changes, if any, in such items since the
preceding year's deliberations. The Independent Trustees noted their confidence
in the capability and integrity of the senior management and staff of the
Investment Manager and the financial strength of the Investment Manager and its
affiliated companies. The Independent Trustees weighed the foregoing factors in
light of the advice given to them by their legal counsel as to the law
applicable to the review of investment advisory contracts. Based upon its
review, the Board of Trustees, including all of the Independent Trustees,
determined, in the exercise of its business judgment, that approval of the
Management Agreement was in the best interests of the Fund and its shareholders.
B. PRINCIPAL UNDERWRITER
The Fund's principal underwriter is the Distributor (which has the same
address as the Investment Manager). In this capacity, the Fund's shares are
distributed by the Distributor. The Distributor has entered into a selected
dealer agreement with Morgan Stanley DW, which through its own sales
organization sells shares of the Fund. In addition, the Distributor may enter
into similar agreements with other selected broker-dealers. The Distributor, a
Delaware corporation, is a wholly-owned subsidiary of Morgan Stanley.
The Distributor bears all expenses it may incur in providing services under
the Distribution Agreement. These expenses include the payment of commissions
for sales of the Fund's shares and incentive compensation to Financial Advisors,
the cost of educational and/or business-related trips, and educational and/or
promotional and business-related expenses. The Distributor also pays certain
expenses in connection with the distribution of the Fund's shares, including the
costs of preparing, printing and distributing advertising or promotional
materials, and the costs of printing and distributing prospectuses and
supplements thereto used in connection with the offering and sale of the Fund's
shares. The Fund bears the costs of initial typesetting, printing and
distribution of prospectuses and supplements thereto to shareholders. The Fund
also bears the costs of registering the Fund and its shares under federal and
state securities laws and pays filing fees in accordance with state securities
laws.
The Fund and the Distributor have agreed to indemnify each other against
certain liabilities, including liabilities under the Securities Act. Under the
Distribution Agreement, the Distributor uses its best efforts in rendering
services to the Fund, but in the absence of willful misfeasance, bad faith,
gross negligence or reckless disregard of its obligations, the Distributor is
not liable to the Fund or any of its shareholders for any error of judgment or
mistake of law or for any act or omission or for any losses sustained by the
Fund or its shareholders.
C. SERVICES PROVIDED BY THE INVESTMENT MANAGER
The Investment Manager manages the investment of the Fund's assets,
including the placing of orders for the purchase and sale of portfolio
securities. The Investment Manager obtains and evaluates the information and
advice relating to the economy, securities markets, and specific securities as
it considers necessary or useful to continuously manage the assets of the Fund
in a manner consistent with its investment objective.
Under the terms of the Management Agreement, in addition to managing the
Fund's investments, the Investment Manager maintains certain of the Fund's books
and records and furnishes, at its own expense, the office space, facilities,
equipment, clerical help, bookkeeping and certain legal services as the Fund may
reasonably require in the conduct of its business, including the preparation of
prospec-
24
tuses, proxy statements and reports required to be filed with federal and state
securities commissions (except insofar as the participation or assistance of
independent auditors and attorneys is, in the opinion of the Investment Manager,
necessary or desirable). The Investment Manager also bears the cost of telephone
service, heat, light, power and other utilities provided to the Fund.
Expenses not expressly assumed by the Investment Manager under the
Management Agreement or by the Distributor, will be paid by the Fund. Such
expenses include, but are not limited to: expenses of the Plan of Distribution
pursuant to Rule 12b-1; charges and expenses of any registrar, custodian, stock
transfer and dividend disbursing agent; brokerage commissions; taxes; engraving
and printing share certificates; registration costs of the Fund and its shares
under federal and state securities laws; the cost and expense of printing,
including typesetting, and distributing prospectuses of the Fund and supplements
thereto to the Fund's shareholders; all expenses of shareholders' and Trustees'
meetings and of preparing, printing and mailing of proxy statements and reports
to shareholders; fees and travel expenses of Trustees or members of any advisory
board or committee who are not employees of the Investment Manager or any
corporate affiliate of the Investment Manager; all expenses incident to any
dividend, withdrawal or redemption options; charges and expenses of any outside
service used for pricing of the Fund's shares; fees and expenses of legal
counsel, including counsel to the Trustees who are not interested persons of the
Fund or of the Investment Manager (not including compensation or expenses of
attorneys who are employees of the Investment Manager); fees and expenses of the
Fund's independent auditors; membership dues of industry associations; interest
on Fund borrowings; postage; insurance premiums on property or personnel
(including officers and Trustees) of the Fund which inure to its benefit;
extraordinary expenses (including, but not limited to, legal claims and
liabilities and litigation costs and any indemnification relating thereto); and
all other costs of the Fund's operation.
The Management Agreement provides that in the absence of willful
misfeasance, bad faith, gross negligence or reckless disregard of its
obligations thereunder, the Investment Manager is not liable to the Fund or any
of its investors for any act or omission by the Investment Manager or for any
losses sustained by the Fund or its investors.
The Management Agreement will remain in effect from year to year, provided
continuance of the Management Agreement is approved at least annually by the
vote of the holders of a majority, as defined in the Investment Company Act, of
the outstanding shares of the Fund, or by the Trustees; provided that in either
event such continuance is approved annually by the vote of a majority of the
Trustees, including a majority of the Independent Trustees.
D. DEALER REALLOWANCES
Upon notice to selected broker-dealers, the Distributor may reallow up to
the full applicable front-end sales charge during periods specified in such
notice. During periods when 90% or more of the sales charge is reallowed, such
selected broker-dealers may be deemed to be underwriters as that term is defined
in the Securities Act.
E. RULE 12b-1 PLAN
The Fund has adopted a Plan of Distribution pursuant to Rule 12b-1 under the
Investment Company Act (the "Plan") pursuant to which the Distributor or any of
its affiliates, including the Investment Manager, is authorized to utilize their
own resources to finance certain activities in connection with the distribution
of the Fund's shares.
The Investment Manager will pay a retention fee to Morgan Stanley Financial
Advisors at an annual rate of 0.05% of the value of shares of the Fund held for
at least one year. Shares purchased through the reinvestment of dividends will
be eligible for a retention fee, provided that such dividends were earned on
shares otherwise eligible for a retention fee payment. Shares owned in variable
annuities, closed-end fund shares and shares held in 401(k) plans where the
Transfer Agent or Morgan Stanley's Retirement Plan Services is either
recordkeeper or trustee are not eligible for a retention fee.
25
The retention fees are paid by the Investment Manager from its own assets,
which may include profits from investment management fees payable under the
Investment Management Agreement, as well as from borrowed funds.
Under the Plan, the Distributor uses its best efforts in rendering services
to the Fund, but in the absence of willful misfeasance, bad faith, gross
negligence or reckless disregard of its obligations, the Distributor is not
liable to the Fund or any of its shareholders for any error of judgment or
mistake of law or for any act or omission or for any losses sustained by the
Fund or its shareholders.
Under the Plan, the Distributor provides the Fund, for review by the
Trustees, and the Trustees review, promptly after the end of each calendar
quarter, a written report regarding the distribution expenses incurred on behalf
of the Fund during such calendar quarter, which report includes (1) an
itemization of the types of expenses and the purposes therefore; (2) the amounts
of such expenses; and (3) a description of the benefits derived by the Fund. In
the Trustees' quarterly review of the Plan they consider its continued
appropriateness and the level of compensation provided therein.
F. OTHER SERVICE PROVIDERS
(1) TRANSFER AGENT/DIVIDEND-PAYING AGENT
Morgan Stanley Trust is the Transfer Agent for the Fund's shares and the
Dividend Disbursing Agent for payment of dividends and distributions on Fund
shares and Agent for shareholders under various investment plans. The principal
business address of the Transfer Agent is Harborside Financial Center, Plaza
Two, 2nd floor, Jersey City, NJ 07311.
(2) CUSTODIAN AND INDEPENDENT AUDITORS
The Bank of New York, 100 Church Street, New York, NY 10007 is the Custodian
of the Fund's assets. Any of the Fund's cash balances with the Custodian in
excess of $100,000 are unprotected by federal deposit insurance. These balances
may, at times, be substantial.
Deloitte & Touche LLP, Two World Financial Center, New York, NY 10281 serves
as the independent auditors of the Fund. The independent auditors are
responsible for auditing the annual financial statements of the Fund.
(3) AFFILIATED PERSONS
The Transfer Agent is an affiliate of the Investment Manager and the
Distributor. As Transfer Agent and Dividend Disbursing Agent, the Transfer
Agent's responsibilities include maintaining shareholder accounts, disbursing
cash dividends and reinvesting dividends, processing account registration
changes, handling purchase and redemption transactions, mailing prospectuses and
reports, mailing and tabulating proxies, processing share certificate
transactions, and maintaining shareholder records and lists. For these services,
the Transfer Agent receives a per shareholder account fee from the Fund and is
reimbursed for its out-of-pocket expenses in connection with such services.
G. CODES OF ETHICS
The Fund, the Investment Manager and the Distributor have each adopted a
Code of Ethics pursuant to Rule 17j-1 under the Investment Company Act. The
Codes of Ethics are designed to detect and prevent improper personal trading.
The Codes of Ethics permit personnel subject to the Codes to invest in
securities, including securities that may be purchased, sold or held by the
Fund, subject to a number of restrictions and controls including prohibitions
against purchases of securities in an Initial Public Offering and a preclearance
requirement with respect to personal securities transactions.
VI. BROKERAGE ALLOCATION AND OTHER PRACTICES
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A. BROKERAGE TRANSACTIONS
Subject to the general supervision of the Trustees, the Investment Manager
is responsible for decisions to buy and sell securities for the Fund, the
selection of brokers and dealers to effect the transactions, and the negotiation
of brokerage commissions, if any. The Fund expects that the primary
26
market for the securities in which it intends to invest will generally be the
over-the-counter market. Securities are generally traded in the over-the-counter
market on a "net" basis with dealers acting as principal for their own accounts
without a stated commission, although the price of the security usually includes
a profit to the dealer. The Fund also expects that securities will be purchased
at times in underwritten offerings where the price includes a fixed amount of
compensation, generally referred to as the underwriter's concession or discount.
Options and futures transactions will usually be effected through a broker and a
commission will be charged. On occasion, the Fund may also purchase certain
money market instruments directly from an issuer, in which case no commissions
or discounts are paid.
For the fiscal years ended April 30, 2000, 2001 and 2002, the Fund paid no
brokerage commissions.
B. COMMISSIONS
Pursuant to an order of the SEC, the Fund may effect principal transactions
in certain money market instruments with Morgan Stanley DW. The Fund will limit
its transactions with Morgan Stanley DW to U.S. government and government agency
securities, bank money instruments (i.e., certificates of deposit and bankers'
acceptances) and commercial paper. The transactions will be effected with Morgan
Stanley DW only when the price available from Morgan Stanley DW is better than
that available from other dealers.
During the fiscal years ended April 30, 2000, 2001 and 2002, the Fund did
not effect any principal transactions with Morgan Stanley DW.
Brokerage transactions in securities listed on exchanges or admitted to
unlisted trading privileges may be effected through Morgan Stanley DW, Morgan
Stanley & Co. and other affiliated brokers and dealers. In order for an
affiliated broker or dealer to effect any portfolio transactions on an exchange
for the Fund, the commissions, fees or other remuneration received by the
affiliated broker or dealer must be reasonable and fair compared to the
commissions, fees or other remuneration paid to other brokers in connection with
comparable transactions involving similar securities being purchased or sold on
an exchange during a comparable period of time. This standard would allow the
affiliated broker or dealer to receive no more than the remuneration which would
be expected to be received by an unaffiliated broker in a commensurate
arm's-length transaction. Furthermore, the Trustees, including the Independent
Trustees, have adopted procedures which are reasonably designed to provide that
any commissions, fees or other remuneration paid to an affiliated broker or
dealer are consistent with the foregoing standard. The Fund does not reduce the
management fee it pays to the Investment Manager by any amount of the brokerage
commissions it may pay to an affiliated broker or dealer.
During the fiscal years ended April 30, 2000, 2001 and 2002, the Fund paid
no brokerage commissions to either Morgan Stanley DW or Morgan Stanley & Co.
C. BROKERAGE SELECTION
The policy of the Fund regarding purchases and sales of securities for its
portfolio is that primary consideration will be given to obtaining the most
favorable prices and efficient executions of transactions. The Fund anticipates
that certain of its transactions involving foreign securities will be effected
on foreign securities exchanges. Fixed commissions on such transactions are
generally higher than negotiated commissions on domestic transactions. There is
also generally less government supervision and regulation of foreign securities
exchanges and brokers than in the United States.
In seeking to implement the Fund's policies, the Investment Manager effects
transactions with those brokers and dealers who the Investment Manager believes
provide the most favorable prices and are capable of providing efficient
executions. If the Investment Manager believes the prices and executions are
obtainable from more than one broker or dealer, it may give consideration to
placing portfolio transactions with those brokers and dealers who also furnish
research and other services to the Fund or the Investment Manager. The services
may include, but are not limited to, any one or more of the following:
information as to the availability of securities for purchase or sale;
statistical or factual information or opinions pertaining to investment; wire
services; and appraisals or evaluations of portfolio
27
securities. The information and services received by the Investment Manager from
brokers and dealers may be utilized by the Investment Manager and any of its
asset management affiliates in the management of accounts of some of its other
clients and may not in all cases benefit the Fund directly.
The information and services received by the Investment Manager from brokers
and dealers may be of benefit to the Investment Manager in the management of
accounts of some of its other clients and may not in all cases benefit the Fund
directly. While the receipt of such information and services is useful in
varying degrees and would generally reduce the amount of research or services
otherwise performed by the Investment Manager and thereby reduce its expenses,
it is of indeterminable value and the Fund does not reduce the management fee it
pays to the Investment Manager by any amount that may be attributable to the
value of such services.
Subject to the principle of obtaining best price and execution, the
Investment Manager may consider a broker-dealer's sales of shares of the Fund as
a factor in selecting from among those broker-dealers qualified to provide
comparable prices and execution on the Fund's portfolio transactions. The Fund
does not, however, require a broker-dealer to sell shares of the Fund in order
for it to be considered to execute portfolio transactions, and will not enter
into any arrangement whereby a specific amount or percentage of the Fund's
transactions will be directed to a broker which sells shares of the Fund to
customers. The Trustees review, periodically, the allocation of brokerage orders
to monitor the operation of these policies.
The Investment Manager, and certain of its affiliates, currently serve as
investment manager to a number of clients, including other investment companies,
and may in the future act as investment manager or advisor to others. It is the
practice of the Investment Manager and its affiliates to cause purchase and sale
transactions to be allocated among clients whose assets they manage (including
the Fund) in such manner they deem equitable. In making such allocations among
the Fund and other client accounts, various factors may be considered, including
the respective investment objectives, the relative size of portfolio holdings of
the same or comparable securities, the availability of cash for investment, the
size of investment commitments generally held and the opinions of the persons
responsible for managing the portfolios of the Fund and other client accounts.
The Investment Manager and its affiliates may operate one or more order
placement facilities and each facility will implement order allocation in
accordance with the procedure described above. From time to time, each facility
may transact in a security at the same time as other facilities are trading in
that security.
D. DIRECTED BROKERAGE
During the fiscal year ended April 30, 2002, the Fund did not pay any
brokerage commissions in connection with transactions because of research
services provided.
E. REGULAR BROKER-DEALERS
During the fiscal year ended April 30, 2002, the Fund purchased securities
issued by Credit Suisse First Boston USA, Inc., Goldman Sachs Group, Inc. and
Lehman Brothers Holdings, Inc., which issuers were among the ten brokers or the
ten dealers that executed transactions for or with the Fund in the largest
dollar amounts during the year. At April 30, 2002, the Fund held securities
issued by Credit Suisse First Boston USA, Inc., Goldman Sachs Group, Inc. and
Lehman Brothers Holdings, Inc. with market values of $808,501, $643,678 and
$752,114, respectively.
VII. CAPITAL STOCK AND OTHER SECURITIES
- --------------------------------------------------------------------------------
The shareholders of the Fund are entitled to a full vote for each full share
of beneficial interest held. The Fund is authorized to issue an unlimited number
of shares of beneficial interest. All shares of beneficial interest of the Fund
are of $0.01 par value and are equal as to earnings, assets and voting
privileges.
28
The Fund's Declaration of Trust permits the Trustees to authorize the
creation of additional series of shares (the proceeds of which would be invested
in separate, independently managed portfolios) and additional Classes of shares
within any series. The Trustees have not presently authorized any such
additional series or Classes of shares other than as set forth in the
PROSPECTUS.
The Fund is not required to hold annual meetings of shareholders and in
ordinary circumstances the Fund does not intend to hold such meetings. The
Trustees may call special meetings of shareholders for action by shareholder
vote as may be required by the Investment Company Act or the Declaration of
Trust. Under certain circumstances, the Trustees may be removed by action of the
Trustees. In addition, under certain circumstances, the shareholders may call a
meeting to remove Trustees and the Fund is required to provide assistance in
communicating with shareholders about such a meeting. The voting rights of
shareholders are not cumulative, so that holders of more than 50 percent of the
shares voting can, if they choose, elect all Trustees being selected, while the
holders of the remaining shares would be unable to elect any Trustees.
Under Massachusetts law, shareholders of a business trust may, under certain
limited circumstances, be held personally liable as partners for the obligations
of the Fund. However, the Declaration of Trust contains an express disclaimer of
shareholder liability for acts or obligations of the Fund, requires that notice
of such Fund obligations include such disclaimer, and provides for
indemnification out of the Fund's property for any shareholder held personally
liable for the obligations of the Fund. Thus, the risk of a shareholder
incurring financial loss on account of shareholder liability is limited to
circumstances in which the Fund itself would be unable to meet its obligations.
Given the above limitations on shareholder personal liability, and the nature of
the Fund's assets and operations, the possibility of the Fund being unable to
meet its obligations is remote and thus, in the opinion of Massachusetts counsel
to the Fund, the risk to Fund shareholders of personal liability is remote.
All of the Trustees, except for James F. Higgins, have been elected by the
shareholders of the Fund, most recently at a Special Meeting of Shareholders
held on May 21, 1997. The Trustees themselves have the power to alter the number
and the terms of office of the Trustees (as provided for in the Declaration of
Trust), and they may at any time lengthen or shorten their own terms or make
their terms of unlimited duration and appoint their own successors, provided
that always at least a majority of the Trustees has been elected by the
shareholders of the Fund.
VIII. PURCHASE, REDEMPTION AND PRICING OF SHARES
- --------------------------------------------------------------------------------
A. PURCHASE/REDEMPTION OF SHARES
Information concerning how Fund shares are offered to the public (and how
they are redeemed and exchanged) is provided in the Fund's PROSPECTUS.
TRANSFER AGENT AS AGENT. With respect to the redemption or repurchase of
Fund shares, the application of proceeds to the purchase of new shares in the
Fund or any other Morgan Stanley Funds and the general administration of the
exchange privilege, the Transfer Agent acts as agent for the Distributor and for
the shareholder's authorized broker-dealer, if any, in the performance of such
functions. With respect to exchanges, redemptions or repurchases, the Transfer
Agent is liable for its own negligence and not for the default or negligence of
its correspondents or for losses in transit. The Fund is not liable for any
default or negligence of the Transfer Agent, the Distributor or any authorized
broker-dealer.
The Distributor and any authorized broker-dealer have appointed the Transfer
Agent to act as their agent in connection with the application of proceeds of
any redemption of Fund shares to the purchase of shares of any other Morgan
Stanley Fund and the general administration of the exchange privilege. No
commission or discounts will be paid to the Distributor or any authorized
broker-dealer for any transaction pursuant to the exchange privilege.
OUTSIDE BROKERAGE ACCOUNTS. If a shareholder wishes to maintain his or her
fund account through a brokerage company other than Morgan Stanley DW, he or she
may do so only if the Distributor
29
has entered into a selected dealer agreement with that brokerage company.
Accounts maintained through a brokerage company other than Morgan Stanley DW may
be subject to certain restrictions on subsequent purchases and exchanges. Please
contact your brokerage company or the Transfer Agent for more information.
B. OFFERING PRICE
The price of Fund shares, called "net asset value," is based on the value of
the Fund's portfolio securities.
In the calculation of the Fund's net asset value: (1) an equity portfolio
security listed or traded on the New York or American Stock Exchange, Nasdaq, 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
latest bid 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 pursuant
to procedures adopted by the Trustees); and (2) all other portfolio securities
for which over-the-counter market quotations are readily available are valued at
the latest bid price. When market quotations are not readily available,
including circumstances under which it is determined by the Investment Manager
that sale or bid prices are not reflective of a security's market value,
portfolio securities are valued at their fair value as determined in good faith
under procedures established by and under the general supervision of the Fund's
Trustees. For valuation purposes, quotations of foreign portfolio securities,
other assets and liabilities and forward contracts stated in foreign currency
are translated into U.S. dollar equivalents at the prevailing market rates prior
to the close of the New York Stock Exchange.
Short-term debt securities with remaining maturities of sixty days or less
at the time of purchase are valued at amortized cost, unless the Trustees
determine such does not reflect the securities' market value, in which case
these securities will be valued at their fair value as determined by the
Trustees.
Certain of the Fund's portfolio securities may be valued by an outside
pricing service approved by the Fund's Trustees. The pricing service may utilize
a matrix system incorporating security quality, maturity and coupon as the
evaluation model parameters, and/or research evaluations by its staff, including
review of broker-dealer market price quotations in determining what it believes
is the fair valuation of the portfolio securities valued by such pricing
service.
Listed options on debt securities 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 will be valued at the mean between their
latest bid and asked prices. Unlisted options on debt securities and all options
on equity securities are valued at the mean between their latest bid and asked
prices. Futures are valued at the latest price published by the commodities
exchange on which they trade unless the Trustees determine such price does not
reflect their market value, in which case they will be valued at their fair
value as determined in good faith under procedures established by and under the
supervision of the Trustees.
Generally, trading in foreign securities, as well as corporate bonds, U.S.
government securities and money market instruments, is substantially completed
each day at various times prior to the close of the New York Stock Exchange. The
values of such securities used in computing the net asset value of the Fund's
shares are determined as of such times. Foreign currency exchange rates are also
generally determined prior to the close of the New York Stock Exchange.
Occasionally, events which may affect the values of such securities and such
exchange rates may occur between the times at which they are determined and the
close of the New York Stock Exchange and will therefore not be reflected in the
computation of the Fund's net asset value. If events that may affect the value
of such securities occur during such period, then these securities may be valued
at their fair value as determined in good faith under procedures established by
and under the supervision of the Trustees.
30
IX. TAXATION OF THE FUND AND SHAREHOLDERS
- --------------------------------------------------------------------------------
The Fund generally will make two basic types of distributions: ordinary
dividends and long-term capital gain distributions. These two types of
distributions are reported differently on a shareholder's income tax return and
they are also subject to different rates of tax. The tax treatment of the
investment activities of the Fund will affect the amount, timing and character
of the distributions made by the Fund. Tax issues relating to the Fund are not
generally a consideration for shareholders such as tax-exempt entities and
tax-advantaged retirement vehicles such as an IRA or 401(k) plan. Shareholders
are urged to consult their own tax professionals regarding specific questions as
to federal, state or local taxes.
INVESTMENT COMPANY TAXATION. The Fund intends to remain qualified as a
regulated investment company under Subchapter M of the Internal Revenue Code of
1986, as amended. As such, the Fund will not be subject to federal income tax on
its net investment income and capital gains, if any, to the extent that it
distributes such income and capital gains to its shareholders.
The Fund generally intends to distribute sufficient income and gains so that
the Fund will not pay corporate income tax on its earnings. The Fund also
generally intends to distribute to its shareholders in each calendar year a
sufficient amount of ordinary income and capital gains to avoid the imposition
of a 4% excise tax. However, the Fund may instead determine to retain all or
part of any net long-term capital gains in any year for reinvestment. In such
event, the Fund will pay federal income tax (and possibly excise tax) on such
retained gains.
Gains or losses on sales of securities by the Fund will be long-term capital
gains or losses if the securities have a tax holding period of more than one
year at the time of such sale. Gains or losses on the sale of securities with a
tax holding period of one year or less will be short-term capital gains or
losses. Special tax rules may change the normal treatment of gains and losses
recognized by the Fund when the Fund invests in forward foreign currency
exchange contracts, options, futures transactions. Those special tax rules can,
among other things, affect the treatment of capital gain or loss as long-term or
short-term and may result in ordinary income or loss rather than capital gain or
loss. The application of these special rules would therefore also affect the
character of distributions made by the Fund.
Under certain tax rules, the Fund may be required to accrue a portion of any
discount at which certain securities are purchased as income each year even
though the Fund receives no payments in cash on the security during the year. To
the extent that the Fund invests in such securities, it would be required to pay
out such income as an income distribution in each year in order to avoid
taxation at the Fund level. Such distributions will be made from the available
cash of the Fund or by liquidation of portfolio securities if necessary. If a
distribution of cash necessitates the liquidation of portfolio securities, the
Investment Manager will select which securities to sell. The Fund may realize a
gain or loss from such sales. In the event the Fund realizes net capital gains
from such transactions, its shareholders may receive a larger capital gain
distribution, if any, than they would in the absence of such transactions.
TAXATION OF DIVIDENDS AND DISTRIBUTIONS. Shareholders normally will have to
pay federal income taxes, and any state and/or local income taxes, on the
dividends and other distributions they receive from the Fund. Such dividends and
distributions, to the extent that they are derived from net investment income or
short-term capital gains, are taxable to the shareholder as ordinary income
regardless of whether the shareholder receives such payments in additional
shares or in cash.
Distributions of net long-term capital gains, if any, are taxable to
shareholders as long-term capital gains regardless of how long a shareholder has
held the Fund's shares and regardless of whether the distribution is received in
additional shares or in cash. Under current law, the maximum tax rate on long-
term capital gains realized by non-corporate shareholders generally is 20%. A
special lower tax rate of 18% on long-term capital gains is available to
non-corporate shareholders to the extent the distributions of long-term capital
gains are derived from securities which the Fund purchased after December 31,
2000, and held for more than five years.
31
Shareholders are generally taxed on any ordinary dividend or capital gain
distributions from the Fund in the year they are actually distributed. However,
if any such dividends or distributions are declared in October, November or
December and paid in January then such amounts will be treated for tax purposes
as received by the shareholders on December 31, to shareholders of record of
such month.
Shareholders who are not citizens or residents of the United States and
certain foreign entities may be subject to withholding of U.S. tax on
distributions by the Fund of investment income and short-term capital gains.
After the end of each calendar year, shareholders will be sent information
on their dividends and capital gain distributions for tax purposes, including
the portion taxable as ordinary income and the portion taxable as long-term
capital gains.
PURCHASES AND REDEMPTIONS AND EXCHANGES OF FUND SHARES. Any dividend or
capital gains distribution received by a shareholder from any investment company
will have the effect of reducing the net asset value of the shareholder's stock
in that company by the exact amount of the dividend or capital gains
distribution. Furthermore, such dividends and capital gains distributions are
subject to federal income taxes. If the net asset value of the shares should be
reduced below a shareholder's cost as a result of the payment of dividends or
the distribution of realized long-term capital gains, such payment or
distribution would be in part a return of the shareholder's investment but
nonetheless would be taxable to the shareholder. Therefore, an investor should
consider the tax implications of purchasing Fund shares immediately prior to a
distribution record date.
In general, a sale of shares results in capital gain or loss, and for
individual shareholders, is taxable at a federal rate dependent upon the length
of time the shares were held. A redemption of a shareholder's Fund shares is
normally treated as a sale for tax purposes. Fund shares held for a period of
one year or less at the time of such sale or redemption will, for tax purposes,
generally result in short-term capital gains or losses and those held for more
than one year will generally result in long-term capital gains or losses. Under
current law, the maximum tax rate on long-term capital gains realized by non-
corporate shareholders generally is 20%. A special lower tax rate of 18% on
long-term capital gains is available for non-corporate shareholders who
purchased shares after December 31, 2000, and held such shares for more than
five years. This special lower tax rate of 18% for five-year property does not
apply to non-corporate shareholders holding Fund shares which were purchased on
or prior to December 31, 2000, unless such shareholders make an election to
treat the Fund shares as being sold and reacquired on January 1, 2001. A
shareholder making such election may realize capital gains. Any loss realized by
shareholders upon a sale or redemption of shares within six months of the date
of their purchase will be treated as a long-term capital loss to the extent of
any distributions of net long-term capital gains with respect to such shares
during the six-month period.
Gain or loss on the sale or redemption of shares in the Fund is measured by
the difference between the amount received and the tax basis of the shares.
Shareholders should keep records of investments made (including shares acquired
through reinvestment of dividends and distributions) so they can compute the tax
basis of their shares. Under certain circumstances a shareholder may compute and
use an average cost basis in determining the gain or loss on the sale or
redemption of shares.
Exchanges of Fund shares for shares of another fund, including shares of
other Morgan Stanley Funds, are also subject to similar tax treatment. Such an
exchange is treated for tax purposes as a sale of the original shares in the
first fund, followed by the purchase of shares in the second fund.
If a shareholder realizes a loss on the redemption or exchange of a fund's
shares and reinvests in that fund's shares within 30 days before or after the
redemption or exchange, the transactions may be subject to the "wash sale"
rules, resulting in a postponement of the recognition of such loss for tax
purposes.
32
X. UNDERWRITERS
- --------------------------------------------------------------------------------
The Fund's shares are offered to the public on a continuous basis. The
Distributor, as the principal underwriter of the shares, has certain obligations
under the Distribution Agreement concerning the distribution of the shares.
These obligations and the compensation the Distributor receives are described
above in the sections titled "Principal Underwriter" and "Rule 12b-1 Plan."
XI. CALCULATION OF PERFORMANCE DATA
- --------------------------------------------------------------------------------
From time to time, the Fund may quote its "yield" and/or "total return" in
advertisements and sales literature. Yield is calculated for any 30-day period
as follows: the amount of interest income for each security in the Fund's
portfolio is determined in accordance with regulatory requirements; the total
for the entire portfolio constitutes the Fund's gross income for the period.
Expenses accrued during the period are subtracted to arrive at "net investment
income." The resulting amount is divided by the product of the maximum offering
price per share on the last day of the period multiplied by the average number
of shares outstanding during the period that were entitled to dividends. This
amount is added to 1 and raised to the sixth power. 1 is then subtracted from
the result and the difference is multiplied by 2 to arrive at the annualized
yield. Based on this calculation, the Fund's annualized yield for the 30-day
period ended April 30, 2002 with a waiver of fees was 3.27%. Based on this
calculation, the Fund's annualized yield for the 30-day period ended April 30,
2002 without a waiver of fees would have been 3.07%.
The Fund's "average annual total return" represents an annualization of the
Fund's total return over a particular period and is computed by finding the
annual percentage rate which will result in the ending redeemable value of a
hypothetical $1,000 investment made at the beginning of a one, five or ten year
period, or for the period from the date of commencement of operations, if
shorter than any of the foregoing. For the purpose of this calculation, it is
assumed that all dividends and distributions are reinvested. The formula for
computing the average annual total return involves a percentage obtained by
dividing the ending redeemable value by the amount of the initial investment,
taking a root of the quotient (where the root is equivalent to the number of
years in the period) and subtracting 1 from the result. The average annual total
return for the one year, five year and life of the Fund (commencing January 10,
1994) for the periods ended April 30, 2002 were 6.50%, 6.12% and 5.58%,
respectively. Without the waiver of fees and assumption of expenses by the
Investment Manager, the average annual total return for the one year, five year
and life of the Fund for the periods ended April 30, 2002 were 6.39%, 5.83% and
5.31%, respectively.
In addition, the Fund may advertise its total return over different periods
of time by means of aggregate, average, year-by-year or other types of total
return figures.
In addition, the Fund may compute its aggregate total return for specified
periods by determining the aggregate percentage rate which will result in the
ending value of a hypothetical $1,000 investment made at the beginning of the
period. For the purpose of this calculation, it is assumed that all dividends
and distributions are reinvested. The formula for computing aggregate total
return involves a percentage obtained by dividing the ending value by the
initial $1,000 investment and subtracting 1 from the result. Based on the this
calculation, the total returns for the one year, five year and life of the Fund
periods ended April 30, 2002, were 6.50%, 34.56% and 56.98%, respectively.
The Fund may also advertise the growth of hypothetical investments of
$10,000, $50,000 and $100,000 of shares of the Fund by adding 1 to the Fund's
aggregate total return to date (expressed as a decimal and multiplying by
$10,000, $50,000 and $100,000 as the case may be. Investments of $10,000,
$50,000 and $100,000 in the Fund at inception would have grown to $15,698,
$78,489 and $156,979, respectively, at April 30, 2002.
The after-tax returns of the Fund may also be advertisted or otherwise
reported. This is generally calculated in a manner similar to the computation of
average annual total returns discussed above,
33
except that the calculation also reflects the effect of taxes on returns. Based
on these calculations, the average annual total returns (after taxes on
distributions) for the Fund for the one year, five year, and the life of the
Fund periods ended April 30, 2002 were 4.55%, 3.75% and 3.46%, respectively, and
the average annual total returns (after taxes on distributions and redemptions)
for the Fund for the one year, five year, and the life of the Fund periods ended
April 30, 2002 were 3.94%, 3.70% and 3.51%, respectively.
The Fund from time to time may also advertise its performance relative to
certain performance rankings and indexes compiled by recognized organizations.
XII. FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
EXPERTS. The financial statements of the Fund for the fiscal year ended
April 30, 2002 included in this STATEMENT OF ADDITIONAL INFORMATION and
incorporated by reference in the PROSPECTUS have been so included and
incorporated in reliance on the report of Deloitte & Touche LLP, independent
auditors, given on the authority of said firm as experts in auditing and
accounting.
* * * * *
This STATEMENT OF ADDITIONAL INFORMATION and the PROSPECTUS do not contain
all of the information set forth in the REGISTRATION STATEMENT the Fund has
filed with the SEC. The complete REGISTRATION STATEMENT may be obtained from the
SEC.
34
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS / / APRIL 30, 2002
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------------------------
Corporate Bonds (26.9%)
AEROSPACE & DEFENSE (0.6%)
$ 475 Lockheed Martin Corp................... 7.25% 05/15/06 $ 505,789
390 Raytheon Co............................ 8.20 03/01/06 424,271
55 Raytheon Co............................ 6.75 08/15/07 57,024
------------
987,084
------------
AIRLINES (0.1%)
130 Southwest Airlines Co.................. 5.496 11/01/06 129,894
------------
AUTO PARTS: O.E.M. (0.5%)
405 Delphi Automotive Systems Corp......... 6.125 05/01/04 414,539
385 Johnson Controls, Inc.................. 5.00 11/15/06 377,791
------------
792,330
------------
BROADCASTING (1.2%)
2,000 Clear Channel Communications Corp.**... 7.25 09/15/03 2,050,068
------------
CABLE/SATELLITE TV (1.5%)
530 Comcast Cable.......................... 6.375 01/30/06 531,759
1,000 Cox Enterprises Inc. - 144A* **........ 6.625 06/14/02 1,002,798
800 Rogers Cablesystems, Ltd............... 9.625 08/01/02 802,000
215 TCI Communications, Inc................ 8.00 08/01/05 226,678
------------
2,563,235
------------
DEPARTMENT STORES (0.4%)
495 Federated Dept Stores.................. 8.50 06/15/03 519,221
130 May Dept Stores Co..................... 6.875 11/01/05 137,974
------------
657,195
------------
DISCOUNT STORES (0.2%)
310 Target Corp............................ 7.50 02/15/05 334,166
------------
DRUGSTORE CHAINS (0.3%)
455 CVS Corp............................... 5.625 03/15/06 456,574
------------
ELECTRIC UTILITIES (0.3%)
525 Progress Energy Inc.................... 6.75 03/01/06 544,046
------------
ENVIRONMENTAL SERVICES (0.4%)
660 WMX Technologies Inc................... 7.00 10/15/06 676,641
------------
SEE NOTES TO FINANCIAL STATEMENTS
35
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS / / APRIL 30, 2002 CONTINUED
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------------------------
FINANCE/RENTAL/LEASING (2.5%)
$ 740 American General Finance Corp.......... 5.875% 07/14/06 $ 751,335
1,090 Ford Motor Credit Co................... 6.875 02/01/06 1,104,187
200 Ford Motor Credit Co................... 6.50 01/25/07 198,701
875 Household Finance Corp................. 6.50 01/24/06 897,343
290 Household Finance Corp................. 5.75 01/30/07 285,856
75 MBNA America Bank N.A.................. 7.75 09/15/05 80,491
445 MBNA America Bank N.A.................. 6.50 06/20/06 453,776
145 Prime Property Funding II - 144A*...... 6.80 08/15/02 146,420
220 Prime Property Funding II - 144A*...... 7.00 08/15/04 227,604
------------
4,145,713
------------
FINANCIAL CONGLOMERATES (1.6%)
1,305 General Electric Capital Corp.**....... 5.375 03/15/07 1,314,725
395 General Motors Acceptance Corp......... 7.50 07/15/05 419,642
765 J.P. Morgan Chase & Co................. 5.35 03/01/07 759,505
160 Tyco Capital Corp...................... 5.625 05/17/04 154,383
85 Tyco Capital Corp...................... 6.50 02/07/06 80,547
------------
2,728,802
------------
FINANCIAL PUBLISHING/SERVICES (0.1%)
200 Reed Elsevier Capital.................. 6.125 08/01/06 205,400
------------
FOOD RETAIL (0.7%)
735 Kroger Co.............................. 7.375 03/01/05 781,967
350 Safeway Inc............................ 6.15 03/01/06 359,729
------------
1,141,696
------------
FOOD: MEAT/FISH/DAIRY (0.2%)
270 ConAgra Foods, Inc..................... 6.00 09/15/06 275,235
------------
FOREIGN GOVERNMENT OBLIGATIONS (0.8%)
1,025 Quebec Province (Canada)**............. 5.50 04/11/06 1,047,893
290 United Mexican States (Mexico)......... 8.625 03/12/08 316,825
------------
1,364,718
------------
FOREST PRODUCTS (0.5%)
815 Weyerhauser Company - 144A*............ 5.50 03/15/05 824,839
------------
GAS DISTRIBUTORS (1.1%)
530 CMS Panhandle Holding Co............... 6.125 03/15/04 541,469
520 Consolidated Natural Gas Co............ 5.375 11/01/06 512,063
SEE NOTES TO FINANCIAL STATEMENTS
36
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS / / APRIL 30, 2002 CONTINUED
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------------------------
$ 375 Nisource Finance Corp.................. 7.625% 11/15/05 $ 376,635
397 Ras Laffan Liquefied Natural Gas Co.
Ltd. - 144A* (Qatar).................. 7.628 09/15/06 415,914
------------
1,846,081
------------
HOME BUILDING (0.2%)
240 Centex Corp............................ 9.75 06/15/05 268,545
------------
HOME FURNISHINGS (0.1%)
195 Mohawk Industries, Inc................. 6.50 04/15/07 198,914
------------
HOME IMPROVEMENT CHAINS (0.4%)
565 Lowe's Co., Inc........................ 7.50 12/15/05 614,067
------------
HOSPITAL/NURSING MANAGEMENT (0.3%)
525 Tenet Healthcare Corp.................. 5.375 11/15/06 517,200
------------
HOTELS/RESORTS/CRUISELINES (0.6%)
280 Hyatt Equities LLC - 144A*............. 9.25 05/15/05 294,991
435 Marriott International Inc. (Ser D).... 8.125 04/01/05 467,388
295 Starwood Hotels Resorts................ 7.375 05/01/07 296,844
------------
1,059,223
------------
INDUSTRIAL CONGLOMERATES (0.7%)
600 Honeywell International, Inc........... 5.125 11/01/06 592,918
565 Tyco International Group S.A.
(Luxembourg).......................... 6.375 02/15/06 476,052
------------
1,068,970
------------
INSURANCE BROKERS (0.4%)
600 Marsh & McLennan Companies, Inc........ 5.375 03/15/07 604,051
------------
INTEGRATED OIL (0.4%)
585 Conoco Inc............................. 5.90 04/15/04 604,940
------------
INVESTMENT BANKS/BROKERS (1.3%)
805 Credit Suisse F/B USA, Inc.**.......... 5.75 04/15/07 808,501
595 Goldman Sachs Group, Inc............... 7.625 08/17/05 643,678
730 Lehman Brothers Holdings, Inc.**....... 6.25 05/15/06 752,114
------------
2,204,293
------------
SEE NOTES TO FINANCIAL STATEMENTS
37
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS / / APRIL 30, 2002 CONTINUED
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------------------------
INVESTMENT MANAGERS (0.6%)
$ 1,045 TIAA Global Markets - 144A*............ 5.00% 03/01/07 $ 1,035,635
------------
LIFE/HEALTH INSURANCE (1.8%)
250 Equitable Life Assurance Corp. -
144A*................................. 6.95 12/01/05 264,763
585 John Hancock Global Fund - 144A*....... 5.625 06/27/06 588,892
625 Metropolitan Life Insurance Co. -
144A*................................. 6.30 11/01/03 645,853
330 Monumental Global Funding II - 144A*... 6.05 01/19/06 340,970
650 Nationwide Mutual Insurance - 144A*.... 6.50 02/15/04 673,085
495 Prudential Insurance Co. - 144A*....... 6.375 07/23/06 510,021
------------
3,023,584
------------
MAJOR BANKS (1.2%)
2,000 First Union Corp.**.................... 8.00 11/15/02 2,057,384
------------
MAJOR TELECOMMUNICATIONS (1.4%)
615 AT&T Corp. - 144A*..................... 6.50 11/15/06 589,232
455 Sprint Capital Corp.................... 6.00 01/15/07 416,210
595 Telus Corp. (Canada)................... 7.50 06/01/07 605,226
675 WorldCom, Inc.......................... 7.875 05/15/03 506,250
340 WorldCom, Inc.......................... 6.50 05/15/04 200,600
------------
2,317,518
------------
MANAGED HEALTH CARE (0.7%)
475 Aetna, Inc............................. 7.375 03/01/06 482,786
275 UnitedHealth Group Inc................. 7.50 11/15/05 298,786
410 Wellpoint Health Network Inc........... 6.375 06/15/06 423,100
------------
1,204,672
------------
MEDIA CONGLOMERATES (0.4%)
635 AOL Time Warner, Inc................... 6.125 04/15/06 621,658
------------
MOTOR VEHICLES (0.3%)
470 DaimierChrysler NA Holding............. 6.40 05/15/06 480,105
------------
MULTI-LINE INSURANCE (1.0%)
465 AIG SunAmerica Global Finance VI -
144A*................................. 5.20 05/10/04 476,787
500 Farmers Insurance Exchange - 144A*..... 8.50 08/01/04 524,110
600 Hartford Financial Services
Group, Inc.**......................... 7.75 06/15/05 651,928
------------
1,652,825
------------
SEE NOTES TO FINANCIAL STATEMENTS
38
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS / / APRIL 30, 2002 CONTINUED
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------------------------
OIL & GAS PIPELINES (0.2%)
$ 415 Williams Companies, Inc................ 6.50% 08/01/06 $ 402,776
------------
OIL & GAS PRODUCTION (0.2%)
300 Pemex Master Trust - 144A*............. 7.875 02/01/09 308,625
------------
RAILROADS (0.5%)
300 Norfolk Southern Corp.**............... 7.875 02/15/04 318,613
470 Union Pacific Corp..................... 5.84 05/25/04 483,400
------------
802,013
------------
REAL ESTATE INVESTMENT TRUSTS (0.6%)
415 EOP Operating LP....................... 8.375 03/15/06 450,866
555 Simon Property Group LP................ 6.375 11/15/07 555,862
------------
1,006,728
------------
SPECIALTY TELECOMMUNICATIONS (0.2%)
490 Qwest Capital Funding Inc.............. 7.75 08/15/06 379,792
------------
WIRELESS TELECOMMUNICATIONS (0.4%)
595 AT&T Wireless Services, Inc............ 7.35 03/01/06 594,735
------------
Total Corporate Bonds
(COST $44,983,467)............................................................... 44,751,970
------------
U.S. Government & Agency Obligations (53.4%)
Mortgage Pass-Through Securities (29.0%)
2,153 Federal Home Loan Mortgage Corp. PC
Gold.................................. 6.00 08/01/02-09/01/03 2,196,961
176 Federal Home Loan Mortgage Corp. PC
Gold.................................. 6.50 07/01/02-09/01/02 179,874
15,050 Federal Home Loan Mortgage Corp. PC
Gold.................................. 7.50 *** 15,703,734
15,500 Federal Home Loan Mortgage Corp........ 6.00 *** 15,713,125
7,000 Federal Home Loan Mortgage Corp........ 7.00 *** 7,216,563
237 Federal National Mortgage Assoc........ 6.00 08/01/02-12/01/02 240,688
7,000 Federal National Mortgage Assoc........ 6.50 *** 7,052,500
------------
48,303,445
------------
U.S. Government Obligations (24.4%)
37,225 U.S. Treasury Notes**.................. 6.75 - 7.875 11/15/04-05/15/05 40,687,991
------------
Total U.S. Government & Agency Obligations
(COST $88,756,005)............................................................... 88,991,436
------------
SEE NOTES TO FINANCIAL STATEMENTS
39
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS / / APRIL 30, 2002 CONTINUED
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------------------------
Asset Backed Securities (12.5%)
FINANCE/RENTAL/LEASING
$ 1,000 American Express Credit Account Master
Trust 2001-2 A........................ 6.40% 04/15/05 $ 1,016,085
135 CIT Marine Trust 1999-A AL............. 5.80 04/15/10 138,555
1,200 Capital Auto Receivables Asset Trust
2002-2A............................... 4.50 10/15/07 1,206,000
875 Chase Credit Card Master Trust 2001-4
A..................................... 5.50 11/17/08 900,117
1,100 Chase Manhattan Auto Owner Trust....... 4.24 09/15/08 1,093,984
500 Connecticut RRB Special Purpose Trust
CL&P-1................................ 5.36 03/30/07 516,241
257 Daimler-Benz Vehicle Trust 1998-A A4... 5.22 12/22/03 257,394
2,200 Daimler Chrysler Auto Trust 2000-C
A3.................................... 4.49 - 6.82 09/06/04-10/06/08 2,234,616
283 First Security Auto Owner Trust 1999-1
A4.................................... 5.74 06/15/04 286,192
1,307 Ford Credit Auto Owner Trust 2002-B.... 4.14 - 6.74 06/15/04-12/15/05 1,331,131
1,200 Harley Davidson Motorcycle Trust
2002-1................................ 4.50 01/15/10 1,197,671
1,991 Honda Auto Receivables Owner Trust
2001-3 A2............................. 2.76 - 6.62 02/18/04-10/17/05 2,005,493
1,325 Household Automotive Trust 2001-3 A3... 3.68 04/17/06 1,327,572
1,200 MBNA Master Card Trust 1997-J A........ 1.98 02/15/07 1,202,307
492 MMCA Automobile Trust 2000-1 A3........ 7.00 06/15/04 501,369
1,100 National City Auto Trust 2002-A........ 4.04 07/15/06 1,109,393
2,098 Nissan Auto Receivables Owner Trust
2002-A A3............................. 3.58 - 7.01 09/15/03-02/15/07 2,133,228
900 Nissan Auto Receivables Owner Trust
2002 B................................ 4.60 09/17/07 909,931
650 Nordstrom Private Label Credit Card
Master Trust - 144A* 2000-C A3........ 4.82 04/15/10 645,437
259 Peco Energy Transition Trust 1999-A
A2.................................... 5.63 03/01/05 263,588
391 Premier Auto Trust 1999-2 A4........... 5.59 02/09/04 396,279
82 Residential Funding Mortgage Securities
Trust 2000-HI4 AI2.................... 7.39 04/25/11 81,860
134 Toyota Auto Receivables Owner Trust
1999-A A3............................. 6.15 08/16/04 134,303
------------
Total Asset Backed Securities
(COST $20,834,777)............................................................... 20,888,746
------------
Collateralized Mortgage Obligations (1.0%)
U.S. Government Agencies
489 Federal Home Loan Mortgage Corp........ 6.50 03/15/29 499,507
1,059 Federal Home Loan Mortgage Corp. CMO
214................................... 6.60 03/15/29 1,089,587
------------
Total Collateralized Mortgage Obligations
(COST $1,587,547)................................................................ 1,589,094
------------
SEE NOTES TO FINANCIAL STATEMENTS
40
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS / / APRIL 30, 2002 CONTINUED
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------------------------
Short-Term Investments (32.0%)
U.S. Government & Agency Obligations (a) (24.3%)
$15,000 Federal Home Loan Banks................ 1.73 - 1.86% 05/03/02-06/26/02 $ 14,978,207
20,000 Federal Home Mortgage Corp............. 1.67 - 3.58 05/31/02-07/03/02 19,949,381
5,000 Federal National Mortgage Assoc........ 1.77 06/05/02 4,991,396
550 U.S. Treasury Bill **.................. 1.88 10/17/02 545,146
------------
Total U.S. Government & Agency Obligations
(COST $40,464,129)............................................................... 40,464,130
------------
Repurchase Agreement (7.7%)
12,912 Joint repurchase agreement account
(dated 04/30/02; proceeds $12,912,683)
(b)
(COST $12,912,000)..................... 1.905 05/01/02 12,912,000
------------
Total Short-Term Investments
(COST $53,376,129)............................................................... 53,376,130
------------
Total Investments
(COST $209,537,925) (c).................................. 125.8% 209,597,376
Liabilities in Excess of Other Assets..................... (25.8) (42,966,540)
----- ------------
Net Assets................................................ 100.0% $166,630,836
===== ============
- ---------------------
* RESALE IS RESTRICTED TO QUALIFIED INSTITUTIONAL INVESTORS.
** SOME OR ALL OF THESE SECURITIES HAVE BEEN SEGREGATED IN
CONNECTION WITH SECURITIES PURCHASED ON A FORWARD COMMITMENT
BASIS AND/OR FUTURES CONTRACTS.
*** SECURITY PURCHASED ON A FORWARD COMMITMENT WITH AN
APPROXIMATE PRINCIPAL AMOUNT AND NO DEFINITE MATURITY DATE;
THE ACTUAL PRINCIPAL AMOUNT AND MATURITY DATE WILL BE
DETERMINED UPON SETTLEMENT.
(A) PURCHASED ON A DISCOUNT BASIS. THE INTEREST RATE SHOWN HAS
BEEN ADJUSTED TO REFLECT A MONEY MARKET EQUIVALENT YIELD.
(B) COLLATERALIZED BY FEDERAL AGENCY AND U.S. TREASURY
OBLIGATIONS.
(C) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES
APPROXIMATES THE AGGREGATE COST FOR BOOK PURPOSES. THE
AGGREGATE GROSS UNREALIZED APPRECIATION IS $1,038,758 AND
THE AGGREGATE GROSS UNREALIZED DEPRECIATION IS $979,307,
RESULTING IN NET UNREALIZED APPRECIATION OF $59,451.
LONG (SHORT) FUTURES CONTRACTS OPEN AT APRIL 30, 2002:
DESCRIPTION, UNDERLYING UNREALIZED
NUMBER OF DELIVERY MONTH, FACE AMOUNT APPRECIATION/
CONTRACTS LONG/SHORT AND YEAR AT VALUE DEPRECIATION
- --------------------------------------------------------------------------------------------------
35 Long U.S. Treasury Notes June 2002 $ 3,711,641 $ 2,386
25 Long U.S. Treasury Notes June 2002 5,227,735 9,822
15 Long U.S. Treasury Bonds June 2002 1,534,688 10,253
289 Short U.S. Treasury Notes June 2002 (30,507,563) (87,844)
--------
Net unrealized depreciation................................................. $(65,383)
========
SEE NOTES TO FINANCIAL STATEMENTS
41
Morgan Stanley Limited Duration Fund
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
APRIL 30, 2002
Assets:
Investments in securities, at value (cost $209,537,925)..... $209,597,376
Receivable for:
Investments sold.......................................... 7,096,651
Interest.................................................. 1,924,399
Shares of beneficial interest sold........................ 1,254,240
Prepaid expenses and other assets........................... 49,720
------------
Total Assets............................................ 219,922,386
------------
Liabilities:
Payable for:
Investments purchased..................................... 52,421,690
Shares of beneficial interest repurchased................. 618,706
Investment management fee................................. 104,081
Dividends to shareholders................................. 72,585
Variation margin.......................................... 22,858
Accrued expenses and other payables......................... 51,630
------------
Total Liabilities....................................... 53,291,550
------------
Net Assets.............................................. $166,630,836
============
Composition of Net Assets:
Paid-in-capital............................................. $169,378,542
Net unrealized depreciation................................. (5,932)
Dividends in excess of net investment income................ (572,326)
Accumulated net realized loss............................... (2,169,448)
------------
Net Assets.............................................. $166,630,836
============
Net Asset Value Per Share,
17,379,848 shares outstanding (unlimited shares
authorized of $.01 par value)........................ $ 9.59
============
SEE NOTES TO FINANCIAL STATEMENTS
42
Morgan Stanley Limited Duration Fund
FINANCIAL STATEMENTS CONTINUED
Statement of Operations
FOR THE YEAR ENDED APRIL 30, 2002
Net Investment Income:
Interest Income............................................. $6,403,612
----------
Expenses
Investment management fee................................... 945,845
Transfer agent fees and expenses............................ 87,612
Professional fees........................................... 67,821
Registration fees........................................... 60,080
Shareholder reports and notices............................. 52,247
Custodian fees.............................................. 16,560
Trustees' fees and expenses................................. 12,192
Other....................................................... 7,233
----------
Total Expenses.......................................... 1,249,590
Less: amounts waived/reimbursed............................. (168,625)
----------
Net Expenses............................................ 1,080,965
----------
Net Investment Income................................... 5,322,647
----------
Net Realized and Unrealized Gain (Loss):
Net realized gain (loss) on:
Investments............................................... 3,861,264
Futures contracts......................................... (287,415)
----------
Net Gain................................................ 3,573,849
----------
Net change in unrealized appreciation/depreciation on:
Investments............................................... (852,647)
Futures contracts......................................... (65,383)
----------
Net Depreciation........................................ (918,030)
----------
Net Gain................................................ 2,655,819
----------
Net Increase................................................ $7,978,466
==========
SEE NOTES TO FINANCIAL STATEMENTS
43
Morgan Stanley Limited Duration Fund
FINANCIAL STATEMENTS CONTINUED
Statement of Changes in Net Assets
FOR THE YEAR FOR THE YEAR
ENDED ENDED
APRIL 30, 2002 APRIL 30, 2001
-------------- --------------
Increase (Decrease) in Net Assets:
Operations:
Net investment income....................................... $ 5,322,647 $ 6,460,933
Net realized gain (loss).................................... 3,573,849 (1,540,949)
Net change in unrealized appreciation/depreciation.......... (918,030) 4,375,709
------------ ------------
Net Increase............................................ 7,978,466 9,295,693
Dividends to shareholders from net investment income........ (6,198,203) (6,469,426)
Net increase (decrease) from transactions in shares of
beneficial interest........................................ 54,933,218 (11,603,065)
------------ ------------
Net Increase (Decrease)................................. 56,713,481 (8,776,798)
Net Assets:
Beginning of period......................................... 109,917,355 118,694,153
------------ ------------
End of Period
(Including dividends in excess of net investment income of
$572,326 and $6,408, respectively)......................... $166,630,836 $109,917,355
============ ============
SEE NOTES TO FINANCIAL STATEMENTS
44
Morgan Stanley Limited Duration Fund
NOTES TO FINANCIAL STATEMENTS / / APRIL 30, 2002
1. Organization and Accounting Policies
Morgan Stanley Limited Duration Fund (the "Fund"), formerly Morgan Stanley
Short-Term Bond Fund, is registered under the Investment Company Act of 1940, as
amended, as a diversified, open-end management investment company. The Fund's
investment objective is to provide a high level of current income consistent
with the preservation of capital. The Fund seeks to achieve its objective by
investing in a diversified portfolio of short-term fixed income securities. The
Fund was organized as a Massachusetts business trust on October 22, 1993 and
commenced operations on January 10, 1994.
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.
The following is a summary of significant accounting policies:
A. Valuation of Investments -- (1) all portfolio securities for which
over-the-counter market quotations are readily available are valued at the
latest available bid price prior to the time of valuation; (2) futures are
valued at the latest price published by the commodities exchange on which they
trade; (3) when market quotations are not readily available, including
circumstances under which it is determined by Morgan Stanley Investment Advisors
Inc. (the "Investment Manager") that sale and bid prices are not reflective of a
security's market value, portfolio securities are valued at their fair value as
determined in good faith under procedures established by and under the general
supervision of the Trustees (valuation of securities for which market quotations
are not readily available may be based upon current market prices of securities
which are comparable in coupon, rating and maturity or an appropriate matrix
utilizing similar factors); (4) certain portfolio securities may be valued by an
outside pricing service approved by the Trustees. The pricing service may
utilize a matrix system incorporating security quality, maturity and coupon as
the evaluation model parameters, and/or research and evaluations by its staff,
including review of broker-dealer market price quotations, if available, in
determining what it believes is the fair valuation of the portfolio securities
valued by such pricing service; and (5) short-term debt securities having a
maturity date of more than sixty days at the 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
45
Morgan Stanley Limited Duration Fund
NOTES TO FINANCIAL STATEMENTS / / APRIL 30, 2002 CONTINUED
identified cost method. Discounts are accreted and premiums are amortized over
the life of the respective securities. Interest income is accrued daily.
C. Joint Repurchase Agreement Account -- Pursuant to an Exemptive Order issued
by the Securities and Exchange Commission, the Fund, along with other affiliated
entities managed by the Investment Manager, may transfer uninvested cash
balances into one or more joint repurchase agreement accounts. These balances
are invested in one or more repurchase agreements for cash, or U.S. Treasury or
federal agency obligations.
D. Futures Contracts -- A futures contract is an agreement between two parties
to buy and sell financial instruments or contracts based on financial indices at
a set price on a future date. Upon entering into such a contract, the Fund is
required to pledge to the broker cash, U.S. government securities or other
liquid portfolio securities equal to the minimum initial margin requirements of
the applicable futures exchange. Pursuant to the contract, the Fund agrees to
receive from or pay to the broker an amount of cash equal to the daily
fluctuation in the value of the contract. Such receipts or payments known as
variation margin are recorded by the Fund as unrealized gains and losses. Upon
closing of the contract, the Fund realizes a gain or loss equal to the
difference between the value of the contract at the time it was opened and the
value at the time it was closed.
E. Federal Income Tax Status -- It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute substantially all of its taxable income to its
shareholders. Accordingly, no federal income tax provision is required.
F. Dividends and Distributions to Shareholders -- The Fund records dividends and
distributions to its shareholders on the ex-dividend date. 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 financial reporting purposes but not for tax purposes are reported as
dividends in excess of net investment income or distributions in excess of net
realized capital gains. To the extent they exceed net investment income and net
realized capital gains for tax purposes, they are reported as distributions of
paid-in-capital.
46
Morgan Stanley Limited Duration Fund
NOTES TO FINANCIAL STATEMENTS / / APRIL 30, 2002 CONTINUED
2. Investment Management Agreement
Pursuant to an Investment Management Agreement, the Fund pays the Investment
Manager a management fee, accrued daily and payable monthly, by applying the
annual rate of 0.70% to the net assets of the Fund determined as of the close of
each business day.
For the year ended April 30, 2002 and through December 31, 2002, the Investment
Manager has agreed to waive its fee and reimburse expenses to the extent they
exceed 0.80% of the daily net assets of the Fund.
3. Security Transactions and Transactions with Affiliates
The cost of purchases and proceeds from sales/prepayments of portfolio
securities, excluding short-term investments, for the year ended April 30, 2002
were $448,906,987, and $379,491,731, respectively. Included in the
aforementioned are purchases and sales/prepayments of U.S. Government securities
of $374,357,774 and $312,442,882, respectively.
Morgan Stanley Trust, an affiliate of the Investment Manager, is the Fund's
transfer agent.
4. Shares of Beneficial Interest
Transactions in shares of beneficial interest were as follows:
FOR THE YEAR FOR THE YEAR
ENDED ENDED
APRIL 30, 2002 APRIL 30, 2001
------------------------------ ------------------------------
SHARES AMOUNT SHARES AMOUNT
------------ -------------- ------------ --------------
Sold.......................................... 35,638,246 $ 340,437,108 34,088,802 $ 318,978,719
Reinvestment of dividends..................... 458,331 4,385,816 495,692 4,636,843
----------- ------------- ----------- -------------
36,096,577 344,822,924 34,584,494 323,615,562
Repurchased................................... (30,358,372) (289,889,706) (35,850,061) (335,218,627)
----------- ------------- ----------- -------------
Net increase (decrease)....................... 5,738,205 $ 54,933,218 (1,265,567) $ (11,603,065)
=========== ============= =========== =============
5. Federal Income Tax Status
During the year ended April 30, 2002, the Fund utilized approximately $2,421,000
of its net capital loss carryover. At April 30, 2002, the Fund had a net capital
loss carryover of approximately $1,890,000 of which $56,000 will be available
through April 30, 2008 and $1,834,000 will be available through April 30, 2009
to offset future capital gains to the extent provided by regulations.
Capital losses incurred after October 31 ("post-October losses") within the
taxable year are deemed to arise on the first business day of the Fund's next
taxable year. The Fund incurred and will elect to defer net capital losses of
approximately $345,000 during fiscal 2002.
47
Morgan Stanley Limited Duration Fund
NOTES TO FINANCIAL STATEMENTS / / APRIL 30, 2002 CONTINUED
As of April 30, 2002, the Fund had temporary book/tax differences primarily
attributable to post-October losses and book amortization of premiums on debt
securities and permanent book/tax differences primarily attributable to tax
adjustments on debt securities sold by the Fund. To reflect reclassifications
arising from the permanent differences, accumulated net realized loss was
charged and dividends in excess of net investment income was credited $586,346.
6. Purposes of and Risks Relating to Certain Financial Instruments
To hedge against adverse interest rate and market risks on portfolio positions
or anticipated positions, the Fund may enter into interest rate futures
contracts ("futures contracts").
These futures contracts involve elements of market risk in excess of the amount
reflected in the Statement and Assets and Liabilities. The Fund bears the risk
of an unfavorable change in the value of the underlying securities.
At April 30, 2002, the Fund had outstanding interest rate futures contracts.
7. Change in Accounting Policy
Effective May 1, 2001, the Fund has adopted the provisions of the AICPA Audit
and Accounting Guide for Investment Companies, as revised, related to premiums
and discounts on debt securities. The cumulative effect of this accounting
change had no impact on the net assets of the Fund, but resulted in a $276,708
decrease in the cost of securities and a corresponding decrease to undistributed
net investment income based on securities held as of April 30, 2001.
The effect of this change for the year ended April 30, 2002 was to decrease net
investment income by $881,963, increase unrealized appreciation by $324,738, and
increase net realized gain by $557,225. The statement of changes in net assets
and financial highlights for prior periods have not been restated to reflect
this change.
8. Fund Merger
On April 25, 2002, the Trustees of Morgan Stanley North American Government
Income Trust ("North American") approved a plan of reorganization whereby North
American would be merged into the Fund. The plan of reorganization is subject to
the consent of North American's shareholders at a special meeting to be held on
September 24, 2002. If approved, the assets of North American would be combined
with the assets of the Fund and shareholders of North American would become
shareholders of the Fund, receiving shares of the Fund equal to the value of
their holdings in North American.
48
Morgan Stanley Limited Duration Fund
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of beneficial interest
outstanding throughout each period:
FOR THE YEAR ENDED APRIL 30,
--------------------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
Selected Per Share Data:
Net asset value, beginning of period... $ 9.44 $ 9.20 $ 9.49 $ 9.49 $ 9.50
------ ------ ------ ------ ------
Income (loss) from investment
operations:
Net investment income................ 0.41(2) 0.55 0.51 0.56 0.65
Net realized and unrealized gain
(loss).............................. 0.19(2) 0.24 (0.29) - -
------ ------ ------ ------ ------
Total income from investment
operations............................ 0.60 0.79 0.22 0.56 0.65
------ ------ ------ ------ ------
Less dividends from net investment
income................................ (0.45) (0.55) (0.51) (0.56) (0.66)
------ ------ ------ ------ ------
Net asset value, end of period......... $ 9.59 $ 9.44 $ 9.20 $ 9.49 $ 9.49
====== ====== ====== ====== ======
Total Return+.......................... 6.50% 8.82% 2.36% 6.00% 7.02%
Ratios to Average Net Assets(1):
Expenses............................... 0.80% 0.80% 0.80% 0.31% -
Net investment income.................. 3.94%(2) 5.87% 5.43% 5.68% 6.52%
Supplemental Data:
Net assets, end of period, in
thousands............................. $166,631 $109,917 $118,694 $186,442 $107,699
Portfolio turnover rate................ 327% 133% 71% 58% 55%
- ---------------------
+ CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST
BUSINESS DAY OF THE PERIOD.
(1) IF THE FUND HAD BORNE ALL EXPENSES THAT WERE ASSUMED OR
WAIVED BY THE INVESTMENT MANAGER, THE ANNUALIZED EXPENSE AND
NET INVESTMENT INCOME RATIOS WOULD HAVE BEEN AS FOLLOWS:
EXPENSE NET INVESTMENT
PERIOD ENDED RATIO INCOME RATIO
- ------------ --------- ----------------
APRIL 30,
2002 0.92% 3.82%
APRIL 30,
2001 0.92 5.75
APRIL 30,
2000 0.90 5.33
APRIL 30,
1999 0.88 5.11
APRIL 30,
1998 1.10 5.42
(2) EFFECTIVE MAY 1, 2001, THE FUND HAS ADOPTED THE PROVISIONS
OF THE AICPA AUDIT AND ACCOUNTING GUIDE FOR INVESTMENT
COMPANIES, AS REVISED, RELATED TO PREMIUMS AND DISCOUNTS ON
DEBT SECURITIES. THE EFFECT OF THIS CHANGE FOR THE YEAR
ENDED APRIL 30, 2002 WAS TO DECREASE NET INVESTMENT INCOME
PER SHARE BY $0.06, INCREASE NET REALIZED AND UNREALIZED
GAIN OR LOSS PER SHARE BY $0.06 AND DECREASE THE RATIO OF
NET INVESTMENT INCOME TO AVERAGE NET ASSETS BY 0.65%. THE
FINANCIAL HIGHLIGHTS DATA PRESENTED IN THIS TABLE FOR PRIOR
PERIODS HAS NOT BEEN RESTATED TO REFLECT THIS CHANGE.
SEE NOTES TO FINANCIAL STATEMENTS
49
Morgan Stanley Limited Duration Fund
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Trustees of
Morgan Stanley Limited Duration Fund:
We have audited the accompanying statement of assets and liabilities of Morgan
Stanley Limited Duration Fund (the "Fund"), formerly Morgan Stanley Short-Term
Bond Fund, including the portfolio of investments, as of April 30, 2002, and the
related statements of operations for the year then ended and changes in net
assets for each of the two years in the period then ended, and the financial
highlights for each of the five years in the period then ended. These financial
statements and financial highlights are the responsibility of the Fund's
management. Our responsibility is to express an opinion on these financial
statements and financial highlights based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. Our procedures included confirmation of
securities owned as of April 30, 2002, by correspondence with the custodian and
brokers. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Morgan
Stanley Limited Duration Fund as of April 30, 2002, the results of its
operations for the year then ended, the changes in its net assets for each of
the two years in the period then ended, and the financial highlights for each of
the five years in the period then ended, in conformity with accounting
principles generally accepted in the United States of America.
Deloitte & Touche LLP
NEW YORK, NEW YORK
JUNE 10, 2002
2002 FEDERAL TAX NOTICE (UNAUDITED)
Of the Fund's ordinary income dividends paid during the fiscal
year ended April 30, 2002, 24.63% was attributable to qualifying
Federal obligations. Please consult your tax advisor to determine
if any portion of the dividends you received is exempt from state
income tax.
50
STATEMENT OF ADDITIONAL INFORMATION
MORGAN STANLEY NORTH
AMERICAN GOVERNMENT
December 31, 2001 INCOME TRUST
- --------------------------------------------------------------------------------
This Statement of Additional Information is not a prospectus. The
Prospectus dated December 31, 2001 for Morgan Stanley North American Government
Income Trust may be obtained without charge from the Fund at its address or
telephone number listed below or from Morgan Stanley DW Inc. at any of its
branch offices.
Morgan Stanley
North American Government Income Trust
c/o Morgan Stanley Trust
Harborside Financial Center, Plaza Two
Jersey City, NJ 07311
(800) 869-NEWS
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
I. Fund History .......................................................... 4
II. Description of the Fund and Its Investments and Risks ................. 4
A. Classification .................................................. 4
B. Investment Strategies and Risks ................................. 4
C. Fund Policies/Investment Restrictions ........................... 12
III. Management of the Fund ................................................ 13
A. Board of Trustees ............................................... 13
B. Management Information .......................................... 13
C. Compensation .................................................... 18
IV. Control Persons and Principal Holders of Securities ................... 20
V. Management, Investment Advice and Other Services ...................... 20
A. The Investment Manager and Sub-Advisor .......................... 20
B. Principal Underwriter ........................................... 20
C. Services Provided by the Investment Manager and the Sub-Advisor . 21
D. Rule 12b-1 Plan ................................................. 22
E. Other Service Providers ......................................... 24
F. Codes of Ethics ................................................. 24
VI. Brokerage Allocation and Other Practices .............................. 24
A. Brokerage Transactions .......................................... 24
B. Commissions ..................................................... 25
C. Brokerage Selection ............................................. 25
D. Directed Brokerage .............................................. 26
E. Regular Broker-Dealers .......................................... 26
VII. Capital Stock and Other Securities .................................... 26
VIII. Purchase, Redemption and Pricing of Shares ............................ 27
A. Purchase/Redemption of Shares ................................... 27
B. Offering Price .................................................. 27
IX. Taxation of the Fund and Shareholders ................................. 28
X. Underwriters .......................................................... 30
XI. Calculation of Performance Data ....................................... 30
XII. Financial Statements .................................................. 31
2
GLOSSARY OF SELECTED DEFINED TERMS
The terms defined in this glossary are frequently used in this Statement
of Additional Information (other terms used occasionally are defined in the
text of the document).
"Custodian" - The Bank of New York.
"Distributor" - Morgan Stanley Distributors Inc., a wholly-owned
broker-dealer subsidiary of Morgan Stanley.
"Financial Advisors" - Morgan Stanley authorized financial services
representatives.
"Fund" - Morgan Stanley North American Government Income Trust, a
registered open-end investment company.
"Independent Trustees" - Trustees who are not "interested persons" (as
defined by the Investment Company Act) of the Fund.
"Investment Manager" - Morgan Stanley Investment Advisors Inc., a
wholly-owned investment advisor subsidiary of Morgan Stanley.
"Morgan Stanley" - Morgan Stanley Dean Witter & Co., a preeminent global
financial services firm.
"Morgan Stanley & Co." - Morgan Stanley & Co. Incorporated, a wholly-owned
broker-dealer subsidiary of Morgan Stanley.
"Morgan Stanley DW" - Morgan Stanley DW Inc., a wholly-owned
broker-dealer subsidiary of Morgan Stanley.
"Morgan Stanley Funds" - Registered investment companies (i) for which
the Investment Manager serves as the investment advisor; and (ii) that hold
themselves out to investors as related companies for investment and investor
services.
"Morgan Stanley Services" - Morgan Stanley Services Company Inc., a
wholly-owned fund services subsidiary of the Investment Manager.
"Sub-Advisor" - TCW Investment Management Company, a wholly-owned
subsidiary of TCW.
"TCW" - The TCW Group, Inc., a preeminent investment management and
investment advisory services firm.
"Transfer Agent" - Morgan Stanley Trust, a wholly-owned transfer agent
subsidiary of Morgan Stanley.
"Trustees" - The Board of Trustees of the Fund.
3
I. FUND HISTORY
- --------------------------------------------------------------------------------
The Fund was organized as a Massachusetts business trust, under a
Declaration of Trust, on February 19, 1992, with the name "TCW/DW North
American Government Income Trust." Effective June 28, 1999, the Fund's name was
changed to Morgan Stanley Dean Witter North American Government Income Trust.
Effective June 18, 2001, the Fund's name was changed to Morgan Stanley North
American Government Income Trust.
II. DESCRIPTION OF THE FUND AND ITS INVESTMENTS AND RISKS
- --------------------------------------------------------------------------------
A. CLASSIFICATION
The Fund is an open-end, management investment company whose investment
objective is to earn a high level of current income while maintaining
relatively low volatility of principal.
The Fund is a "non-diversified" mutual fund and, as such, its investments
are not required to meet certain diversification requirements under federal
securities law. Compared with "diversified" funds, the Fund may invest a
greater percentage of its assets in the securities of an individual corporation
or governmental entity. Thus, the Fund's assets may be concentrated in fewer
securities than other funds. A decline in the value of those investments would
cause the Fund's overall value to decline to a greater degree. The Fund's
investments, however, are currently diversified and may remain diversified in
the future.
B. INVESTMENT STRATEGIES AND RISKS
The following discussion of the Fund's investment strategies and risks
should be read with the sections of the Fund's Prospectus titled "Principal
Investment Strategies," "Principal Risks," "Additional Investment Strategy
Information" and "Additional Risk Information."
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS. The Fund may enter into
forward foreign currency exchange contracts ("forward contracts") to facilitate
settlement or in an attempt to limit the effect of changes in the relationship
between the U.S. dollar and the foreign currency during the period between the
date on which the security is purchased or sold and the date on which payment
is made or received. The Fund may conduct its foreign currency exchange
transactions either on a spot (i.e., cash) basis at the spot rate prevailing in
the foreign currency exchange market, or through entering into forward
contracts to purchase or sell foreign currencies. A forward contract involves
an obligation to purchase or sell a specific currency at a future date, which
may be any fixed number of days from the date of the contract agreed upon by
the parties, at a price set at the time of the contract. These contracts are
traded in the interbank market conducted directly between currency traders
(usually large commercial and investment banks) and their customers. Forward
contracts will only be entered into with United States banks and their foreign
branches, insurance companies or other dealers or foreign banks whose assets
total $1 billion or more. A forward contract generally has no deposit
requirement, and no commissions are charged at any stage for trades.
The Fund will not enter into forward currency contracts or maintain a net
exposure to these contracts where the consummation of the contracts would
obligate the Fund to deliver an amount of foreign currency in excess of the
value of the Fund's portfolio securities.
When required by law, the Fund will cause its custodian bank to earmark
cash, U.S. government securities or other appropriate liquid portfolio
securities in an amount equal to the value of the Fund's total assets committed
to the consummation of forward contracts entered into under the circumstances
set forth above. If the value of the securities so earmarked declines,
additional cash or securities will be placed in the account on a daily basis so
that the value of such securities will equal the amount of the Fund's
commitments with respect to such contracts.
Although the Fund values its assets daily in terms of U.S. dollars, it
does not intend to convert its holdings of foreign currencies into U.S. dollars
on a daily basis. It will, however, do so from time to time, and investors
should be aware of the costs of currency conversion. Although foreign exchange
dealers do not charge a fee for conversion, they do realize a profit based on
the spread between the prices at
4
which they are buying and selling various currencies. Thus, a dealer may offer
to sell a foreign currency to the Fund at one rate, while offering a lesser
rate of exchange should the Fund desire to resell that currency to the dealer.
The Fund may be limited in its ability to enter into hedging transactions
involving forward contracts by the Internal Revenue Code requirements relating
to qualification as a regulated investment company.
Forward contracts may limit gains on portfolio securities that could
otherwise be realized had they not been utilized and could result in losses.
The contracts also may increase the Fund's volatility and may involve a
significant amount of risk relative to the investment of cash.
OPTION AND FUTURES TRANSACTIONS. The Fund may engage in transactions in
listed and OTC options. Listed options are issued or guaranteed by the exchange
on which they are traded or by a clearing corporation such as the Options
Clearing Corporation ("OCC"). Ownership of a listed call option gives the Fund
the right to buy from the OCC (in the U.S.) or other clearing corporation or
exchange, the underlying security covered by the option at the stated exercise
price (the price per unit of the underlying security) by filing an exercise
notice prior to the expiration date of the option. The writer (seller) of the
option would then have the obligation to sell to the OCC (in the U.S.) or other
clearing corporation or exchange, the underlying security at that exercise
price prior to the expiration date of the option, regardless of its then
current market price. Ownership of a listed put option would give the Fund the
right to sell the underlying security to the OCC (in the U.S.) or other
clearing corporation or exchange, at the stated exercise price. Upon notice of
exercise of the put option, the writer of the put would have the obligation to
purchase the underlying security from the OCC (in the U.S.) or other clearing
corporation or exchange, at the exercise price.
Covered Call Writing. The Fund is permitted to write covered call options
on portfolio securities, without limit. The Fund will receive from the
purchaser, in return for a call it has written, a "premium;" i.e., the price of
the option. Receipt of these premiums may better enable the Fund to earn a
higher level of current income than it would earn from holding the underlying
securities alone. Moreover, the premium received will offset a portion of the
potential loss incurred by the Fund if the securities underlying the option
decline in value.
The Fund may be required, at any time during the option period, to deliver
the underlying security against payment of the exercise price on any calls it
has written. This obligation is terminated upon the expiration of the option
period or at such earlier time when the writer effects a closing purchase
transaction. A closing purchase transaction is accomplished by purchasing an
option of the same series as the option previously written. However, once the
Fund has been assigned an exercise notice, the Fund will be unable to effect a
closing purchase transaction.
A call option is "covered" if the Fund owns the underlying security
subject to the option or has an absolute and immediate right to acquire that
security without additional cash consideration (or for additional consideration
(in cash, Treasury bills or other liquid portfolio securities) held in a
segregated account on the Fund's books) upon conversion or exchange of other
securities held in its portfolio. A call option is also covered if the Fund
holds a call on the same security as the call written where the exercise price
of the call held is (i) equal to or less than the exercise price of the call
written or (ii) greater than the exercise price of the call written if the
difference is maintained by the Fund in cash, Treasury bills or other liquid
portfolio securities in a segregated account on the Fund's books.
Options written by the Fund normally have expiration dates of up to
eighteen months from the date written. The exercise price of a call option may
be below, equal to or above the current market value of the underlying security
at the time the option is written.
Covered Put Writing. A writer of a covered put option incurs an obligation
to buy the security underlying the option from the purchaser of the put, at the
option's exercise price at any time during the option period, at the
purchaser's election. Through the writing of a put option, the Fund would
receive income from the premium paid by purchasers. The potential gain on a
covered put option is limited to the premium received on the option (less the
commissions paid on the transaction). During the option period, the Fund may be
required to make payment of the exercise price against delivery of the
underlying
5
security. A put option is "covered" if the Fund maintains cash, Treasury bills
or other liquid portfolio securities with a value equal to the exercise price
in a segregated account on the Fund's books, or holds a put on the same
security as the put written where the exercise price of the put held is equal
to or greater than the exercise price of the put written. The aggregate value
of the obligations underlying puts may not exceed 50% of the Fund's net assets.
The operation of and limitations on covered put options in other respects are
substantially identical to those of call options.
Purchasing Call and Put Options. The Fund may purchase listed and OTC call
and put options in amounts equaling up to 5% of its total assets. The purchase
of a call option would enable the Fund, in return for the premium paid to lock
in a purchase price for a security during the term of the option. The purchase
of a put option would enable the Fund, in return for a premium paid, to lock in
a price at which it may sell a security during the term of the option.
OTC Options. OTC options are purchased from or sold (written) to dealers
or financial institutions which have entered into direct agreements with the
Fund. With OTC options, such variables as expiration date, exercise price and
premium will be agreed upon between the Fund and the transacting dealer,
without the intermediation of a third party such as the OCC. The Fund may
engage in OTC option transactions only with member banks of the Federal Reserve
Bank System or primary dealers in U.S. Government securities or with affiliates
of such banks or dealers.
Risks of Options Transactions. The successful use of options depends on
the ability of the Investment Manager or the Sub-Advisor, to forecast correctly
interest rates and/or market movements. If the market value of the portfolio
securities upon which call options have been written increases, the Fund may
receive a lower total return from the portion of its portfolio upon which calls
have been written than it would have had such calls not been written. During
the option period, the covered call writer has, in return for the premium on
the option, given up the opportunity for capital appreciation above the
exercise price should the market price of the underlying security increase, but
has retained the risk of loss should the price of the underlying security
decline. The covered put writer also retains the risk of loss should the market
value of the underlying security decline below the exercise price of the option
less the premium received on the sale of the option. In both cases, the writer
has no control over the time when it may be required to fulfill its obligation
as a writer of the option. Prior to exercise or expiration, an option position
can only be terminated by entering into a closing purchase or sale transaction.
Once an option writer has received an exercise notice, it cannot effect a
closing purchase transaction in order to terminate its obligation under the
option and must deliver or receive the underlying securities at the exercise
price.
The Fund's ability to close out its position as a writer of an option is
dependent upon the existence of a liquid secondary market on option exchanges.
There is no assurance that such a market will exist, particularly in the case
of OTC options.
In the event of the bankruptcy of a broker through which the Fund engages
in transactions in options, the Fund could experience delays and/or losses in
liquidating open positions purchased or sold through the broker and/or incur a
loss of all or part of its margin deposits with the broker. In the case of OTC
options, if the transacting dealer fails to make or take delivery of the
securities underlying an option it has written, in accordance with the terms of
that option, due to insolvency or otherwise, the Fund would lose the premium
paid for the option as well as any anticipated benefit of the transaction.
Each of the exchanges has established limitations governing the maximum
number of call or put options on the same underlying security which may be
written by a single investor, whether acting alone or in concert with others
(regardless of whether such options are written on the same or different
exchanges or are held or written on one or more accounts or through one or more
brokers). An exchange may order the liquidation of positions found to be in
violation of these limits and it may impose other sanctions or restrictions.
These position limits may restrict the number of listed options which the Fund
may write.
The hours of trading for options may not conform to the hours during which
the underlying securities are traded. To the extent that the option markets
close before the markets for the underlying securities, significant price and
rate movements can take place in the underlying markets that cannot be
reflected in the option markets.
6
There can be no assurance that a liquid secondary market will exist for a
particular option at any specific time.
Futures Contracts. The Fund may purchase and sell interest rate and index
futures contracts that are traded on U.S. commodity exchanges on such
underlying securities as U.S. Treasury bonds, notes, bills, GNMA Certificates
and on any foreign government fixed-income security, and on such indexes of
U.S. securities (and, if applicable, foreign securities) as may exist or come
into existence.
A futures contract purchaser incurs an obligation to take delivery of a
specified amount of the obligation underlying the contract at a specified time
in the future for a specified price. A seller of a futures contract incurs an
obligation to deliver the specified amount of the underlying obligation at a
specified time in return for an agreed upon price. The purchase of a futures
contract enables the Fund, during the term of the contract, to lock in a price
at which it may purchase a security and protect against a rise in prices
pending purchase of portfolio securities. The sale of a futures contract
enables the Fund to lock in a price at which it may sell a security and protect
against declines in the value of portfolio securities.
Although most futures contracts call for actual delivery or acceptance of
securities, the contracts usually are closed out before the settlement date
without the making or taking of delivery. Index futures contracts provide for
the delivery of an amount of cash equal to a specified dollar amount times the
difference between the index value at the open or close of the last trading day
of the contract and the futures contract price. A futures contract sale is
closed out by effecting a futures contract purchase for the same aggregate
amount of the specific type of security and the same delivery date. If the sale
price exceeds the offsetting purchase price, the seller would be paid the
difference and would realize a gain. If the offsetting purchase price exceeds
the sale price, the seller would pay the difference and would realize a loss.
Similarly, a futures contract purchase is closed out by effecting a futures
contract sale for the same aggregate amount of the specific type of security
and the same delivery date. If the offsetting sale price exceeds the purchase
price, the purchaser would realize a gain, whereas if the purchase price
exceeds the offsetting sale price, the purchaser would realize a loss. There is
no assurance that the Fund will be able to enter into a closing transaction.
Margin. If the Fund enters into a futures contract, it is initially
required to deposit an "initial margin" of cash, U.S. government securities or
other liquid portfolio securities ranging from approximately 2% to 5% of the
contract amount. Initial margin requirements are established by the exchanges
on which futures contracts trade and may, from time to time, change. In
addition, brokers may establish margin deposit requirements in excess of those
required by the exchanges.
Initial margin in futures transactions is different from margin in
securities transactions in that initial margin does not involve the borrowing
of funds by a broker's client but is, rather, a good faith deposit on the
futures contract which will be returned to the Fund upon the proper termination
of the futures contract. The margin deposits made are marked to market daily
and the Fund may be required to make subsequent deposits of cash, U.S.
government securities or other liquid portfolio securities, called "variation
margin," which are reflective of price fluctuations in the futures contract.
Options on Futures Contracts. The Fund may purchase and write call and put
options on futures contracts and enter into closing transactions with respect
to such options to terminate an existing position. An option on a futures
contract gives the purchaser the right (in return for the premium paid), and
the writer the obligation, to assume a position in a futures contract (a long
position if the option is a call and a short position if the option is a put)
at a specified exercise price at any time during the term of the option. Upon
exercise of the option, the delivery of the futures position by the writer of
the option to the holder of the option is accompanied by delivery of the
accumulated balance in the writer's futures margin account, which represents
the amount by which the market price of the futures contract at the time of
exercise exceeds, in the case of a call, or is less than, in the case of a put,
the exercise price of the option on the futures contract.
The writer of an option on a futures contract is required to deposit
initial and variation margin pursuant to requirements similar to those
applicable to futures contracts. Premiums received from the writing of an
option on a futures contract are included in initial margin deposits.
7
Limitations on Futures Contracts and Options on Futures. The Fund may not
enter into futures contracts or purchase related options thereon if,
immediately thereafter, the amount committed to margin plus the amount paid for
premiums for unexpired options on futures contracts exceeds 5% of the value of
the Fund's total assets, after taking into account unrealized gains and
unrealized losses on such contracts into which it has entered; provided,
however, that in the case of an option that is in-the-money (the exercise price
of the call (put) option is less (more) than the market price of the underlying
security) at the time of purchase, the in-the-money amount may be excluded in
calculating the 5%. However, there is no overall limitation on the percentage
of the Fund's net assets which may be subject to a hedge position.
Risks of Transactions in Futures Contracts and Related Options. The prices
of securities and indexes subject to futures contracts (and thereby the futures
contract prices) may correlate imperfectly with the behavior of the cash prices
of the Fund's securities. Also, prices of futures contracts may not move in
tandem with the changes in prevailing interest rates, market movements and/or
currency exchange rates against which the Fund seeks a hedge. A correlation may
also be distorted (a) temporarily, by short-term traders seeking to profit from
the difference between a contract or security price objective and their cost of
borrowed funds; (b) by investors in futures contracts electing to close out
their contracts through offsetting transactions rather than meet margin deposit
requirements; (c) by investors in futures contracts opting to make or take
delivery of underlying securities rather than engage in closing transactions,
thereby reducing liquidity of the futures market; and (d) temporarily, by
speculators who view the deposit requirements in the futures markets as less
onerous than margin requirements in the cash market. Due to the possibility of
price distortion in the futures market and because of the possible imperfect
correlation between movements in the prices of securities and movements in the
prices of futures contracts, a correct forecast of interest rate and/or market
movement trends by the Investment Manager and/or the Sub-Advisor may still not
result in a successful hedging transaction.
There is no assurance that a liquid secondary market will exist for
futures contracts and related options in which the Fund may invest. In the
event a liquid market does not exist, it may not be possible to close out a
futures position and, in the event of adverse price movements, the Fund would
continue to be required to make daily cash payments of variation margin. The
absence of a liquid market in futures contracts might cause the Fund to make or
take delivery of the underlying securities at a time when it may be
disadvantageous to do so.
Exchanges also limit the amount by which the price of a futures contract
may move on any day. If the price moves equal the daily limit on successive
days, then it may prove impossible to liquidate a futures position until the
daily limit moves have ceased. In the event of adverse price movements, the
Fund would continue to be required to make daily cash payments of variation
margin on open futures positions. In these situations, if the Fund has
insufficient cash, it may have to sell portfolio securities to meet daily
variation margin requirements at a time when it may be disadvantageous to do
so. In addition, the Fund may be required to take or make delivery of the
instruments underlying interest rate futures contracts it holds at a time when
it is disadvantageous to do so. The inability to close out options and futures
positions could also have an adverse impact on the Fund's ability to
effectively hedge its portfolio.
Futures contracts and options thereon which are purchased or sold on
foreign commodities exchanges may have greater price volatility than their U.S.
counterparts. Furthermore, foreign commodities exchanges may be less regulated
and under less governmental scrutiny than U.S. exchanges. Brokerage
commissions, clearing costs and other transaction costs may be higher on
foreign exchanges. Greater margin requirements may limit the Fund's ability to
enter into certain commodity transactions on foreign exchanges. Moreover,
differences in clearance and delivery requirements on foreign exchanges may
occasion delays in the settlement of the Fund's transactions effected on
foreign exchanges.
In the event of the bankruptcy of a broker through which the Fund engages
in transactions in futures or options thereon, the Fund could experience delays
and/or losses in liquidating open positions purchased or sold through the
broker and/or incur a loss of all or part of its margin deposits with the
broker.
8
If the Fund maintains a short position in a futures contract or has sold a
call option in a futures contract, it will cover this position by holding, in a
segregated account maintained on the books of the Fund, cash, U.S. government
securities or other liquid portfolio securities equal in value (when added to
any initial or variation margin on deposit) to the market value of the
securities underlying the futures contract or the exercise price of the option.
Such a position may also be covered by owning the securities underlying the
futures contract (in the case of a stock index futures contract a portfolio of
securities substantially replicating the relevant index), or by holding a call
option permitting the Fund to purchase the same contract at a price no higher
than the price at which the short position was established.
In addition, if the Fund holds a long position in a futures contract or
has sold a put option on a futures contract, it will hold cash, U.S. government
securities or other liquid portfolio securities equal to the purchase price of
the contract or the exercise price of the put option (less the amount of
initial or variation margin on deposit) in a segregated account maintained on
the books of the Fund. Alternatively, the Fund could cover its long position by
purchasing a put option on the same futures contract with an exercise price as
high or higher than the price of the contract held by the Fund.
MONEY MARKET SECURITIES. The Fund may invest in various money market
securities for cash management purposes or when assuming a temporary defensive
position, which among others may include commercial paper, bank acceptances,
bank obligations, corporate debt securities, certificates of deposit, U.S.
government securities and obligations of savings institutions and repurchase
agreements. Such securities are limited to:
U.S. Government Securities. Obligations issued or guaranteed as to
principal and interest by the United States or its agencies (such as the
Export-Import Bank of the United States, Federal Housing Administration and
Government National Mortgage Association) or its instrumentalities (such as the
Federal Home Loan Bank), including Treasury bills, notes and bonds;
Bank Obligations. Obligations (including certificates of deposit and
bankers' acceptances) of banks subject to regulation by the U.S. government and
having total assets of $1 billion or more, and instruments secured by such
obligations, not including obligations of foreign branches of domestic banks
except to the extent below;
Eurodollar Certificates of Deposit. Eurodollar certificates of deposit
issued by foreign branches of domestic banks having total assets of $1 billion
or more;
Obligations of Savings Institutions. Certificates of deposit of savings
banks and savings and loan associations, having total assets of $1 billion or
more;
Fully Insured Certificates of Deposit. Certificates of deposit of banks
and savings institutions having total assets of less than $1 billion, if the
principal amount of the obligation is federally insured by the Bank Insurance
Fund or the Savings Association Insurance Fund (each of which is administered
by the FDIC), limited to $100,000 principal amount per certificate and to 15%
or less of the Fund's net assets in all such obligations and in all illiquid
assets, in the aggregate;
Commercial Paper. Commercial paper rated within the two highest grades by
Standard & Poor's Corporation ("S&P") or by Moody's Investor's Service, Inc.
("Moody's") or, if not rated, issued by a company having an outstanding debt
issue rated at least AAA by S&P or Aaa by Moody's; and
Repurchase Agreements. The Fund may invest in repurchase agreements. When
cash may be available for only a few days, it may be invested by the Fund in
repurchase agreements until such time as it may otherwise be invested or used
for payments of obligations of the Fund. These agreements, which may be viewed
as a type of secured lending by the Fund, typically involve the acquisition, by
the Fund, of debt securities from a selling financial institution such as a
bank, savings and loan association or broker-dealer. The agreement provides
that the Fund will sell back to the institution, and that the institution will
repurchase, the underlying security serving as collateral at a specified price
and at a fixed time in the future, usually not more than seven days from the
date of purchase. The collateral will be marked-to-market daily to determine
that the value of the collateral, as specified in the agreement, does not
decrease below the purchase price plus accrued interest. If such decrease
occurs, additional
9
collateral will be requested and, when received, added to the account to
maintain full collateralization. The Fund will accrue interest from the
institution until the time when the repurchase is to occur. Although this date
is deemed by the Fund to be the maturity date of a repurchase agreement, the
maturities of securities subject to repurchase agreements are not subject to
any limits.
While repurchase agreements involve certain risks not associated with
direct investments in debt securities, the Fund follows procedures approved by
the Trustees designed to minimize such risks. These procedures include
effecting repurchase transactions only with large, well-capitalized and
well-established financial institutions whose financial condition will be
continually monitored by the Investment Manager and/or Sub-Advisor subject to
procedures established by the Trustees. In addition, as described above, the
value of the collateral underlying the repurchase agreement will be at least
equal to the repurchase price, including any accrued interest earned on the
repurchase agreement. In the event of a default or bankruptcy by a selling
financial institution, the Fund will seek to liquidate such collateral.
However, the exercising of the Fund's right to liquidate such collateral could
involve certain costs or delays and, to the extent that proceeds from any sale
upon a default of the obligation to repurchase were less than the repurchase
price, the Fund could suffer a loss. It is the current policy of the Fund not
to invest in repurchase agreements that do not mature within seven days if any
such investment, together with any other illiquid assets held by the Fund,
amounts to more than 15% of its net assets.
REVERSE REPURCHASE AGREEMENTS AND DOLLAR ROLLS. The Fund may use reverse
repurchase agreements as part of its investment strategy and may also use
dollar rolls as part of its investment strategy.
Reverse repurchase agreements involve sales by the Fund of assets
concurrently with an agreement by the Fund to repurchase the same assets at a
later date at a fixed price. Reverse repurchase agreements involve the risk
that the market value of the securities the Fund is obligated to purchase under
the agreement may decline below the repurchase price. In the event the buyer of
securities under a reverse repurchase agreement files for bankruptcy or becomes
insolvent, the Fund's use of the proceeds of the agreement may be restricted
pending a determination by the other party, or its trustee or receiver, whether
to enforce the Fund's obligation to repurchase the securities.
Dollar rolls involve the Fund selling securities for delivery in the
current month and simultaneously contracting to repurchase substantially
similar (same type and coupon) securities on a specified future date. During
the roll period, the Fund will forgo principal and interest paid on the
securities. The Fund is compensated by the difference between the current sales
price and the lower forward price for the future purchase (often referred to as
the "drop") as well as by the interest earned on the cash proceeds of the
initial sale.
Reverse repurchase agreements and dollar rolls are speculative techniques
involving leverage and are considered borrowings by the Fund.
LENDING PORTFOLIO SECURITIES. The Fund may lend its portfolio securities
to brokers, dealers and other financial institutions, provided that the loans
are callable at any time by the Fund, and are at all times secured by cash or
cash equivalents, which are maintained in a segregated account pursuant to
applicable regulations and that are equal to at least 100% of the market value,
determined daily, of the loaned securities. The advantage of these loans is
that the Fund continues to receive the income on the loaned securities while at
the same time earning interest on the cash amounts deposited as collateral,
which will be invested in short-term obligations. The Fund will not lend more
than 25% of the value of its total assets.
As with any extensions of credit, there are risks of delay in recovery
and, in some cases, even loss of rights in the collateral should the borrower
of the securities fail financially. However, these loans of portfolio
securities will only be made to firms deemed by the Fund's management to be
creditworthy and when the income which can be earned from such loans justifies
the attendant risks. Upon termination of the loan, the borrower is required to
return the securities to the Fund. Any gain or loss in the market price during
the loan period would inure to the Fund.
10
When voting or consent rights which accompany loaned securities pass to
the borrower, the Fund will follow the policy of calling the loaned securities,
to be delivered within one day after notice, to permit the exercise of the
rights if the matters involved would have a material effect on the Fund's
investment in the loaned securities. The Fund will pay reasonable finder's,
administrative and custodial fees in connection with a loan of its securities.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES AND FORWARD COMMITMENTS. The
Fund may purchase securities on a when-issued or delayed delivery basis or may
purchase or sell securities on a forward commitment basis. When these
transactions are negotiated, the price is fixed at the time of the commitment,
but delivery and payment can take place a month or more after the date of
commitment. While the Fund will only purchase securities on a when-issued,
delayed delivery or forward commitment basis with the intention of acquiring
the securities, the Fund may sell the securities before the settlement date, if
it is deemed advisable. The securities so purchased or sold are subject to
market fluctuation and no interest or dividends accrue to the purchaser prior
to the settlement date.
At the time the Fund makes the commitment to purchase or sell securities
on a when-issued, delayed delivery or forward commitment basis, it will record
the transaction and thereafter reflect the value, each day, of such security
purchased, or if a sale, the proceeds to be received, in determining its net
asset value. At the time of delivery of the securities, their value may be more
or less than the purchase or sale price. An increase in the percentage of the
Fund's assets committed to the purchase of securities on a when-issued, delayed
delivery or forward commitment basis may increase the volatility of its net
asset value. The Fund will also establish a segregated account on the Fund's
books in which it will continually maintain cash or cash equivalents or other
liquid portfolio securities equal in value to commitments to purchase
securities on a when-issued, delayed delivery or forward commitment basis.
WHEN, AS AND IF ISSUED SECURITIES. The Fund may purchase securities on a
"when, as and if issued" basis under which the issuance of the security depends
upon the occurrence of a subsequent event, such as approval of a merger,
corporate reorganization or debt restructuring. The commitment for the purchase
of any such security will not be recognized in the portfolio of the Fund until
the Investment Manager and/or Sub-Advisor determines that issuance of the
security is probable. At that time, the Fund will record the transaction and,
in determining its net asset value, will reflect the value of the security
daily. At that time, the Fund will also establish a segregated account on the
Fund's books in which it will maintain cash or cash equivalents or other liquid
portfolio securities equal in value to recognized commitments for such
securities.
An increase in the percentage of the Fund's assets committed to the
purchase of securities on a "when, as and if issued" basis may increase the
volatility of its net asset value. The Fund may also sell securities on a
"when, as and if issued" basis provided that the issuance of the security will
result automatically from the exchange or conversion of a security owned by the
Fund at the time of sale.
PRIVATE PLACEMENTS AND RESTRICTED SECURITIES. The Fund may invest up to
15% of its net assets in securities which are subject to restrictions on resale
because they have not been registered under the Securities Act of 1933 (the
"Securities Act"), or which are otherwise not readily marketable. (Securities
eligible for resale pursuant to Rule 144A under the Securities Act, and
determined to be liquid pursuant to the procedures discussed in the following
paragraph, are not subject to the foregoing restriction.) These securities are
generally referred to as "private placements" or "restricted securities."
Limitations on the resale of these securities may have an adverse effect on
their marketability, and may prevent the Fund from disposing of them promptly
at reasonable prices. The Fund may have to bear the expense of registering the
securities for resale and the risk of substantial delays in effecting the
registration.
Rule 144A permits the Fund to sell restricted securities to qualified
institutional buyers without limitation. The Investment Manager and/or
Sub-Advisor, pursuant to procedures adopted by the Trustees, will make a
determination as to the liquidity of each restricted security purchased by the
Fund. If a restricted security is determined to be "liquid," the security will
not be included within the category "illiquid securities," which may not exceed
15% of the Fund's net assets. However, investing in Rule 144A securities could
have the effect of increasing the level of Fund illiquidity to the extent the
Fund, at a particular point in time, may be unable to find qualified
institutional buyers interested in purchasing such securities.
11
C. FUND POLICIES/INVESTMENT RESTRICTIONS
The investment objective, policies and restrictions listed below have been
adopted by the Fund as fundamental policies. Under the Investment Company Act
of 1940, as amended (the "Investment Company Act"), a fundamental policy may
not be changed without the vote of a majority of the outstanding voting
securities of the Fund. The Investment Company Act defines a majority as the
lesser of (a) 67% or more of the shares present at a meeting of shareholders,
if the holders of 50% of the outstanding shares of the Fund are present or
represented by proxy; or (b) more than 50% of the outstanding shares of the
Fund. For purposes of the following restrictions: (i) all percentage
limitations apply immediately after a purchase or initial investment; and (ii)
any subsequent change in any applicable percentage resulting from market
fluctuations or other changes in total or net assets does not require
elimination of any security from the portfolio.
The Fund will:
1. Seek to earn a high level of current income while maintaining
relatively low volatility of principal.
The Fund may not:
1. Invest 25% or more of the value of its total assets in securities of
issuers in any one industry, except that the Fund will concentrate in
mortgage-backed securities (unless it has adopted a temporary
"defensive" posture). This restriction does not apply to obligations
issued or guaranteed by the United States Government, its agencies or
instrumentalities.
2. Invest more than 5% of the value of its total assets in securities of
issuers having a record, together with predecessors, of less than three
years of continuous operation. This restriction shall not apply to
mortgage-backed securities or asset-backed securities or to any
obligation of the United States Government, its agencies or
instrumentalities.
3. Purchase or sell commodities or commodities contracts except that the
Fund may purchase and sell financial futures contracts and related
options thereon.
4. Purchase or sell real estate or interests therein (including limited
partnership interests), although the Fund may purchase securities of
issuers which engage in real estate operations and securities secured
by real estate or interests therein.
5. Purchase oil, gas or other mineral leases, rights or royalty contracts
or exploration or development programs, except that the Fund may invest
in the securities of companies which operate, invest in, or sponsor
such programs.
6. Borrow money, except that the Fund (i) may borrow from a bank for
temporary or emergency purposes in amounts not exceeding 5% (taken at
the lower of cost or current value) of its total assets (not including
the amount borrowed), and (ii) may engage in reverse repurchase
agreements and dollar rolls.
7. Pledge its assets or assign or otherwise encumber them except to secure
permitted borrowings. For the purpose of this restriction, collateral
arrangements with respect to initial or variation margin for futures
are not deemed to be pledges of assets.
8. Issue senior securities as defined in the Act except insofar as the
Fund may be deemed to have issued a senior security by reason of (a)
entering into any repurchase agreement; (b) purchasing any securities
on a when-issued or delayed delivery basis; (c) purchasing or selling
any financial futures contracts or options thereon; (d) borrowing
money; or (e) lending portfolio securities.
9. Make loans of money or securities, except: (a) by the purchase of
portfolio securities; (b) by investment in repurchase agreements; or
(c) by lending its portfolio securities.
10. Make short sales of securities.
12
11. Purchase securities on margin, except for such short-term loans as are
necessary for the clearance of portfolio securities. The deposit or
payment by the Fund of initial or variation margin in connection with
futures contracts is not considered the purchase of a security on
margin.
12. Engage in the underwriting of securities, except insofar as the Fund
may be deemed an underwriter under the Securities Act in disposing of a
portfolio security.
13. Invest for the purpose of exercising control or management of any
other issuer.
As a non-fundamental policy, the Fund may not, as to 75% of its total
assets, purchase more than 10% of the voting securities of any issuer.
III. MANAGEMENT OF THE FUND
- --------------------------------------------------------------------------------
A. BOARD OF TRUSTEES
The Board of Trustees of the Fund oversees the management of the Fund but
does not itself manage the Fund. The Trustees review various services provided
by or under the direction of the Investment Manager to ensure that the Fund's
general investment policies and programs are properly carried out. The Trustees
also conduct their review to ensure that administrative services are provided
to the Fund in a satisfactory manner.
Under state law, the duties of the Trustees are generally characterized as
a duty of loyalty and a duty of care. The duty of loyalty requires a Trustee to
exercise his or her powers in the interest of the Fund and not the Trustee's
own interest or the interest of another person or organization. A Trustee
satisfies his or her duty of care by acting in good faith with the care of an
ordinarily prudent person and in a manner the Trustee reasonably believes to be
in the best interest of the Fund and its shareholders.
B. MANAGEMENT INFORMATION
TRUSTEES AND OFFICERS. The Board of the Fund consists of nine (9)
Trustees. These same individuals also serve as directors or trustees for all of
the Morgan Stanley Funds. Six Trustees (67% of the total number) have no
affiliation or business connection with the Investment Manager or any of its
affiliated persons and do not own any stock or other securities issued by the
Investment Manager's parent company, Morgan Stanley or the Sub-Advisor's parent
company, TCW. These are the "disinterested" or "independent" Trustees. The
other three Trustees (the "management Trustees") are affiliated with the
Investment Manager.
The Trustees and executive officers of the Fund, their principal business
occupations during the last five years and their affiliations, if any, with the
Investment Manager or the Sub-Advisor, and with the Morgan Stanley Funds (there
were 97 such Funds as of the calendar year ended December 31, 2000) are shown
below.
NAME, AGE, POSITION WITH FUND AND ADDRESS PRINCIPAL OCCUPATIONS DURING LAST FIVE YEARS
- ------------------------------------------- ---------------------------------------------------
Michael Bozic (60) ........................ Retired; Director or Trustee of the Morgan Stanley
Trustee Funds; formerly Vice Chairman of Kmart
c/o Mayer, Brown & Platt Corporation (December 1998-October 2000),
Counsel to the Independent Trustees Chairman and Chief Executive Officer of Levitz
1675 Broadway Furniture Corporation (November 1995-November
New York, New York 1998) and President and Chief Executive Officer of
Hills Department Stores (May 1991-July 1995);
formerly variously Chairman, Chief Executive
Officer, President and Chief Operating Officer
(1987-1991) of the Sears Merchandise Group of
Sears, Roebuck and Co.; Director of Weirton Steel
Corporation.
13
NAME, AGE, POSITION WITH FUND AND ADDRESS PRINCIPAL OCCUPATIONS DURING LAST FIVE YEARS
- ------------------------------------------- ------------------------------------------------------
Charles A. Fiumefreddo* (68) .............. Chairman, Director or Trustee and Chief Executive
Chairman of the Board, Officer of the Morgan Stanley Funds; formerly
c/o Morgan Stanley Trust Chairman, Chief Executive Officer and Director of
Harborside Financial Center, Plaza Two the Investment Manager, the Distributor and
Jersey City, New Jersey Morgan Stanley Services, Executive Vice President
and Director of Morgan Stanley DW, Chairman and
Director of the Transfer Agent, and Director and/or
officer of various Morgan Stanley subsidiaries (until
June 1998).
Edwin J. Garn (69) ........................ Director or Trustee of the Morgan Stanley Funds;
Trustee formerly United States Senator (R-Utah) (1974-
c/o Summit Ventures LLC 1992) and Chairman, Senate Banking Committee
1 Utah Center (1980-1986); formerly Mayor of Salt Lake City,
201 S. Main Street Utah (1971-1974); formerly Astronaut, Space
Salt Lake City, Utah Shuttle Discovery (April 12-19, 1985); Vice
Chairman, Huntsman Corporation (chemical
company); Director of Franklin Covey (time
management systems), BMW Bank of North
America, Inc. (industrial loan corporation), United
Space Alliance (joint venture between Lockheed
Martin and the Boeing Company) and Nuskin Asia
Pacific (multilevel marketing); member of the Utah
Regional Advisory Board of Pacific Corp.; member
of the board of various civic and charitable
organizations.
Wayne E. Hedien (67) ...................... Retired; Director or Trustee of the Morgan Stanley
Trustee Funds; Director of The PMI Group, Inc. (private
c/o Mayer, Brown & Platt mortgage insurance); Trustee and Vice Chairman
Counsel to the Independent Trustees of The Field Museum of Natural History; formerly
1675 Broadway associated with the Allstate Companies (1966-
New York, New York 1994), most recently as Chairman of The Allstate
Corporation (March 1993-December 1994) and
Chairman and Chief Executive Officer of its wholly-
owned subsidiary, Allstate Insurance Company
(July 1989-December 1994); director of various
other business and charitable organizations.
James F. Higgins* (53) .................... Chairman of the Individual Investor Group of
Trustee Morgan Stanley (since August 2000); Director of
c/o Morgan Stanley Trust the Transfer Agent, the Distributor and Dean Witter
Harborside Financial Center, Plaza Two Realty Inc.; Director or Trustee of the Morgan
Jersey City, New Jersey Stanley Funds (since June 2000); previously
President and Chief Operating Officer of the Private
Client Group of Morgan Stanley (May 1999-August
2000), President and Chief Operating Officer of
Individual Securities of Morgan Stanley (February
1997-May 1999), President and Chief Operating
Officer of Dean Witter Securities of Morgan Stanley
(1995-February 1997), and Director (1985-1997)
of Morgan Stanley.
14
NAME, AGE, POSITION WITH FUND AND ADDRESS PRINCIPAL OCCUPATIONS DURING LAST FIVE YEARS
- ------------------------------------------- ----------------------------------------------------
Dr. Manuel H. Johnson (52) ................ Senior Partner, Johnson Smick International, Inc.,
Trustee a consulting firm; Co-Chairman and a founder of
c/o Johnson Smick International, Inc. the Group of Seven Council (G7C), an international
1133 Connecticut Avenue, N.W. economic commission; Chairman of the Audit
Washington, D.C. Committee and Director or Trustee of the Morgan
Stanley Funds; Director of NVR, Inc. (home
construction); Chairman and Trustee of the
Financial Accounting Foundation (oversight
organization of the Financial Accounting Standards
Board); formerly Vice Chairman of the Board of
Governors of the Federal Reserve System and
Assistant Secretary of the U.S. Treasury.
Michael E. Nugent (65) .................... General Partner, Triumph Capital, L.P., a private
Trustee investment partnership; Chairman of the Insurance
c/o Triumph Capital, L.P. Committee and Director or Trustee of the Morgan
237 Park Avenue Stanley Funds; director/trustee of various
New York, New York investment companies managed by Morgan
Stanley Investment Management Inc. and Morgan
Stanley Investments LP (since July 2001); formerly
Vice President, Bankers Trust Company and BT
Capital Corporation; director of various business
organizations.
Philip J. Purcell* (58) ................... Chairman of the Board of Directors and Chief
Trustee Executive Officer of Morgan Stanley, Morgan
1585 Broadway Stanley DW and Novus Credit Services Inc.;
New York, New York Director of the Distributor; Director or Trustee of
the Morgan Stanley Funds; Director of American
Airlines, Inc. and its parent company, AMR
Corporation; Director and/or officer of various
Morgan Stanley subsidiaries.
John L. Schroeder (71) .................... Retired; Chairman of the Deriatives Committee
Trustee and Director or Trustee of the Morgan Stanley
c/o Mayer, Brown & Platt Funds; Director of Citizens Communications
Counsel to the Independent Trustees Company (telecommunications company); formerly
1675 Broadway Executive Vice President and Chief Investment
New York, New York Officer of Home Insurance Company (August 1991-
September 1995).
15
NAME, AGE, POSITION WITH FUND AND ADDRESS PRINCIPAL OCCUPATIONS DURING LAST FIVE YEARS
- ------------------------------------------- ------------------------------------------------------
Mitchell M. Merin (48) .................... President and Chief Operating Officer of Morgan
President Stanley Investment Management (since December
1221 Avenue of the Americas 1998); President and Director (since April 1997)
New York, New York and Chief Executive Officer (since June 1998) of
the Investment Manager and Morgan Stanley
Services; Chairman, Chief Executive Officer and
Director of the Distributor (since June 1998);
Chairman and Chief Executive Officer (since June
1998) and Director (since January 1998) of the
Transfer Agent; Director of various Morgan Stanley
subsidiaries; President of the Morgan Stanley
Funds (since May 1999); Trustee of various Van
Kampen investment companies (since December
1999); previously Chief Strategic Officer of the
Investment Manager and Morgan Stanley Services
and Executive Vice President of the Distributor
(April 1997-June 1998), Vice President of the
Morgan Stanley Funds (May 1997-April 1999), and
Executive Vice President of Morgan Stanley.
Barry Fink (46) ........................... General Counsel (since May 2000) and Managing
Vice President, Director (since December 2000) of Morgan Stanley
Secretary and General Counsel Investment Management; Managing Director (since
1221 Avenue of the Americas December 2000) and Secretary and General
New York, New York Counsel (since February 1997) and Director (since
July 1998) of the Investment Manager and Morgan
Stanley Services; Vice President, Secretary and
General Counsel of the Morgan Stanley Funds
(since February 1997); Vice President and
Secretary of the Distributor; previously, Senior Vice
President (March 1997-December 1999), First Vice
President, Assistant Secretary and Assistant
General Counsel of the Investment Manager and
Morgan Stanley Services.
Philip A. Barach (49) ..................... Group Managing Director and Chief Investment
Vice President Officer-Investment Grade Fixed-Income of the
865 South Figueroa Street Sub-Advisor, Trust Company of the West and TCW
Los Angeles, California Asset Management Company.
Jeffrey E. Gundlach (42) .................. Group Managing Director and Chairman, Multi-
Vice President Strategy Fixed Income Committee of the Sub-
865 South Figueroa Street Advisor, Trust Company of the West and TCW
Los Angeles, California Asset Management Company.
Frederick H. Horton (43) .................. Managing Director of the Sub-Advisor, Trust
Vice President Company of the West and TCW Asset Management
865 South Figueroa Street Company.
Los Angeles, California
Thomas F. Caloia (55) ..................... First Vice President and Assistant Treasurer of the
Treasurer Investment Manager, the Distributor and Morgan
c/o Morgan Stanley Trust Stanley Services; Treasurer of the Morgan Stanley
Harborside Financial Center, Plaza Two Funds.
Jersey City, New Jersey
- ----------
* Denotes Trustees who are "interested persons" of the Fund as defined by the
Investment Company Act.
16
Ronald E. Robison, Managing Director, Chief Administrative Officer and
Director of the Investment Manager and Morgan Stanley Services and Chief
Executive Officer and Director of the Transfer Agent, Robert S. Giambrone,
Executive Director of the Investment Manager, Morgan Stanley Services, the
Distributor and the Transfer Agent and Director of the Transfer Agent, and
Joseph J. McAlinden, Managing Director and Chief Investment Officer of the
Investment Manager and Director of the Transfer Agent, are Vice Presidents of
the Fund.
In addition, A. Thomas Smith III, Managing Director and General Counsel of
the Investment Manager and Morgan Stanley Services, is a Vice President and
Assistant Secretary of the Fund, and Todd Lebo, Lou Anne D. McInnis, Carsten
Otto and Ruth Rossi, Executive Directors and Assistant General Counsels of the
Investment Manager and Morgan Stanley Services, Marilyn K. Cranney, First Vice
President and Assistant General Counsel of the Investment Manager and Morgan
Stanley Services, and Natasha Kassian and George Silfen, Vice Presidents and
Assistant General Counsels of the Investment Manager and Morgan Stanley
Services, are Assistant Secretaries of the Fund.
INDEPENDENT DIRECTORS/TRUSTEES AND THE COMMITTEES. Law and regulation
establish both general guidelines and specific duties for the independent
directors/trustees. The Morgan Stanley Funds seek as independent
directors/trustees individuals of distinction and experience in business and
finance, government service or academia; these are people whose advice and
counsel are in demand by others and for whom there is often competition. To
accept a position on the Funds' boards, such individuals may reject other
attractive assignments because the Funds make substantial demands on their
time. All of the independent directors/trustees serve as members of the Audit
Committee. In addition, three of the directors/trustees, including two
independent directors/trustees, serve as members of the Derivatives Committee
and the Insurance Committee.
The independent directors/trustees are charged with recommending to the
full board approval of management, advisory and administration contracts, Rule
12b-1 plans and distribution and underwriting agreements; continually reviewing
Fund performance; checking on the pricing of portfolio securities, brokerage
commissions, transfer agent costs and performance, and trading among Funds in
the same complex; and approving fidelity bond and related insurance coverage
and allocations, as well as other matters that arise from time to time. The
independent directors/trustees are required to select and nominate individuals
to fill any independent directors/trustees vacancy on the board of any Fund
that has a Rule 12b-1 plan of distribution. Most of the Morgan Stanley Funds
have a Rule 12b-1 plan.
The Audit Committee is charged with recommending to the full board the
engagement or discharge of the Fund's independent auditors; directing
investigations into matters within the scope of the independent auditors'
duties, including the power to retain outside specialists; reviewing with the
independent auditors the audit plan and results of the auditing engagement;
approving professional services provided by the independent auditors and other
accounting firms prior to the performance of the services; reviewing the
independence of the independent auditors; considering the range of audit and
non-audit fees; reviewing the adequacy of the Fund's system of internal
controls; and preparing and submitting Committee meeting minutes to the full
board.
The board of each Fund has a Derivatives Committee to approve parameters
for and monitor the activities of the Fund with respect to derivative
investments, if any, made by the Fund.
Finally, the board of each Fund has formed an Insurance Committee to
review and monitor the insurance coverage maintained by the Fund.
ADVANTAGES OF HAVING SAME INDIVIDUALS AS INDEPENDENT DIRECTORS/TRUSTEES
FOR ALL MORGAN STANLEY FUNDS. The independent directors/trustees and the Funds'
management believe that having the same independent directors/trustees for each
of the Morgan Stanley Funds avoids the duplication of effort that would arise
from having different groups of individuals serving as independent directors/
trustees for each of the funds or even of sub-groups of funds. They believe
that having the same individuals serve as independent directors/trustees of all
the Funds tends to increase their knowledge and expertise regarding matters
which affect the Fund complex generally and enhances their ability to negotiate
on behalf of each fund with the fund's service providers. This arrangement also
precludes the
17
possibility of separate groups of independent directors/trustees arriving at
conflicting decisions regarding operations and management of the funds and
avoids the cost and confusion that would likely ensue. Finally, having the same
independent directors/trustees serve on all fund boards enhances the ability of
each fund to obtain, at modest cost to each separate fund, the services of
independent directors/ trustees, of the caliber, experience and business
acumen of the individuals who serve as independent directors/trustees of the
Morgan Stanley Funds.
TRUSTEE AND OFFICER INDEMNIFICATION. The Fund's Declaration of Trust
provides that no Trustee, officer, employee or agent of the Fund is liable to
the Fund or to a shareholder, nor is any Trustee, officer, employee or agent
liable to any third persons in connection with the affairs of the Fund, except
as such liability may arise from his/her or its own bad faith, willful
misfeasance, gross negligence or reckless disregard of his/her or its duties.
It also provides that all third persons shall look solely to the Fund property
for satisfaction of claims arising in connection with the affairs of the Fund.
With the exceptions stated, the Declaration of Trust provides that a Trustee,
officer, employee or agent is entitled to be indemnified against all liability
in connection with the affairs of the Fund.
C. COMPENSATION
The Fund pays each Independent Trustee an annual fee of $800 plus a per
meeting fee of $50 for meetings of the Board of Trustees, the Independent
Trustees or Committees of the Board of Trustees attended by the Trustee (the
Fund pays the Chairman of the Audit Committee an additional annual fee of $750,
and the Chairman of the Derivatives and Insurance Committees additional annual
fees of $500). If a Board meeting and a meeting of the Independent Trustees or
a Committee meeting, or a meeting of the Independent Trustees and/or more than
one Committee meeting, take place on a single day, the Trustees are paid a
single meeting fee by the Fund. The Fund also reimburses such Trustees for
travel and other out-of-pocket expenses incurred by them in connection with
attending such meetings. Trustees and officers of the Fund who are or have been
employed by the Investment Manager or an affiliated company receive no
compensation or expense reimbursement from the Fund for their services as
Trustee.
The following table illustrates the compensation that the Fund paid to its
Independent Trustees for the fiscal year ended October 31, 2001.
FUND COMPENSATION
AGGREGATE
COMPENSATION
NAME OF INDEPENDENT TRUSTEE FROM THE FUND
- ------------------------------- --------------
Michael Bozic ................. $1,650
Edwin J. Garn ................. 1,650
Wayne E. Hedien ............... 1,650
Dr. Manuel H. Johnson ......... 2,400
Michael E. Nugent ............. 2,150
John L. Schroeder ............. 2,150
The following table illustrates the compensation paid to the Fund's
Independent Trustees for the calendar year ended December 31, 2000 for services
to the 97 Morgan Stanley Funds that were in operation at December 31, 2000.
18
CASH COMPENSATION FROM MORGAN STANLEY FUNDS
TOTAL CASH
COMPENSATION
FOR SERVICES TO
97 MORGAN
NAME OF INDEPENDENT TRUSTEE STANLEY FUNDS
- ------------------------------- ----------------
Michael Bozic ................. $146,917
Edwin J. Garn ................. 151,717
Wayne E. Hedien ............... 151,567
Dr. Manuel H. Johnson ......... 223,655
Michael E. Nugent ............. 199,759
John L. Schroeder ............. 194,809
As of the date of this Statement of Additional Information, 53 of the
Morgan Stanley Funds, not including the Fund, have adopted a retirement program
under which an independent director/trustee who retires after serving for at
least five years (or such lesser period as may be determined by the Board) as
an independent director/trustee of any Morgan Stanley Fund that has adopted the
retirement program (each such Fund referred to as an "Adopting Fund" and each
such trustee referred to as an "Eligible Trustee") is entitled to retirement
payments upon reaching the eligible retirement age (normally, after attaining
age 72), Annual payments are based upon length of service.
Currently, upon retirement, each Eligible Trustee is entitled to receive
from the Adopting Fund, commencing as of his or her retirement date and
continuing for the remainder of his or her life, an annual retirement benefit
(the "Regular Benefit") equal to 30.22% of his or her Eligible Compensation
plus 0.5036667% of such Eligible Compensation for each full month of service as
an independent director/trustee of any Adopting Fund in excess of five years up
to a maximum of 60.44% after ten years of service. The foregoing percentages
may be changed by the Board(1). "Eligible Compensation" is one-fifth of the
total compensation earned by such Eligible Trustee for service to the Adopting
Fund in the five year period prior to the date of the Eligible Trustee's
retirement. Benefits under the retirement program are accrued as expenses on
the books of the Adopting Funds. Such benefits are not secured or funded by the
Adopting Funds.
The following table illustrates the retirement benefits accrued to the
Fund's Independent Trustees by the 53 Morgan Stanley Funds (not including the
Fund) for the year ended December 31, 2000, and the estimated retirement
benefits for the Independent Trustees, to commence upon their retirement, from
the 53 Morgan Stanley Funds as of December 31, 2000.
RETIREMENT BENEFITS FROM ALL MORGAN STANLEY FUNDS
FOR ALL ADOPTING FUNDS
---------------------------------
ESTIMATED
CREDITED
YEARS ESTIMATED RETIREMENT BENEFITS ESTIMATED ANNUAL
OF SERVICE AT PERCENTAGE OF ACCRUED AS EXPENSES BENEFITS UPON RETIREMENT
RETIREMENT ELIGIBLE BY ALL FROM ALL
NAME OF INDEPENDENT TRUSTEE (MAXIMUM 10) COMPENSATION ADOPTING FUNDS ADOPTING FUNDS(2)
- ----------------------------- --------------- --------------- --------------------- -------------------------
Michael Bozic ............... 10 60.44% $20,001 $52,885
Edwin J. Garn ............... 10 60.44 29,348 52,817
Wayne E. Hedien ............. 9 51.37 37,886 44,952
Dr. Manuel H. Johnson ....... 10 60.44 21,187 77,817
Michael E. Nugent ........... 10 60.44 36,202 69,506
John L. Schroeder ........... 8 50.37 65,337 53,677
- ----------
(1) An Eligible Trustee may elect alternative payments of his or her
retirement benefits based upon the combined life expectancy of the
Eligible Trustee and his or her spouse on the date of such Eligible
Trustee's retirement. In addition, the Eligible Trustee may elect that
the surviving spouse's periodic payment of benefits will be equal to a
lower percentage of the periodic amount when both spouses were alive. The
amount estimated to be payable under this method, through the remainder
of the later of the lives of the Eligible Trustee and spouse, will be the
actuarial equivalent of the Regular Benefit.
(2) Based on current levels of compensation. Amount of annual benefits also
varies depending on the Trustee's elections described in Footnote (1)
above.
19
IV. CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
- --------------------------------------------------------------------------------
No persons owned 5% or more of the shares of the Fund as of December 7,
2001.
As of the date of this Statement of Additional Information, the aggregate
number of shares of beneficial interest of the Fund owned by the Fund's
officers and Trustees as a group was less than 1% of the Fund's shares of
beneficial interest outstanding.
V. INVESTMENT MANAGEMENT AND OTHER SERVICES
- --------------------------------------------------------------------------------
A. INVESTMENT MANAGER AND SUB-ADVISOR
The Investment Manager to the Fund is Morgan Stanley Investment Advisors
Inc., a Delaware corporation, whose address is 1221 Avenue of the Americas, New
York, NY 10020. The Investment Manager is a wholly-owned subsidiary of Morgan
Stanley, a Delaware corporation. Morgan Stanley is a preeminent global
financial services firm that maintains leading market positions in each of its
three primary businesses: securities, asset management and credit services.
The Sub-Advisor is TCW Investment Management Company, a wholly-owned
subsidiary of TCW, whose direct and indirect subsidiaries provide a variety of
trust, investment management and investment advisory services. The Sub-Advisor
is headquartered at 865 South Figueroa Street, Suite 1800, Los Angeles,
California 90017. Robert A. Day, who is Chairman of the Board of Directors of
TCW, may be deemed to be a control person of the Sub-Advisor by virtue of the
aggregate ownership by Mr. Day and his family of more than 25% of the
outstanding voting stock of TCW. Societe Generale Asset Management, S.A., a
wholly-owned subsidiary of Societe Generale, S.A., owns a majority interest in
TCW.
Pursuant to an Investment Management Agreement (the "Management
Agreement") with the Investment Manager, the Fund has retained the Investment
Manager to provide administrative services and manage its business affairs. The
Fund pays the Investment Manager monthly compensation calculated daily by
applying the following annual rates to the net assets of the Fund determined as
of the close of each business day: 0.65% to the portion of daily net assets not
exceeding $500 million; and 0.60% to the portion of daily net assets exceeding
$500 million. The Investment Manager has retained its wholly-owned subsidiary,
Morgan Stanley Services, to perform administrative services for the Fund.
Under a Sub-Advisory Agreement (the "Sub-Advisory Agreement") between the
Sub-Advisor and the Investment Manager, the Sub-Advisor provides the Fund with
investment advice and portfolio management relating to the Fund's investments
in securities, subject to the overall supervision of the Investment Manager.
The Investment Manager pays the Sub-Advisor monthly compensation equal to 40%
of the Investment Manager's fee.
Prior to June 28, 1999, the Fund was managed by Morgan Stanley Services,
pursuant to a management agreement between the Fund and Morgan Stanley Services
and was advised by TCW Investment Management Company pursuant to an advisory
agreement between the Fund and TCW Investment Management Company.
For the fiscal period November 1, 1998 through June 28, 1999, Morgan
Stanley Services accrued total compensation under the old management agreement
in the amount of $363,182. For the same period, TCW Investment Management
Company accrued total compensation in its former capacity as advisor to the
Fund in the amount of $242,121.
For the period June 28, 1999 through October 31, 1999 and for the fiscal
years ended October 31, 2000 and 2001, the Investment Manager accrued total
compensation under the new Management Agreement in the amounts of $293,087,
$685,082 and $587,228, respectively, of which $117,235, $274,032 and $234,891
were paid to the Sub-Advisor for the same periods, respectively.
B. PRINCIPAL UNDERWRITER
The Fund's principal underwriter is the Distributor (which has the same
address as the Investment Manager). In this capacity, the Fund's shares are
distributed by the Distributor. The Distributor has
20
entered into a Selected Dealer Agreement with Morgan Stanley DW, which through
its own sales organization sells shares of the Fund. In addition, the
Distributor may enter into similar agreements with other selected
broker-dealers. The Distributor, a Delaware corporation, is a wholly-owned
subsidiary of Morgan Stanley.
The Distributor bears all expenses it may incur in providing services
under the Distribution Agreement. These expenses include the payment of
commissions for sales of the Fund's shares and incentive compensation to
Financial Advisors, the cost of educational and/or business-related trips, and
educational and/or promotional and business-related expenses. The Distributor
also pays certain expenses in connection with the distribution of the Fund's
shares, including the costs of preparing, printing and distributing advertising
or promotional materials, and the costs of printing and distributing
prospectuses and supplements thereto used in connection with the offering and
sale of the Fund's shares. The Fund bears the costs of initial typesetting,
printing and distribution of prospectuses and supplements thereto to
shareholders. The Fund also bears the costs of registering the Fund and its
shares under federal and state securities laws and pays filing fees in
accordance with state securities laws.
The Fund and the Distributor have agreed to indemnify each other against
certain liabilities, including liabilities under the Securities Act. Under the
Distribution Agreement, the Distributor uses its best efforts in rendering
services to the Fund, but in the absence of willful misfeasance, bad faith,
gross negligence or reckless disregard of its obligations, the Distributor is
not liable to the Fund or any of its shareholders for any error of judgment or
mistake of law or for any act or omission or for any losses sustained by the
Fund or its shareholders.
C. SERVICES PROVIDED BY THE INVESTMENT MANAGER AND THE SUB-ADVISOR
The Investment Manager manages the Fund's business affairs and supervises
the investment of the Fund's assets. The Sub-Advisor manages the investment of
the Fund's assets, including the placing of orders for the purchase and sale of
portfolio securities. The Sub-Advisor obtains and evaluates the information and
advice relating to the economy, securities markets, and specific securities as
it considers necessary or useful to continuously manage the assets of the Fund
in a manner consistent with its investment objective.
Under the terms of the Management Agreement, the Investment Manager also
maintains certain of the Fund's books and records and furnishes, at its own
expense, the office space, facilities, equipment, clerical help, bookkeeping
and certain legal services as the Fund may reasonably require in the conduct of
its business, including the preparation of prospectuses, proxy statements and
reports required to be filed with federal and state securities commissions
(except insofar as the participation or assistance of independent auditors and
attorneys is, in the opinion of the Investment Manager, necessary or
desirable). The Investment Manager also bears the cost of telephone service,
heat, light, power and other utilities provided to the Fund.
Pursuant to the Sub-Advisory Agreement, the Sub-Advisor has been retained,
subject to the overall supervision of the Investment Manager, to continuously
furnish investment advice concerning individual security selections, asset
allocations and overall economic trends.
Expenses not expressly assumed by the Investment Manager or the
Sub-Advisor under the Management Agreement and the Sub-Advisory Agreement or by
the Distributor, will be paid by the Fund. Such expenses include, but are not
limited to: expenses of the Plan of Distribution pursuant to Rule 12b-1;
charges and expenses of any registrar, custodian, stock transfer and dividend
disbursing agent; brokerage commissions; taxes; engraving and printing share
certificates; registration costs of the Fund and its shares under federal and
state securities laws; the cost and expense of printing, including typesetting,
and distributing prospectuses of the Fund and supplements thereto to the Fund's
shareholders; all expenses of shareholders' and Trustees' meetings and of
preparing, printing and mailing of proxy statements and reports to
shareholders; fees and travel expenses of Trustees or members of any advisory
board or committee who are not employees of the Investment Manager or the
Sub-Advisor or any corporate affiliate of the Investment Manager or the
Sub-Advisor; all expenses
21
incident to any dividend, withdrawal or redemption options; charges and
expenses of any outside service used for pricing of the Fund's shares; fees and
expenses of legal counsel, including counsel to the Trustees who are not
interested persons of the Fund or of the Investment Manager (not including
compensation or expenses of attorneys who are employees of the Investment
Manager or Sub-Advisor); fees and expenses of the Fund's independent auditors;
membership dues of industry associations; interest on Fund borrowings; postage;
insurance premiums on property or personnel (including officers and Trustees)
of the Fund which inure to its benefit; extraordinary expenses (including, but
not limited to, legal claims and liabilities and litigation costs and any
indemnification relating thereto); and all other costs of the Fund's operation.
The Management Agreement provides that in the absence of willful
misfeasance, bad faith, gross negligence or reckless disregard of its
obligations thereunder, the Investment Manager is not liable to the Fund or any
of its investors for any act or omission by the Investment Manager or for any
losses sustained by the Fund or its investors.
The Management Agreement will remain in effect from year to year, provided
continuance of the Management Agreement is approved at least annually by the
vote of the holders of a majority, as defined in the Investment Company Act, of
the outstanding shares of the Fund, or by the Trustees; provided that in either
event such continuance is approved annually by the vote of a majority of the
Trustees, including a majority of the Independent Trustees.
D. RULE 12B-1 PLAN
In accordance with a Plan of Distribution pursuant to Rule 12b-1 under the
Investment Company Act between the Fund and the Distributor, the Distributor
provides certain services in connection with the promotion of sales of Fund
shares (the "Plan").
The Plan provides that the Distributor bears the expense of all
promotional and distribution related activities on behalf of the Fund, except
for expenses that the Trustees determine to reimburse, as described below. The
following activities and services may be provided by the Distributor under the
Plan: (1) compensation to, and expenses of, Morgan Stanley DW's Financial
Advisors and other Selected Broker-Dealers' account executives and other
employees, including overhead and telephone expenses (expenses may include the
cost of Fund-related educational and/or business-related trips or payment of
Fund-related educational and/or promotional expenses; for example, the
Distributor has implemented a compensation program available only to Financial
Advisors meeting specified criteria under which certain marketing and/or
promotional expenses of those Financial Advisors are paid by the Distributor
out of compensation it receives under the Plan); (2) sales incentives and
bonuses to sales representatives and to marketing personnel in connection with
promoting sales of the Fund's shares; (3) expenses incurred in connection with
promoting sales of the Fund's shares; (4) preparing and distributing sales
literature; and (5) providing advertising and promotional activities, including
direct mail solicitation and television, radio, newspaper, magazine and other
media advertisements.
The Investment Manager pays a retention fee to Financial Advisors at an
annual rate of 0.05% of the value of shares of the Fund held for at least one
year. Shares purchased through the reinvestment of dividends will be eligible
for a retention fee, provided that such dividends were earned on shares
otherwise eligible for a retention fee payment. Shares owned in variable
annuities, closed-end fund shares and shares held in 401(k) plans where the
Transfer Agent or Morgan Stanley's Retirement Plan Services is either
recordkeeper or trustee are not eligible for a retention fee.
The retention fees are paid by the Investment Manager from its own assets,
which may include profits from investment management fees payable under the
Management Agreement, as well as from borrowed funds.
The Fund is authorized to reimburse specific expenses incurred or to be
incurred in promoting the distribution of the Fund's shares. Reimbursement is
made through payments at the end of each month. The amount of each monthly
payment may in no event exceed an amount equal to a payment at the annual rate
of 0.75 of 1% of the Fund's average daily net assets during the month. No
interest or other financing charges will be incurred for which reimbursement
payments under the Plan will be made. In
22
addition, no interest charges, if any, incurred on any distribution expenses
will be reimbursable under the Plan. In the case of all expenses other than
expenses representing a residual to Financial Advisors and other authorized
financial representatives, such amounts shall be determined at the beginning of
each calendar quarter by the Trustees, including a majority of the Independent
Trustees. Expenses representing a residual to Financial Advisors and other
authorized financial representatives, may be reimbursed without prior
determination. In the event that the Distributor proposes that monies shall be
reimbursed for other than such expenses, then in making quarterly
determinations of the amounts that may be expended by the Fund, the Investment
Manager provides and the Trustees review a quarterly budget of projected
incremental distribution expenses to be incurred on behalf of the Fund,
together with a report explaining the purposes and anticipated benefits of
incurring such expenses. The Trustees determine which particular expenses, and
the portions thereof, that may be borne by the Fund, and in making such a
determination shall consider the scope of the Distributor's commitment to
promoting the distribution of the Fund's shares.
The Fund accrued a total of $663,568 pursuant to the Plan of Distribution
for the fiscal year ended October 31, 2001. It is estimated that the amounts
paid by the Fund for distribution were for expenses which relate to
compensation of sales personnel and associated overhead expenses.
Under the Plan, the Distributor uses its best efforts in rendering
services to the Fund, but in the absence of willful misfeasance, bad faith,
gross negligence or reckless disregard of its obligations, the Distributor is
not liable to the Fund or any of its shareholders for any error of judgment or
mistake of law or for any act or omission or for any losses sustained by the
Fund or its shareholders.
Under the Plan, the Distributor provides the Fund, for review by the
Trustees, and the Trustees review, promptly after the end of each calendar
quarter, a written report regarding the incremental distribution expenses
incurred on behalf of the Fund during such calendar quarter, which report
includes (1) an itemization of the types of expenses and the purposes
therefore; (2) the amounts of such expenses; and (3) a description of the
benefits derived by the Fund. In the Trustees' quarterly review of the Plan
they consider its continued appropriateness and the level of compensation
provided therein.
No interested person of the Fund nor any Independent Trustee has any
direct financial interest in the operation of the Plan except to the extent
that the Distributor, the Investment Manager, Morgan Stanley DW, Morgan Stanley
Services or certain of their employees may be deemed to have such an interest
as a result of benefits derived from the successful operation of the Plan or as
a result of receiving a portion of the amounts expended thereunder by the Fund.
On an annual basis, the Trustees, including a majority of the Independent
Trustees, consider whether the Plan should be continued. Prior to approving the
last continuation of the Plan, the Trustees requested and received from the
Distributor and reviewed all the information which they deemed necessary to
arrive at an informed determination. In making their determination to continue
the Plan, the Trustees considered: (1) the Fund's experience under the Plan and
whether such experience indicates that the Plan is operating as anticipated;
(2) the benefits the Fund had obtained, was obtaining and would be likely to
obtain under the Plan, including that: the Plan is essential in order to enable
the Fund to continue to grow and avoid a pattern of net redemptions which, in
turn, is essential for effective investment management; and without the
compensation to individual brokers and the reimbursement of distribution and
account maintenance expenses of Morgan Stanley DW's branch offices made
possible by the 12b-1 fees, Morgan Stanley DW could not establish and maintain
an effective system for distribution, servicing of Fund shareholders and
maintenance of shareholder accounts; and (3) what services had been provided
and were continuing to be provided under the Plan to the Fund and its
shareholders. Based upon their review, the Trustees, including each of the
Independent Trustees, determined that continuation of the Plan would be in the
best interest of the Fund and would have a reasonable likelihood of continuing
to benefit the Fund and its shareholders. In the Trustees' quarterly review of
the Plan, they will consider its continued appropriateness and the level of
compensation provided therein.
The Plan may not be amended to increase materially the amount to be spent
for the services described therein without approval by the shareholders of the
Fund, and all material amendments to the
23
Plan must also be approved by the Trustees. The Plan may be terminated at any
time, without payment of any penalty, by vote of a majority of the Independent
Trustees or by a vote of a majority of the outstanding voting securities of the
Fund (as defined in the Investment Company Act) on not more than thirty days'
written notice to any other party to the Plan. So long as the Plan is in
effect, the election and nomination of Independent Trustees shall be committed
to the discretion of the Independent Trustees.
E. OTHER SERVICE PROVIDERS
(1) TRANSFER AGENT/DIVIDEND-PAYING AGENT
Morgan Stanley Trust is the Transfer Agent for the Fund's shares and the
Dividend Disbursing Agent for payment of dividends and distributions on Fund
shares and Agent for shareholders under various investment plans. The principal
business address of the Transfer Agent is Harborside Financial Center, Plaza
Two, 2nd Floor, Jersey City, NJ 07311.
(2) CUSTODIAN AND INDEPENDENT AUDITORS
The Bank of New York, 100 Church Street, New York, NY 10007, is the
Custodian of the Fund's assets. Any of the Fund's cash balances with the
Custodian in excess of $100,000 are unprotected by federal deposit insurance.
These balances may, at times, be substantial.
Deloitte & Touche LLP, Two World Financial Center, New York, NY 10281,
serves as the independent auditors of the Fund. The independent auditors are
responsible for auditing the annual financial statements of the Fund.
(3) AFFILIATED PERSONS
The Transfer Agent is an affiliate of the Investment Manager, and of the
Distributor. As Transfer Agent and Dividend Disbursing Agent, the Transfer
Agent's responsibilities include maintaining shareholder accounts, disbursing
cash dividends and reinvesting dividends, processing account registration
changes, handling purchase and redemption transactions, mailing prospectuses
and reports, mailing and tabulating proxies, processing share certificate
transactions, and maintaining shareholder records and lists. For these
services, the Transfer Agent receives a per shareholder account fee from the
Fund and is reimbursed for its out-of-pocket expenses in connection with such
services.
F. CODES OF ETHICS
The Fund, the Investment Manager, the Sub-Advisor and the Distributor have
each adopted a Code of Ethics pursuant to Rule 17j-1 under the Investment
Company Act. The Codes of Ethics are designed to detect and prevent improper
personal trading. The Codes of Ethics permit personnel subject to the Codes to
invest in securities, including securities that may be purchased, sold or held
by the Fund, subject to a number of restrictions and controls including
prohibitions against purchases of securities in an Initial Public Offering and
a preclearance requirement with respect to personal securities transactions.
VI. BROKERAGE ALLOCATION AND OTHER PRACTICES
- --------------------------------------------------------------------------------
A. BROKERAGE TRANSACTIONS
Subject to the general supervision of the Trustees, the Investment Manager
and/or Sub-Advisor are responsible for decisions to buy and sell securities for
the Fund, the selection of brokers and dealers to effect the transactions, and
the negotiation of brokerage commissions, if any. The Fund expects that the
primary market for the securities in which it invests will generally be the
over-the-counter market. In the over-the-counter market, securities are
generally traded on a "net" basis with dealers acting as principal for their
own accounts without a stated commission, although the price of the security
usually includes a profit to the dealer. The Fund also expects that securities
will be purchased at times in underwritten offerings where the price includes a
fixed amount of compensation, generally referred to as the underwriter's
concession or discount. On occasion, the Fund may also purchase certain money
market instruments directly from an issuer, in which case no commissions or
discounts are paid.
24
During the fiscal years ended October 31, 1999, 2000 and 2001, the Fund
paid no brokerage commissions.
B. COMMISSIONS
Pursuant to an order of the SEC, the Fund may effect principal
transactions in certain money market instruments with Morgan Stanley DW. The
Fund will limit its transactions with Morgan Stanley DW to U.S. government and
government agency securities, bank money instruments (i.e., certificates of
deposit and bankers' acceptances) and commercial paper. The transactions will
be effected with Morgan Stanley DW only when the price available from Morgan
Stanley DW is better than that available from other dealers.
During the fiscal years ended October 31, 1999, 2000 and 2001, the Fund
did not effect any principal transactions with Morgan Stanley DW.
Brokerage transactions in securities listed on exchanges or admitted to
unlisted trading privileges may be effected through Morgan Stanley DW, Morgan
Stanley & Co. and other affiliated brokers and dealers. In order for an
affiliated broker or dealer to effect any portfolio transactions on an exchange
for the Fund, the commissions, fees or other remuneration received by the
affiliated broker or dealer must be reasonable and fair compared to the
commissions, fees or other remuneration paid to other brokers in connection
with comparable transactions involving similar securities being purchased or
sold on an exchange during a comparable period of time. This standard would
allow the affiliated broker or dealer to receive no more than the remuneration
which would be expected to be received by an unaffiliated broker in a
commensurate arm's-length transaction. Furthermore, the Trustees, including the
Independent Trustees, have adopted procedures which are reasonably designed to
provide that any commissions, fees or other remuneration paid to an affiliated
broker or dealer are consistent with the foregoing standard. The Fund does not
reduce the management fee it pays to the Investment Manager by any amount of
the brokerage commissions it may pay to an affiliated broker or dealer.
C. BROKERAGE SELECTION
The policy of the Fund regarding purchases and sales of securities for its
portfolio is that primary consideration will be given to obtaining the most
favorable prices and efficient executions of transactions. Consistent with this
policy, when securities transactions are effected on a stock exchange, the
Fund's policy is to pay commissions which are considered fair and reasonable
without necessarily determining that the lowest possible commissions are paid
in all circumstances. The Fund believes that a requirement always to seek the
lowest possible commission cost could impede effective portfolio management and
preclude the Fund and the Investment Manager and/or the Sub-Advisor from
obtaining a high quality of brokerage and research services. In seeking to
determine the reasonableness of brokerage commissions paid in any transaction,
the Investment Manager and/or the Sub-Advisor relies upon its experience and
knowledge regarding commissions generally charged by various brokers and on its
judgment in evaluating the brokerage and research services received from the
broker effecting the transaction. These determinations are necessarily
subjective and imprecise, as in most cases an exact dollar value for those
services is not ascertainable.
In seeking to implement the Fund's policies, the Investment Manager and
the Sub-Advisor effect transactions with those brokers and dealers who they
believe provide the most favorable prices and are capable of providing
efficient executions. If the Investment Manager and/or the Sub-Advisor believes
the prices and executions are obtainable from more than one broker or dealer,
it may give consideration to placing portfolio transactions with those brokers
and dealers who also furnish research and other services to the Fund or the
Investment Manager and the Sub-Advisor. The services may include, but are not
limited to, any one or more of the following: information as to the
availability of securities for purchase or sale; statistical or factual
information or opinions pertaining to investment; wire services; and appraisals
or evaluations of portfolio securities. The information and services received
by the Investment Manager and/or Sub-Advisor from brokers and dealers may be
utilized by them and any of their asset management affiliates in the management
of accounts of some of their other clients and may not in all cases benefit the
Fund directly.
25
The Investment Manager, the Sub-Advisor and certain of their affiliates
currently serve as investment manager to a number of clients, including other
investment companies, and may in the future act as investment manager or
advisor to others. It is the practice of the Investment Manager, the
Sub-Advisor or their affiliates to cause purchase and sale transactions to be
allocated among the clients whose assets they manage (including the Fund) in
such manner as they deem equitable. In making such allocations among the Fund
and other client accounts, various factors may be considered, including the
respective investment objectives, the relative size of portfolio holdings of
the same or comparable securities, the availability of cash for investment, the
size of investment commitments generally held and the opinions of the persons
responsible for managing the portfolios of the Fund and other client accounts.
The Investment Manager, the Sub-Advisor and their affiliates may operate one or
more order placement facilities and each facility will implement order
allocation in accordance with the procedures described above. From time to
time, each facility may transact in a security at the same time as other
facilities are trading in that security.
D. DIRECTED BROKERAGE
During the fiscal year ended October 31, 2001, the Fund did not pay any
brokerage commissions to brokers because of research services provided.
E. REGULAR BROKER-DEALERS
During the fiscal year ended October 31, 2001, the Fund did not purchase
securities issued by brokers or dealers that were among the ten brokers or the
ten dealers that executed transactions for or with the Fund in the largest
dollar amounts during the year. At October 31, 2001, the Fund did not own any
securities issued by any of such issuers.
VII. CAPITAL STOCK AND OTHER SECURITIES
- --------------------------------------------------------------------------------
The shareholders of the Fund are entitled to a full vote for each full
share of beneficial interest held. The Fund is authorized to issue an unlimited
number of shares of beneficial interest. All shares of beneficial interest of
the Fund are of $0.01 par value and are equal as to earnings, assets and voting
privileges.
The Fund's Declaration of Trust permits the Trustees to authorize the
creation of additional series of shares (the proceeds of which would be
invested in separate, independently managed portfolios) and additional Classes
of shares within any series. The Trustees have not presently authorized any
such additional series or Classes of shares other than as set forth in the
Prospectus.
The Fund is not required to hold annual meetings of shareholders and in
ordinary circumstances the Fund does not intend to hold such meetings. The
Trustees may call special meetings of shareholders for action by shareholder
vote as may be required by the Investment Company Act or the Declaration of
Trust. Under certain circumstances the Trustees may be removed by action of the
Trustees. In addition, under certain circumstances, the shareholders may call a
meeting to remove the Trustees and the Fund is required to provide assistance
in communicating with shareholders about such a meeting. The voting rights of
shareholders are not cumulative, so that holders of more than 50 percent of the
shares voting can, if they choose, elect all Trustees being selected, while the
holders of the remaining shares would be unable to elect any Trustees.
Under Massachusetts law, shareholders of a business trust may, under
certain limited circumstances, be held personally liable as partners for the
obligations of the Fund. However, the Declaration of Trust contains an express
disclaimer of shareholder liability for acts or obligations of the Fund,
requires that notice of such Fund obligations include such disclaimer, and
provides for indemnification out of the Fund's property for any shareholder
held personally liable for the obligations of the Fund. Thus, the risk of a
shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which the Fund itself would be unable to meet its
obligations. Given the above limitations on shareholder personal liability, and
the nature of the Fund's assets and operations, the possibility of the Fund
being unable to meet its obligations is remote and thus, in the opinion of
Massachusetts counsel to the Fund, the risk to Fund shareholders of personal
liability is remote.
26
All of the Trustees, except for James F. Higgins, have been elected by the
shareholders of the Fund, most recently at a Special Meeting of Shareholders
held on June 8, 1999. The Trustees themselves have the power to alter the
number and the terms of office of the Trustees (as provided for in the
Declaration of Trust), and they may at any time lengthen or shorten their own
terms or make their terms of unlimited duration and appoint their own
successors, provided that always at least a majority of the Trustees has been
elected by the shareholders of the Fund.
VIII. PURCHASE, REDEMPTION AND PRICING OF SHARES
- --------------------------------------------------------------------------------
A. PURCHASE/REDEMPTION OF SHARES
Information concerning how Fund shares are offered to the public (and how
they are redeemed and exchanged) is provided in the Fund's Prospectus.
TRANSFER AGENT AS AGENT. With respect to the redemption or repurchase of
Fund shares, the application of proceeds to the purchase of new shares in the
Fund or any other Morgan Stanley Fund and the general administration of the
exchange privilege, the Transfer Agent acts as agent for the Distributor and
for the shareholder's authorized broker-dealer, if any, in the performance of
such functions. With respect to exchanges, redemptions or repurchases, the
Transfer Agent shall be liable for its own negligence and not for the default
or negligence of its correspondents or for losses in transit. The Fund is not
liable for any default or negligence of the Transfer Agent, the Distributor or
any authorized broker-dealer.
The Distributor and any authorized broker-dealer have appointed the
Transfer Agent to act as their agent in connection with the application of
proceeds of any redemption of Fund shares to the purchase of shares of any
other continuously offered Morgan Stanley Fund and the general administration
of the exchange privilege. No commission or discounts will be paid to the
Distributor or any authorized broker-dealer for any transaction pursuant to the
exchange privilege.
OUTSIDE BROKERAGE ACCOUNTS. If a shareholder wishes to maintain his or her
fund account through a brokerage company other than Morgan Stanley DW, he or
she may do so only if the Distributor has entered into a selected dealer
agreement with that brokerage company. Accounts maintained through a brokerage
company other than Morgan Stanley DW may be subject to certain restrictions on
subsequent purchases and exchanges. Please contact your brokerage company or
the Transfer Agent for more information.
B. OFFERING PRICE
The price of Fund shares, called "net asset value," is based on the value
of the Fund's portfolio securities. Net asset value per Fund share is
calculated by dividing the value of the Fund's securities and other assets,
less the liabilities, by the number of shares outstanding.
In the calculation of the Fund's net asset value all portfolio securities
for which over-the-counter market quotations are readily available are valued
at the latest bid price. When market quotations are not readily available,
including circumstances under which it is determined by the Investment Manager
or the Sub-Advisor that sale or bid prices are not reflective of a security's
market value, portfolio securities are valued at their fair value as determined
in good faith under procedures established by and under the general supervision
of the Fund's Trustees. For valuation purposes, quotations of foreign portfolio
securities, other assets and liabilities and forward contracts stated in
foreign currency are translated into U.S. dollar equivalents at the prevailing
market rates prior to the close of the New York Stock Exchange.
Short-term debt securities with remaining maturities of sixty days or less
at the time of purchase are valued at amortized cost, unless the Trustees
determine such does not reflect the securities' market value, in which case
these securities will be valued at their fair value as determined by the
Trustees.
Certain of the Fund's portfolio securities may be valued by an outside
pricing service approved by the Fund's Trustees. The pricing service may
utilize a matrix system incorporating security quality,
27
maturity and coupon as the evaluation model parameters, and/or research
evaluations by its staff, including review of broker-dealer market price
quotations in determining what it believes is the fair valuation of the
portfolio securities valued by such pricing service.
Generally, trading in foreign securities, as well as corporate bonds, U.S.
government securities and money market instruments, is substantially completed
each day at various times prior to the close of the New York Stock Exchange.
The values of such securities used in computing the net asset value of the
Fund's shares are determined as of such times. Foreign currency exchange rates
are also generally determined prior to the close of the New York Stock
Exchange. Occasionally, events which may affect the values of such securities
and such exchange rates may occur between the times at which they are
determined and the close of the New York Stock Exchange and will therefore not
be reflected in the computation of the Fund's net asset value. If events that
may affect the value of such securities occur during such period, then these
securities may be valued at their fair value as determined in good faith under
procedures established by and under the supervision of the Trustees.
IX. TAXATION OF THE FUND AND SHAREHOLDERS
- --------------------------------------------------------------------------------
The Fund generally will make two basic types of distributions: ordinary
dividends and long-term capital gain distributions. These two types of
distributions are reported differently on a shareholder's income tax return and
they are also subject to different rates of tax. The tax treatment of the
investment activities of the Fund will affect the amount, timing and character
of the distributions made by the Fund. Tax issues relating to the Fund are not
generally a consideration for shareholders such as tax- exempt entities and
tax-advantaged retirement vehicles such as an IRA or 401(k) plan. Shareholders
are urged to consult their own tax professionals regarding specific questions
as to federal, state or local taxes.
INVESTMENT COMPANY TAXATION. The Fund intends to remain qualified as a
regulated investment company under Subchapter M of the Internal Revenue Code of
1986, as amended. As such, the Fund will not be subject to federal income tax
on its net investment income and capital gains, if any, to the extent that it
distributes such income and capital gains to its shareholders.
The Fund generally intends to distribute sufficient income and gains so
that the Fund will not pay corporate income tax on its earnings. The Fund also
generally intends to distribute to its shareholders in each calendar year a
sufficient amount of ordinary income and capital gains to avoid the imposition
of a 4% excise tax. However, the Fund may instead determine to retain all or
part of any net long-term capital gains in any year for reinvestment. In such
event, the Fund will pay federal income tax (and possibly excise tax) on such
retained gains.
Gains or losses on sales of securities by the Fund will be long-term
capital gains or losses if the securities have a tax holding period of more
than one year at the time of such sale. Gains or losses on the sale of
securities with a tax holding period of one year or less will be short-term
capital gains or losses. Special tax rules may change the normal treatment of
gains and losses recognized by the Fund when the Fund invests in forward
foreign currency exchange contracts, options, futures transactions, and
non-U.S. corporations classified as "passive foreign investment companies."
Those special tax rules can, among other things, affect the treatment of
capital gain or loss as long-term or short-term and may result in ordinary
income or loss rather than capital gain or loss. The application of these
special rules would therefore also affect the character of distributions made
by the Fund.
Under certain tax rules, the Fund may be required to accrue a portion of
any discount at which certain securities are purchased as income each year even
though the Fund receives no payments in cash on the security during the year.
To the extent that the Fund invests in such securities, it would be required to
pay out such income as an income distribution in each year in order to avoid
taxation at the Fund level. Such distributions will be made from the available
cash of the Fund or by liquidation of portfolio securities if necessary. If a
distribution of cash necessitates the liquidation of portfolio securities, the
Investment Manager and/or Sub-Advisor will select which securities to sell. The
Fund may realize a gain or loss from such sales. In the event the Fund realizes
net capital gains from such transactions, its shareholders may receive a larger
capital gain distribution, if any, than they would in the absence of such
transactions.
28
TAXATION OF DIVIDENDS AND DISTRIBUTIONS. Shareholders normally will have
to pay federal income taxes, and any state and/or local income taxes, on the
dividends and other distributions they receive from the Fund. Such dividends
and distributions, to the extent that they are derived from net investment
income or short-term capital gains, are taxable to the shareholder as ordinary
income regardless of whether the shareholder receives such payments in
additional shares or in cash.
Distributions of net long-term capital gains, if any, are taxable to
shareholders as long-term capital gains regardless of how long a shareholder
has held the Fund's shares and regardless of whether the distribution is
received in additional shares or in cash. Under current law, the maximum tax
rate on long-term capital gains realized by non-corporate shareholders
generally is 20%. A special lower tax rate of 18% on long-term capital gains is
available to non-corporate shareholders to the extent the distributions of
long-term capital gains are derived from securities which the Fund purchased
after December 31, 2000, and held for more than five years.
Shareholders are generally taxed on any ordinary dividend or capital gain
distributions from the Fund in the year they are actually distributed. However,
if any such dividends or distributions are declared in October, November or
December and paid in January then such amounts will be treated for tax purposes
as received by the shareholders on December 31, to shareholders of record of
such month.
Shareholders who are not citizens or residents of the United States and
certain foreign entities may be subject to withholding of United States tax on
distributions made by the Fund of investment income and short term capital
gains.
After the end of each calendar year, shareholders will be sent information
on their dividends and capital gain distributions for tax purposes, including
the portion taxable as ordinary income and the portion taxable as long-term
capital gains.
PURCHASES AND REDEMPTIONS AND EXCHANGES OF FUND SHARES. Any dividend or
capital gains distribution received by a shareholder from any investment
company will have the effect of reducing the net asset value of the
shareholder's stock in that company by the exact amount of the dividend or
capital gains distribution. Furthermore, such dividends and capital gains
distributions are subject to federal income taxes. If the net asset value of
the shares should be reduced below a shareholder's cost as a result of the
payment of dividends or the distribution of realized long-term capital gains,
such payment or distribution would be in part a return of the shareholder's
investment but nonetheless would be taxable to the shareholder. Therefore, an
investor should consider the tax implications of purchasing Fund shares
immediately prior to a distribution record date.
In general, a sale of shares results in capital gain or loss, and for
individual shareholders, is taxable at a federal rate dependent upon the length
of time the shares were held. A redemption of a shareholder's Fund shares is
normally treated as a sale for tax purposes. Fund shares held for a period of
one year or less at the time of such sale or redemption will, for tax purposes,
generally result in short-term capital gains or losses and those held for more
than one year generally result in long-term capital gains or losses. Under
current law, the maximum tax rate on long-term capital gains realized by
non-corporate shareholders generally is 20%. A special lower tax rate of 18% on
long-term capital gains is available for non-corporate shareholders who
purchased shares after December 31, 2000, and held such shares for more than
five years. This special lower tax rate of 18% for five-year property does not
apply to non-corporate shareholders holding Fund shares which were purchased on
or prior to December 31, 2000, unless such shareholders make an election to
treat the Fund shares as being sold and reacquired on January 1, 2001. A
shareholder making such election may realize capital gains. Any loss realized
by shareholders upon a sale or redemption of shares within six months of the
date of their purchase will be treated as a long-term capital loss to the
extent of any distributions of net long-term capital gains with respect to such
shares during the six-month period.
Gain or loss on the sale or redemption of shares in the Fund is measured
by the difference between the amount received and the tax basis of the shares.
Shareholders should keep records of investments made (including shares acquired
through reinvestment of dividends and distributions) so they can compute the
tax basis of their shares. Under certain circumstances a shareholder may
compute and use an average cost basis in determining the gain or loss on the
sale or redemption of shares.
29
Exchanges of Fund shares for shares of another fund, including shares of
other Morgan Stanley Funds, are also subject to similar tax treatment. Such an
exchange is treated for tax purposes as a sale of the original shares in the
first fund, followed by the purchase of shares in the second fund.
If a shareholder realizes a loss on the redemption or exchange of a fund's
shares and reinvests in that fund's shares within 30 days before or after the
redemption or exchange, the transactions may be subject to the "wash sale"
rules, resulting in a postponement of the recognition of such loss for tax
purposes.
X. UNDERWRITERS
- --------------------------------------------------------------------------------
The Fund's shares are offered to the public on a continuous basis. The
Distributor, as the principal underwriter of the shares, has certain
obligations under the Distribution Agreement concerning the distribution of the
shares. These obligations and the compensation the Distributor receives are
described above in the sections titled "Principal Underwriter" and "Rule 12b-1
Plan".
XI. CALCULATION OF PERFORMANCE DATA
- --------------------------------------------------------------------------------
From time to time the Fund may quote its "yield" and/or its "total return"
in advertisements and sales literature.
Yield is calculated for any 30-day period as follows: the amount of
interest income for each security in the Fund's portfolio is determined as
described below; the total for the entire portfolio constitutes the Fund's
gross income for the period. Expenses accrued during the period are subtracted
to arrive at "net investment income." The resulting amount is divided by the
product of the maximum offering price per share on the last day of the period
(reduced by any undeclared earned income per share that is expected to be
declared shortly after the end of the period) multiplied by the average number
of Fund shares outstanding during the period that were entitled to dividends.
This amount is added to 1 and raised to the sixth power. 1 is then subtracted
from the result and the difference is multiplied by 2 to arrive at the
annualized yield.
To determine interest income from debt obligations, a yield-to-maturity,
expressed as a percentage, is determined for obligations held at the beginning
of the period, based on the current market value of the security plus accrued
interest, generally as of the end of the month preceding the 30-day period, or,
for obligations purchased during the period, based on the cost of the security
(including accrued interest). The yield-to-maturity is multiplied by the market
value (plus accrued interest) for each security and the result is divided by
360 and multiplied by 30 days or the number of days the security was held
during the period, if less. Modifications are made for determining
yield-to-maturity on certain tax-exempt securities. For the 30-day period ended
October 31, 2001, the Fund's yield, calculated pursuant to the formula
described above was 3.11%.
The Fund's "average annual total return" represents an annualization of
the Fund's total return over a particular period and is computed by finding the
annual percentage rate which will result in the ending redeemable value of a
hypothetical $1,000 investment made at the beginning of a one, five or ten year
period, or for the period from the date of commencement of the Fund's
operations, if shorter than any of the foregoing. For the purpose of this
calculation, it is assumed that all dividends and distributions are reinvested.
The formula for computing the average annual total return involves a percentage
obtained by dividing the ending redeemable value by the amount of the initial
investment (which is reduced by the initial sales charge), taking a root of the
quotient (where the root is equivalent to the number of years in the period)
and subtracting 1 from the result. Based on this calculation, the average
annual total returns of the Fund for the one and five year periods ended
October 31, 2001 and for the period July 31, 1992 (commencement of operations)
through October 31, 2001 were 7.43%, 6.03% and 4.66%, respectively.
In addition, the Fund may compute its aggregate total return for specified
periods by determining the aggregate percentage rate which will result in the
ending value of a hypothetical $1,000 investment made at the beginning of the
period. For the purpose of this calculation, it is assumed that all dividends
and distributions are reinvested. The formula for computing aggregate total
return involves a percentage obtained by dividing the ending value (without
reduction for any sales charge) by the initial $1,000
30
investment and subtracting 1 from the result. Based on this calculation, the
Fund's total returns for the one and five year periods ended October 31, 2001
and for the period July 31, 1992 through October 31, 2001 were 7.43%, 34.04%
and 52.36%, respectively.
The Fund may also advertise the growth of hypothetical investments of
$10,000, $50,000 and $100,000 in shares of the Fund by adding 1 to the Fund's
aggregate total return to date and multiplying $10,000, $50,000 or $100,000.
Investments of $10,000, $50,000 and $100,000 in the Fund since inception would
have grown to $15,236, $76,180, and $152,360, respectively, at October 31,
2001.
The after-tax returns of the Fund may also be advertised or otherwise
reported. This is generally calculated in a manner similar to the computation
of average annual total returns discussed above, except that the calculation
also reflects the effect of taxes on returns.
The Fund from time to time may also advertise its performance relative to
certain performance rankings and indexes compiled by recognized organizations.
XII. FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
EXPERTS. The financial statements of the Fund for the fiscal year ended
Ocrober 31, 2001 included in this Statement of Additional Information and
incorporated by reference in the Prospectus have been so included and
incorporated in reliance on the report of Deloitte & Touche LLP, independent
auditors, given on the authority of said firm as experts in auditing and
accounting.
* * * * *
This Statement of Additional Information and the Prospectus do not contain
all of the information set forth in the Registration Statement the Fund has
filed with the SEC. The complete Registration Statement may be obtained from
the SEC.
31
Morgan Stanley North American Government Income Trust
PORTFOLIO OF INVESTMENTS o OCTOBER 31, 2001
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------------------
U.S. Government Agency Mortgage-Backed Securities (59.7%)
$ 5,000 Federal Farm Credit Bank ................................... 6.25 % 12/02/02 $5,215,915
5,000 Federal Home Loan Mortgage Corp. ........................... 4.50 08/15/04 5,169,575
1,467 Federal Home Loan Mortgage Corp. ARM ....................... 7.035 03/01/25 1,503,383
4,087 Federal National Mortgage Assoc. ........................... 5.876 07/01/31 4,158,695
4,743 Federal National Mortgage Assoc. ........................... 7.00 01/01/04 5,012,770
464 Federal National Mortgage Assoc. ........................... 9.50 06/01/20 516,803
8,760 Government National Mortgage Assoc. II ARM ................. 6.375 06/20/22-
06/20/25 8,973,913
8,218 Government National Mortgage Assoc. II ARM ................. 6.50 08/20/29 8,375,144
4,261 Government National Mortgage Assoc. II ARM ................. 7.00 07/20/29-
09/20/29 4,356,565
2,164 Government National Mortgage Assoc. II ARM ................. 7.625 10/20/24-
12/20/24 2,225,930
8,341 Government National Mortgage Assoc. II ARM ................. 7.75 08/20/22 8,581,233
----------
Total U.S. Government Agency Mortgage Backed-Securities
(Cost $52,830,255) .................................................................. 54,089,926
----------
Collateralized Mortgage Obligations (16.0%)
U.S. Government Agencies
5 Federal Home Loan Mortgage Corp. 1370 K (PAC IO) ........... 1,089.16 09/15/22 79,763
8,186 Federal Home Loan Mortgage Corp. G 21 M .................... 6.50 10/25/23 8,648,329
404 Federal National Mortgage Assoc. 1993-167 M (PAC) .......... 6.00 09/25/23 404,279
5,000 Federal National Mortgage Assoc. G96-1 PJ (PAC) ............ 7.50 11/17/25 5,345,300
----------
Total Collateralized Mortgage Obligations (Cost $13,970,383)......................... 14,477,671
----------
Short-Term Investments (24.6%)
Commercial Paper (a) (21.8%)
Finance/Rental/Leasing (18.5%)
12,000 International Lease Finance Corp. .......................... 2.48 11/05/01 11,996,693
4,800 International Lease Finance Corp. .......................... 2.50 11/06/01 4,798,333
----------
16,795,026
----------
Insurance (3.3%)
3,000 American General Corp. ..................................... 2.47 11/06/01 2,998,971
----------
Total Commercial Paper (Cost $19,793,997)............................................ 19,793,997
----------
See Notes to Financial Statements
32
Morgan Stanley North American Government Income Trust
PORTFOLIO OF INVESTMENTS o OCTOBER 31, 2001 CONTINUED
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------
Repurchase Agreement (2.8%)
$ 2,557 The Bank of New York (dated 10/31/01; proceeds
$2,557,353) (b) (Cost $2,557,175)................. 2.5 % 11/01/01 $ 2,557,175
-----------
Total Short-Term Investments (Cost $22,351,172)......................... 22,351,172
-----------
Total Investments (Cost $89,151,810) (c).......... 100.3 % 90,918,769
Liabilities in Excess of Other Assets ............ (0.3) (307,495)
------- -----------
Net Assets ....................................... 100.0 % $90,611,274
======= ===========
- ------------
ARM Adjustable Rate Mortgage.
IO Interest-only securities.
PAC Planned Amortization Class.
(a) Purchased on a discount basis. The interest rate shown has been
adjusted to reflect a money market equivalent yield.
(b) Collateralized by $1,896,866 U.S. Treasury Bond 7.875% due 02/15/21
valued at $2,608,323.
(c) The aggregate cost for federal income tax purposes approximates the
aggregate cost for book purposes. The aggregate gross unrealized
appreciation is $2,228,467 and the aggregate gross unrealized
depreciation is $461,508, resulting in net unrealized appreciation
of $1,766,959.
See Notes to Financial Statements
33
Morgan Stanley North American Government Income Trust
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
October 31, 2001
Assets:
Investments in securities, at value
(cost $89,151,810) ............................... $ 90,918,769
Receivable for:
Interest ...................................... 513,178
Shares of beneficial interest sold ............ 80,037
Principal paydowns ............................ 56,078
Prepaid expenses ................................... 15,229
------------
Total Assets .................................... 91,583,291
------------
Liabilities:
Payable for:
Shares of beneficial interest repurchased ..... 736,504
Distribution fee .............................. 59,057
Investment management fee ..................... 51,183
Payable to bank .................................... 68,845
Accrued expenses ................................... 56,428
------------
Total Liabilities ............................... 972,017
------------
Net Assets ...................................... $ 90,611,274
============
Composition of Net Assets:
Paid-in-capital .................................... $320,616,404
Net unrealized appreciation ........................ 1,766,959
Accumulated undistributed net investment
income ........................................... 329,619
Accumulated net realized loss ...................... (232,101,708)
------------
Net Assets ...................................... $ 90,611,274
============
Net Asset Value Per Share,
10,278,823 shares outstanding (unlimited
shares authorized of $.01 par value) .......... $8.82
=====
Statement of Operations
For the year ended October 31, 2001
Net Investment Income:
Interest Income ............................... $5,715,195
----------
Expenses
Distribution fee .............................. 663,568
Investment management fee ..................... 587,228
Transfer agent fees and expenses .............. 180,881
Professional fees ............................. 68,090
Shareholder reports and notices ............... 50,430
Registration fees ............................. 40,483
Custodian fees ................................ 14,262
Trustees' fees and expenses ................... 12,511
Other ......................................... 11,976
----------
Total Expenses ............................. 1,629,429
Less: expense offset .......................... (13,363)
----------
Net Expenses ............................... 1,616,066
----------
Net Investment Income ...................... 4,099,129
----------
Net change in unrealized depreciation ......... 2,295,697
----------
Net Increase .................................. $6,394,826
==========
See Notes to Financial Statements
34
Morgan Stanley North American Government Income Trust
FINANCIAL STATEMENTS continued
Statement of Changes in Net Assets
FOR THE YEAR FOR THE YEAR
ENDED ENDED
OCTOBER 31, 2001 OCTOBER 31, 2000
------------------ -----------------
Increase (Decrease) in Net Assets:
Operations:
Net investment income ....................................................... $ 4,099,129 $ 4,837,596
Net realized gain ........................................................... - 792,094
Net change in unrealized depreciation ....................................... 2,295,697 (109,419)
------------ -------------
Net Increase .............................................................. 6,394,826 5,520,271
Dividends to shareholders from net investment income ........................ (4,171,176) (4,457,000)
Net decrease from transactions in shares of beneficial interest ............. (3,307,860) (29,670,526)
------------ -------------
Net Decrease .............................................................. (1,084,210) (28,607,255)
Net Assets:
Beginning of period ......................................................... 91,695,484 120,302,739
------------ -------------
End of Period
(Including accumulated undistributed net investment income of $329,619 and
$504,364, respectively)...................................................... $ 90,611,274 $ 91,695,484
============ =============
See Notes to Financial Statements
35
Morgan Stanley North American Government Income Trust
NOTES TO FINANCIAL STATEMENTS o OCTOBER 31, 2001
1. Organization and Accounting Policies
Morgan Stanley North American Government Income Trust (the "Fund"), formerly
Morgan Stanley Dean Witter North American Government Income Trust, is
registered under the Investment Company Act of 1940, as amended (the "Act"), as
a non-diversified, open-end management investment company. The Fund's
investment objective is to earn a high level of income while maintaining
relatively low volatility of principal. The Fund was organized as a
Massachusetts business trust on February 19, 1992 and commenced operations on
July 31, 1992.
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.
The following is a summary of significant accounting policies:
A. Valuation of Investments - (1) portfolio securities for which
over-the-counter market quotations are readily available are valued at the
latest available bid price prior to the time of valuation; (2) when market
quotations are not readily available, including circumstances under which it is
determined by Morgan Stanley Investment Advisors Inc. (the "Investment
Manager"), formerly Morgan Stanley Dean Witter Advisors Inc., or TCW Investment
Management Company (the "Sub-Advisor") that sale or bid prices are not
reflective of a security's market value, portfolio securities are valued at
their fair value as determined in good faith under procedures established by
and under the general supervision of the Trustees (valuation of debt securities
for which market quotations are not readily available may be based upon current
market prices of securities which are comparable in coupon, rating and maturity
or an appropriate matrix utilizing similar factors); and (3) 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.
The Fund amortizes premiums and accretes discounts based on the respective life
of the securities. Interest income is accrued daily.
C. Foreign Currency Translation - The books and records of the Fund are
maintained in U.S. dollars as follows: (1) the foreign currency market value of
investment securities, other assets and liabilities and forward foreign
currency contracts ("forward contracts") are translated at the exchange rates
prevailing at the end of the period; and (2) purchases, sales, income and
expenses are translated at the exchange rates prevailing on the respective
dates of such transactions. The resultant exchange gains and losses are
36
Morgan Stanley North American Government Income Trust
NOTES TO FINANCIAL STATEMENTS o OCTOBER 31, 2001 continued
included in the Statement of Operations as realized and unrealized gain/loss on
foreign exchange transactions. Pursuant to U.S. federal income tax regulations,
certain foreign exchange gains/losses included in realized and unrealized
gain/loss are included in or are a reduction of ordinary income for federal
income tax purposes. The Fund does not isolate that portion of the results of
operations arising as a result of changes in the foreign exchange rates from
the changes in the market prices of the securities.
D. Forward Foreign Currency Contracts - The Fund may enter into forward
contracts which are valued daily at the appropriate exchange rates. The
resultant unrealized exchange gains and losses are included in the Statement of
Operations as unrealized foreign currency gain or loss. The Fund records
realized gains or losses on delivery of the currency or at the time the forward
contract is extinguished (compensated) by entering into a closing transaction
prior to delivery.
E. Dollar Rolls - The Fund may enter into dollar rolls in which the Fund sells
securities for delivery and simultaneously contracts to repurchase
substantially similar securities at the current sales price on a specified
future date. The difference between the current sales price and the lower
forward price for the future purchase (often referred to as the "drop") is
amortized over the life of the dollar roll.
F. Federal Income Tax Status - It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute substantially all of its taxable income to its
shareholders. Accordingly, no federal income tax provision is required.
G. Dividends and Distributions to Shareholders - The Fund records dividends and
distributions to its shareholders on the ex-dividend date. 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.
2. Investment Management and Sub-Advisory Agreements
Pursuant to an Investment Management Agreement, the Fund pays the Investment
Manager a management 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: 0.65% to the portion of the daily net assets not
exceeding $500 million and 0.60% to the portion of the daily net assets
exceeding $500 million.
37
Morgan Stanley North American Government Income Trust
NOTES TO FINANCIAL STATEMENTS o OCTOBER 31, 2001 continued
Under a Sub-Advisory Agreement between the Investment Manager and the
Sub-Advisor, the Sub-Advisor provides the Fund with investment advice and
portfolio management relating to the Fund's investments in securities, subject
to the overall supervision of the Investment Manager. As compensation for its
services provided pursuant to the Sub-Advisory Agreement, the Investment
Manager pays the Sub-Advisor compensation equal to 40% of its monthly
compensation.
3. Plan of Distribution
Morgan Stanley Distributors Inc. (the "Distributor"), an affiliate of the
Investment Manager, is the distributor of the Fund's shares and, in accordance
with a Plan of Distribution (the "Plan") pursuant to Rule 12b-1 under the Act,
finances certain expenses in connection with the distribution of shares of the
Fund.
The Fund is authorized to reimburse the Distributor for specific expenses the
Distributor incurs or plans to incur in promoting the distribution of the
Fund's shares. The amount of each monthly reimbursement payment may in no event
exceed an amount equal to a payment at the annual rate of 0.75% of the Fund's
average daily net assets during the month. Expenses incurred pursuant to the
Plan in any fiscal year in excess of 0.75% of the Fund's average daily net
assets will not be reimbursed by the Fund through payments accrued in any
subsequent fiscal year. For the year ended October 31, 2001, the distribution
fee was accrued at the annual rate of 0.73%.
4. Security Transactions and Transactions with Affiliates
The purchases and proceeds from prepayments of portfolio securities, excluding
short-term investments, for the year ended October 31, 2001 were as follows:
PURCHASES PREPAYMENTS
-------------- --------------
U.S. Government Agencies ......................................................... $14,444,850 $31,100,601
Private Issue CMOs ............................................................... -- 1,781,743
Morgan Stanley Trust, an affiliate of the Investment Manager and Distributor,
is the Fund's transfer agent. At October 31, 2001, the Fund had transfer agent
fees and expenses payable of approximately $8,100.
38
Morgan Stanley North American Government Income Trust
NOTES TO FINANCIAL STATEMENTS [|] OCTOBER 31, 2001 continued
5. Shares of Beneficial Interest
Transactions in shares of beneficial interest were as follows:
FOR THE YEAR FOR THE YEAR
ENDED ENDED
OCTOBER 31, 2001 OCTOBER 31, 2000
---------------------------------- ----------------------------------
SHARES AMOUNT SHARES AMOUNT
---------------- ----------------- ---------------- -----------------
Sold .............................. 13,631,877 $ 119,393,140 27,659,513 $ 235,059,575
Reinvestment of dividends ......... 359,700 3,137,960 390,253 3,309,760
Repurchased ....................... (14,370,369) (125,838,960) (31,548,244) (268,039,861)
----------- -------------- ----------- --------------
Net decrease ...................... (378,792) $ (3,307,860) (3,498,478) $ (29,670,526)
=========== ============== =========== ==============
6. Federal Income Tax Status
During the year ended October 31, 2001, the Fund utilized approximately
$103,000 of its net capital loss carryover. At October 31, 2001, the Fund had a
net capital loss carryover of approximately $232,102,000, to offset future
capital gains to the extent provided by regulations, available through October
31 of the following years:
AMOUNT IN THOUSANDS
- --------------------------------------------------------------------------------
2002 2003 2004 2005 2006 2007 2008
- ------------ ----------- ---------- --------- ------ --------- -----
$ 52,983 $160,560 $14,716 $2,013 $152 $1,657 $21
========= ======== ======= ====== ==== ====== ===
As of October 31, 2001, the Fund had permanent book/tax differences
attributable to reclassifications of net gains on paydowns. To reflect
reclassifications arising from these differences, accumulated undistributed net
investment income was charged $102,698 and accumulated net realized loss was
credited $102,698.
7. Reverse Repurchase and Dollar Roll Agreements
Reverse repurchase and dollar roll agreements involve the risk that the market
value of the securities the Fund is obligated to repurchase under the agreement
may decline below the repurchase price. In the event the buyer of securities
under a reverse repurchase or dollar roll agreement files for bankruptcy or
becomes insolvent, the Fund's use of proceeds of the agreement may be
restricted pending a determination by the other party, its trustee or receiver,
whether to enforce the Fund's obligation to repurchase the securities.
Reverse repurchase agreements are collateralized by Fund securities with a
market value in excess of the Fund's obligation under the contract.
At October 31, 2001, there were no outstanding reverse repurchase or dollar
roll agreements.
39
Morgan Stanley North American Government Income Trust
NOTES TO FINANCIAL STATEMENTS o OCTOBER 31, 2001 continued
8. Expense Offset
The expense offset represents a reduction of the custodian fees for earnings on
cash balances maintained by the Fund.
9. Purposes of and Risks Relating to Certain Financial Instruments
The Fund may enter into forward contracts to facilitate settlement of foreign
currency denominated portfolio transactions or to manage foreign currency
exposure associated with foreign currency denominated securities.
Forward contracts involve elements of market risk in excess of the amounts
reflected in the Statement of Assets and Liabilities. The Fund bears the risk
of an unfavorable change in the foreign exchange rates underlying the forward
contracts. Risks may also arise upon entering into these contracts from the
potential inability of the counterparties to meet the terms of their contracts.
At October 31, 2001, there were no outstanding forward contracts.
10. Change in Accounting Policy
Effective November 1, 2001, the Fund will adopt the provisions of the AICPA
Audit and Accounting Guide for Investment Companies, as revised, related to
premiums and discounts on debt securities. The cumulative effect of this
accounting change will have no impact on the net assets of the Fund, but will
result in an adjustment to the cost of securities and a corresponding
adjustment to undistributed net investment income based on securities held as
of October 31, 2001.
40
Morgan Stanley North American Government Income Trust
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of beneficial interest
outstanding throughout each period:
FOR THE YEAR ENDED OCTOBER 31
----------------------------------
2001 2000
----------------- ----------------
Selected Per Share Data:
Net asset value, beginning of period ............. $8.60 $8.50
----- -----
Income (loss) from investment operations:
Net investment income ........................... 0.40 0.40
Net realized and unrealized gain (loss) ......... 0.22 0.06
----- -----
Total income from investment operations .......... 0.62 0.46
----- -----
Less dividends and distributions from:
Net investment income ........................... (0.40) (0.36)
Paid-in-capital ................................. - -
----- -----
Total dividends and distributions ................ (0.40) (0.36)
----- -----
Net asset value, end of period ................... $8.82 $8.60
===== =====
Total Return+ ................................... 7.43% 5.55%
Ratios to Average Net Assets:
Expenses (before expense offset) ................. 1.80%(1) 1.76%(1)
Net investment income ............................ 4.51% 4.58%
Supplemental Data:
Net assets, end of period, in thousands .......... $90,611 $91,695
Portfolio turnover rate .......................... 19% -
FOR THE YEAR ENDED OCTOBER 31
----------------------------------------------------
1999 1998 1997
----------------- ------------------ ---------------
Selected Per Share Data:
Net asset value, beginning of period ............. $8.60 $8.59 $8.39
----- ----- -----
Income (loss) from investment operations:
Net investment income ........................... 0.44 0.49 0.44
Net realized and unrealized gain (loss) ......... (0.09) (0.05) 0.19
----- ----- -----
Total income from investment operations .......... 0.35 0.44 0.63
----- ----- -----
Less dividends and distributions from:
Net investment income ........................... (0.38) (0.43) (0.43)
Paid-in-capital ................................. (0.07) - -
----- ----- -----
Total dividends and distributions ................ (0.45) (0.43) (0.43)
----- ----- -----
Net asset value, end of period ................... $8.50 $8.60 $8.59
===== ===== =====
Total Return+ ................................... 4.30% 5.13% 7.80%
Ratios to Average Net Assets:
Expenses (before expense offset) ................. 1.81%(1) 1.69%(1) 1.65%
Net investment income ............................ 5.11% 5.52% 5.18%
Supplemental Data:
Net assets, end of period, in thousands .......... $120,303 $150,441 $212,040
Portfolio turnover rate .......................... 43% 8% -
- -----------
+ Calculated based on the net asset value as of the last business day of the
period.
(1) Does not reflect the effect of expense offset of 0.01%.
See Notes to Financial Statements
41
Morgan Stanley North American Government Income Trust
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Trustees of
Morgan Stanley North American Government Income Trust:
We have audited the accompanying statement of assets and liabilities of Morgan
Stanley North American Government Income Trust (the "Fund"), formerly Morgan
Stanley Dean Witter North American Government Income Trust, including the
portfolio of investments, as of October 31, 2001, and the related statement of
operations for the year then ended, the statements of changes in net assets for
each of the two years in the period then ended, and the financial highlights
for each of the five years in the period then ended. These financial statements
and financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements and financial highlights are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. Our procedures
included confirmation of securities owned as of October 31, 2001, by
correspondence with the custodian. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Morgan Stanley North American Government Income Trust as of October 31, 2001,
the results of its operations for the year then ended, the changes in its net
assets for each of the two years in the period then ended, and the financial
highlights for each of the five years in the period then ended, in conformity
with accounting principles generally accepted in the United States of America.
Deloitte & Touche LLP
New York, New York
December 11, 2001
2001 Federal Tax Notice (unaudited)
Of the Fund's ordinary income dividends paid during the fiscal year ended
October 31, 2001, 3.08% was attributable to qualifying Federal
obligations. Please consult your tax advisor to determine if any portion
of the dividends you received is exempt from state income tax.
42
MORGAN STANLEY LIMITED DURATION FUND
PART C
OTHER INFORMATION
ITEM 15. INDEMNIFICATION
The response to this item is incorporated herein by reference to Exhibits
1 and 2 under Item 16 below and by reference to Item 23 of Post-Effective
Amendment No. 11 to the Registrant's Registration Statement on Form N-1A, dated
June 28, 2002, which was filed electronically pursuant to Regulation S-T on
June 28, 2002 as an amendment to Registrant's Registration Statement on Form
N-1A (File Nos. 811-7117 and 33-50857).
ITEM 16. EXHIBITS
(1) Declaration of Trust dated October 21, 1993 (incorporated herein by
reference to Exhibit 1 of Pre-Effective Amendment No. 1 to the
Registration Statement on Form N-1A, filed on December 9, 1993); Amendment
to the Declaration of Trust of the Registrant dated June 22, 1998
(incorporated herein by reference to Exhibit 1 of Post-Effective Amendment
No. 5 to the Registration Statement on Form N-1A, filed on June 30, 1998);
Amendment to the Declaration of Trust of the Registrant dated June 18,
2001 (incorporated herein by reference to Exhibit 1(b) of Post-Effective
Amendment No. 8 to the Registration Statement on Form N-1A, filed on June
29, 2001; and Amendment to the Declaration of Trust of the Registrant
dated December 27, 2001 (incorporated herein by reference to Exhibit 1(c)
of Post-Effective Amendment No. 10 to the Registration Statement on Form
N-1A, filed on December 27, 2001).
(2) Amended and Restated By-Laws of Registrant dated as of May 1, 1999
(incorporated herein by reference to Exhibit 2 of Post-Effective Amendment
No. 6 to the Registration Statement on Form N-1A, filed on June 22, 1999).
(3) Not Applicable.
(4) Copy of Agreement and Plan of Reorganization (filed herewith as Exhibit A
to the Proxy Statement and Prospectus).
(5) Not Applicable.
(6) Amended Investment Management Agreement between the Registrant and Morgan
Stanley Investment Advisors Inc. dated May 31, 1997, and amended as of April
30, 1998, (incorporated herein by reference to Exhibit 5 of Post-Effective
Amendment No. 5 to the Registration Statement on Form N-1A filed on June 30,
1998).
(7) (a) Amended Distribution Agreement between Registrant and Morgan Stanley
Distributors Inc. (incorporated herein by reference to Exhibit 5 of
Post-Effective Amendment No. 5 to the Registration Statement on Form
N-1A, filed on June 30, 1998).
(b) Form of Selected Dealer Agreement between Morgan Stanley Distributors
Inc. and Morgan Stanley DW Inc. (incorporated herein by reference to
Exhibit 6(b) of Pre-Effective Amendment No. 1 to the Registration
Statement on Form N-1A, filed on December 9, 1993).
(c) Omnibus Selected Dealer Agreement between Morgan Stanley Distributors
Inc. and National Financial Services Corporation, dated October 17, 1998
(incorporated by reference to Exhibit 5(c) of Post-Effective Amendment
No. 6 to the Registration Statement) on Form N-1A, filed on June 22,
1999).
(8) Not Applicable
(9) (a) Custody Agreement between the Registrant and The Bank of New York dated
December 21, 1993 (incorporated herein by reference to Exhibit 8(a) of
Pre-Effective Amendment No. 1 to the
C-1
Registration Statement on Form N-1A, filed on December 9, 1993);
Amendment dated April 17, 1996 to the Custody Agreement between the
Registrant and The Bank of New York (incorporated to Exhibit 8 of
Post-Effective Amendment No. 3 to the Registration Statement on Form
N-1A, filed on June 21, 1996; Amendment dated June 15, 2001 to the
Custody Agreement between the Registrant and The Bank of New York
(incorporated herein by reference to Exhibit 7(c) of Post-Effective
Amendment No. 9 to the Registration Statement on Form N-1A, filed on
November 2, 2001).
(b) Foreign Custody Manager Agreement between the Registrant and The Bank of
New York dated June 15, 2001 (incorporated herein by reference to
Exhibit 7(d) to Post-Effective Amendment No. 9 to the Registration
Statement on Form N-1A filed on November 2, 2001).
(c) Amended and Restated Transfer Agency and Services Agreement dated
September 1, 2000 between the Registrant and Morgan Stanley Trust
(incorporated herein by reference to Exhibit 8(a) of Post-Effective
Amendment No. 8 to the Registration Statement on Form N-1A filed on June
29, 2001).
(10) Amended and Restated Plan of Distribution pursuant to Rule 12b-1
(incorporated herein by reference to Exhibit 15 of Pre-Effective Amendment
No. 1 to the Registration Statement on Form N-1A, filed on December 9,
1993).
(11)(a) Opinion and consent of Mayer, Brown, Rowe & Maw (previously filed with
Registrant's initial Registration Statement on Form N-14 filed on June
21, 2002 and incorporated herein by reference).
(b) Opinion and consent of Nutter, McClennen & Fish LLP (previously filed
with Registrant's initial Registration Statement on Form N-14 filed on
June 21, 2002 and incorporated herein by reference).
(12) Opinion and consent of Mayer, Brown, Rowe & Maw regarding tax matters
(previously filed with Registrant's initial Registration Statement on Form
N-14 filed on June 21, 2002 and incorporated herein by reference).
(13) Form of Services Agreement between Morgan Stanley Investment Advisors Inc.
and Morgan Stanley Services Company Inc. (incorporated herein by reference
to Exhibit 9 of Post-Effective Amendment No. 5 to the Registration
Statement on Form N-1A, filed on June 30, 1998).
(14) Consent of Independent Auditors, filed herein.
(15) Not Applicable.
(16) Powers of Attorney (previously filed with Registrant's initial
Registration Statement on Form N-14 filed on June 21, 2002 and
incorporated herein by reference).
(17)(a) Registrant's Rule 24f-2 Notice pursuant to Rule 24f-2 under the
Investment Company Act of 1940, for its fiscal year ended April 30,
2002 (incorporated herein by reference to Form 24f-2 filed with the
Securities and Exchange Commission on May 28, 2002).
(b) Form of Proxy.
(c) Voting Information Card.
ITEM 17. UNDERTAKINGS
1. The undersigned Registrant agrees that prior to any public reoffering
of the securities registered through the use of the prospectus which is a part
of this registration statement on Form N-14 by any person or
C-2
party who is deemed to be an underwriter within the meaning of Rule 145(c) of
the Securities Act of 1933, the reoffering prospectus will contain the
information called for by the applicable registration form for reofferings by
persons who may be deemed underwriters, in addition to the information called
for by the other items of the applicable form.
2. The undersigned Registrant agrees that every prospectus that is filed
under paragraph (1) above will be filed as a part of an amendment to this
registration statement on Form N-14 and will not be used until the amendment is
effective, and that, in determining any liability under the Securities Act of
1933, each post-effective amendment shall be deemed to be a new registration
statement for the securities offered therein, and the offering of the
securities at that time shall be deemed to be the initial bona fide offering of
them.
C-3
SIGNATURES
As required by the Securities Act of 1933, this Pre-Effective Amendment
No. 1 to the Registration Statement on Form N-14 has been signed on behalf of
the registrant, in the City of New York and State of New York, on the 16th day
of July, 2002.
MORGAN STANLEY LIMITED DURATION FUND
By: /s/ Barry Fink
------------------------------------
Barry Fink
Vice President and Secretary
As required by the Securities Act of 1933, this registration statement has
been signed by the following persons in the capacities and on the dates
indicated.
SIGNATURE TITLE DATE
- ------------------------------ ------------------------------------- --------------
1. Principal Executive Officer
/s/ Charles A. Fiumefreddo Chief Executive Officer, Trustee and
............................
Chairman July 16, 2002
2. Principal Financial Officer
/s/ Thomas F. Caloia Treasurer and Principal
............................
Accounting Officer July 16, 2002
3. Majority of Trustees
/s/ Michael Bozic Trustee July 16, 2002
............................
/s/ Edwin J. Garn Trustee July 16, 2002
............................
/s/ Wayne E. Hedien Trustee July 16, 2002
............................
/s/ James F. Higgins Trustee July 16, 2002
............................
/s/ Manuel H. Johnson Trustee July 16, 2002
............................
/s/ Michael E. Nugent Trustee July 16, 2002
............................
/s/ John L. Schroeder Trustee July 16, 2002
............................
/s/ Philip J. Purcell Trustee July 16, 2002
............................
C-4
MORGAN STANLEY LIMITED DURATION FUND
EXHIBIT INDEX
14 Consent of Independent Auditors
17 Proxy Card