AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 3, 2002
REGISTRATION NO. 333-99029
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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
HIGH YIELD SECURITIES INC.
(Exact Name of Registrant as Specified in Charter)
(formerly named Morgan Stanley Dean Witter High Yield Securities Inc.)
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)
---------------------
COPY TO:
STUART M. STRAUSS, ESQ.
Mayer, Brown, Rowe & Maw
1675 Broadway
New York, New York 10019
---------------------
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
As soon as practicable after the effective date of this Registration statement.
REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL REGISTRANT SHALL FILE A
FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS 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.
2-64782; 811-2932).
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FORM N-14
MORGAN STANLEY HIGH YIELD SECURITIES INC.
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) ....................... Available Information -- Back Cover Page
(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) ....................... Front Cover Page, Introduction Synopsis, Principal Risk
Factors, Comparison of Investment Objectives, Policies and
Restrictions, Additional Matters Regarding Morgan Stanley
High Income Advantage Trust III, Additional Information
About Morgan Stanley High Income Advantage Trust III
and Morgan Stanley High Yield Securities Inc., Available
Information
(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 High Yield --
Securities Inc.
(b) ........................ *
(c) ........................ *
13(a) ........................ *
(b) ........................ Additional Information about Morgan Stanley High Income
Advantage Trust III
(c) ........................ *
14 .......................... Registrant's Annual Report for the fiscal year ended
August 31, 2002. Morgan Stanley High Income Advantage
Trust III's Annual Report for the fiscal year ended
January 31, 2002 and Semi-Annual Report for the six
months ended July 31, 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 HIGH INCOME ADVANTAGE TRUST III
1221 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10020
(800) 869-NEWS
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD DECEMBER 10, 2002
TO THE SHAREHOLDERS OF MORGAN STANLEY HIGH INCOME ADVANTAGE TRUST III
Notice is hereby given of a Special Meeting of the Shareholders of Morgan
Stanley High Income Advantage Trust III ("HIAT III"), to be held in Room 209,
2nd Floor, at 1221 Avenue of the Americas, New York, New York 10020, at 10:00
A.M., Eastern time, on December 10, 2002, and any adjournments thereof (the
"Meeting"), for the following purposes:
1. To consider and vote upon an Agreement and Plan of Reorganization, dated
July 25, 2002 (the "Reorganization Agreement"), between HIAT III and Morgan
Stanley High Yield Securities Inc. ("High Yield"), pursuant to which
substantially all of the assets of HIAT III would be combined with those of
High Yield and shareholders of HIAT III would become shareholders of High
Yield receiving Class D shares of High Yield with a value equal to the net
asset value of their holdings in HIAT III (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
September 9, 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 HIAT III 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
October 3, 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. AS DISCUSSED IN
THE ENCLOSED PROXY STATEMENT CERTAIN 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 HIGH YIELD SECURITIES INC.
1221 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10020
(800) 869-NEWS
ACQUISITION OF THE ASSETS OF
MORGAN STANLEY HIGH INCOME ADVANTAGE TRUST III
BY AND IN EXCHANGE FOR CLASS D SHARES OF
MORGAN STANLEY HIGH YIELD SECURITIES INC.
This Proxy Statement and Prospectus is being furnished to shareholders of
Morgan Stanley High Income Advantage Trust III ("HIAT III"), in connection with
an Agreement and Plan of Reorganization, dated July 25, 2002 (the
"Reorganization Agreement"), pursuant to which substantially all the assets of
HIAT III, a closed-end management investment company, will be combined with
those of Morgan Stanley High Yield Securities Inc. ("High Yield"), an open-end
management investment company, in exchange for Class D shares of High Yield
(the "Reorganization"). As a result of this transaction, shareholders of HIAT
III will become shareholders of High Yield and will receive Class D shares of
High Yield with a value equal to the net asset value of their holdings in HIAT
III. The terms and conditions of this transaction are more fully described in
this Proxy Statement and Prospectus and in the Reorganization Agreement between
HIAT III and High Yield, attached hereto as Exhibit A. The address of HIAT III
is that of High Yield set forth above. This Proxy Statement also constitutes a
Prospectus of High Yield, which is dated October 3, 2002, filed by High Yield
with the Securities and Exchange Commission (the "Commission") as part of its
Registration Statement on Form N-14 (the "Registration Statement").
High Yield is an open-end diversified management investment company whose
primary investment objective is to earn a high level of current income. As a
secondary objective, the fund seeks capital appreciation but only to the extent
consistent with its primary objective. The fund seeks to achieve its objective
by investing at least 80% of its assets in fixed-income securities rated lower
than Baa by Moody's Investors Service or lower than BBB by Standard & Poor's
Corporation or in non-rated securities considered by the fund's investment
manager, Morgan Stanley Investment Advisors Inc., to be appropriate investments
for the fund.
This Proxy Statement and Prospectus sets forth concisely information about
High Yield that shareholders of HIAT III should know before voting on the
Reorganization Agreement. A copy of the Prospectus for High Yield dated
September 30, 2002, is attached as Exhibit B and incorporated herein by
reference. Also enclosed and incorporated herein by reference is High Yield's
Annual Report for the fiscal year ended August 31, 2002. A Statement of
Additional Information relating to the Reorganization, described in this Proxy
Statement and Prospectus (the "Additional Statement"), dated October 3, 2002,
has been filed with the Commission and is also incorporated herein by
reference. Also incorporated herein by reference is HIAT III's Annual Report
for its fiscal year ended January 31, 2002 and the succeeding Semi-Annual
Report for the six months ended July 31, 2002. Such documents are available
without charge by calling (800) 869-NEWS (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 OCTOBER 3, 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 .............................................................. 3
Vote Required ......................................................................... 3
SYNOPSIS ................................................................................. 4
The Reorganization .................................................................... 4
Fee Table ............................................................................. 4
Example ............................................................................... 5
Tax Consequences of the Reorganization ................................................ 6
Reasons for the Reorganization ........................................................ 6
Comparison of HIAT III and High Yield ................................................. 6
PRINCIPAL RISK FACTORS ................................................................... 8
THE REORGANIZATION ....................................................................... 10
The Board's Consideration ............................................................. 10
The Reorganization Agreement .......................................................... 11
Tax Aspects of the Reorganization ..................................................... 13
Tax Consequences of the Reorganization to HIAT III and High Yield ..................... 14
Description of Shares of High Yield and HIAT III and the Organization of the Two Funds 14
Capitalization Table (unaudited) ...................................................... 16
Appraisal Rights ...................................................................... 16
COMPARISON OF INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS ........................... 16
Investment Objectives and Policies .................................................... 16
Investment Restrictions ............................................................... 17
ADDITIONAL MATTERS REGARDING HIAT III .................................................... 19
History of Public Trading of HIAT III's Shares ........................................ 19
Investment Manager .................................................................... 20
Portfolio Management .................................................................. 20
Expenses Borne by HIAT III ............................................................ 20
ADDITIONAL INFORMATION ABOUT HIAT III AND HIGH YIELD ..................................... 21
General ............................................................................... 21
Litigation ............................................................................ 21
Financial Information ................................................................. 22
Management ............................................................................ 22
Description of Securities and Shareholder Inquiries ................................... 22
Custodian and Transfer Agent and Dividend Paying Agent ................................ 22
Dividends, Distributions and Taxes .................................................... 22
Purchases and Redemptions ............................................................. 22
MANAGEMENT'S DISCUSSION OF FUND PERFORMANCE .............................................. 23
FINANCIAL STATEMENTS AND EXPERTS ......................................................... 23
LEGAL MATTERS ............................................................................ 23
AVAILABLE INFORMATION .................................................................... 23
OTHER BUSINESS ........................................................................... 23
Exhibit A -- Agreement and Plan of Reorganization, dated July 25, 2002, by and between
HIAT III and High Yield
Exhibit B -- Prospectus of High Yield dated September 30, 2002.
MORGAN STANLEY HIGH INCOME ADVANTAGE TRUST III
1221 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10020
(800) 869-NEWS
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PROXY STATEMENT AND PROSPECTUS
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SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD DECEMBER 10, 2002
INTRODUCTION
GENERAL
This Proxy Statement and Prospectus is being furnished to the shareholders
of the Morgan Stanley High Income Advantage Trust III ("HIAT III"), a
closed-end diversified management investment company, in connection with the
solicitation by the Board of Trustees of HIAT III (the "Board") of proxies to
be used at the Special Meeting of Shareholders of HIAT III to be held in Room
209, 2nd Floor, at 1221 Avenue of the Americas, New York, New York 10020 at
10:00 A.M., Eastern time, on December 10, 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 October 7, 2002.
At the Meeting, HIAT III shareholders ("Shareholders") will consider and
vote upon an Agreement and Plan of Reorganization, dated July 25, 2002 (the
"Reorganization Agreement"), between HIAT III and Morgan Stanley High Yield
Securities Inc. ("High Yield") pursuant to which substantially all of the
assets of HIAT III will be combined with those of High Yield in exchange for
Class D shares of High Yield. As a result of this transaction, Shareholders
will become shareholders of High Yield and will receive Class D shares of High
Yield equal to the net asset value of their holdings in HIAT III on the closing
date of such transaction (the "Reorganization"). The Class D shares to be
issued by High Yield pursuant to the Reorganization (the "High Yield Shares")
will be issued at net asset value and will not be subject to any sales charge.
Further information relating to High Yield is set forth herein and in High
Yield's current Prospectus, dated September 30, 2002 ("High Yield's
Prospectus"), attached to this Proxy Statement and Prospectus and incorporated
herein by reference.
The information concerning HIAT III contained herein has been supplied by
HIAT III and the information concerning High Yield contained herein has been
supplied by High Yield.
RECORD DATE; SHARE INFORMATION
The Board has fixed the close of business on September 9, 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 12,782,079 shares of HIAT III issued and outstanding. There are no
HIAT III shares held by HIAT III. 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
No persons were known to own of record or beneficially 5% or more of the
outstanding shares of HIAT III as of the Record Date although from time to
time, the number of shares held in "street name" accounts of various securities
dealers for the benefit of their clients or in centralized securities
depositories may exceed 5% of the total outstanding shares of HIAT III. As of
the Record Date, the trustees and officers of HIAT III, as a group, owned less
than 1% of the outstanding shares of HIAT III.
The following person was known to own of record or beneficially 5% or more
of the outstanding shares of a Class of High Yield as of the Record Date:
Class A -- Robert M. Sullivan, Jr., 1428 Longmeadow Street, Longmeadow, MA
01106-2239. As of the Record Date, the trustees and officers of High Yield, as
a group, owned less than 1% of the outstanding shares of High Yield.
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 HIAT III at 1221 Avenue of the
Americas, New York, New York 10020; (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
HIAT III 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. Abstentions and broker "non-votes" will not count in
favor of or against any such vote for adjournment.
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 and Prospectus. 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 ("MS Trust"), an affiliate of
Morgan Stanley Investment Advisors Inc. ("MS Advisors" or the "Investment
Manager") or Alamo Direct Mail Services Inc. ("Alamo") may call Shareholders to
ask if they would be willing to have their votes recorded by telephone. The
telephone
2
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
the Reorganization Agreement other than to refer to the recommendation of the
Board. HIAT III 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 Prospectus 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.
EXPENSES OF SOLICITATION
The expenses of this solicitation, including the cost of preparing and
mailing this Proxy Statement and Prospectus, are expected to approximate
$100,000 and will be borne by HIAT III. HIAT III and High Yield will bear all
of their respective other expenses associated with the Reorganization. In
addition to the solicitation of proxies by mail, proxies may be solicited by
officers of HIAT III, and officers and regular employees of MS Advisors and MS
Trust, Morgan Stanley Services Company Inc. ("MS Services") and/or Morgan
Stanley DW Inc. ("Morgan Stanley DW"), affiliates of MS Advisors, personally or
by mail, telephone, telegraph or otherwise, without compensation therefor. In
addition, HIAT III will employ Alamo to make telephone calls to Shareholders to
remind them to vote. In addition, HIAT III may also employ D.F. King & Co.,
("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, HIAT III would pay D.F. King $3,000 and the expenses outlined below.
Brokerage houses, banks and other fiduciaries may be requested to forward
soliciting material to the beneficial owners of shares and to obtain
authorization for the execution of proxies. With respect to the solicitation of
a telephonic vote by Alamo, expenses would be approximately $1.00 per outbound
telephone contact, which would be borne by HIAT III. 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 HIAT III.
VOTE REQUIRED
Approval of the Reorganization Agreement by the Shareholders requires the
vote of a majority of the outstanding shares of HIAT III which means an
affirmative vote of the lesser of (1) a majority of the outstanding shares of
HIAT III, or (2) 67% or more of the shares of HIAT III represented at the
Meeting if more than 50% of the outstanding shares of HIAT III are present or
represented by proxy. If the Reorganization Agreement is not approved by
Shareholders, HIAT III 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, High Yield'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 HIAT III, subject to stated liabilities, to High Yield in
exchange for the High Yield Shares. The aggregate net asset value of the High
Yield Shares issued in the exchange will equal the aggregate value of the net
assets of HIAT III received by High Yield. On or after the closing date of the
Reorganization, currently anticipated to be December 16, 2002, (the "Closing
Date"), HIAT III will distribute the High Yield Shares received by HIAT III to
Shareholders as of the Valuation Date (as defined below under "The
Reorganization Agreement") in complete liquidation of HIAT III and HIAT III
will thereafter be de-registered as an investment company under the Investment
Company Act of 1940, as amended (the "1940 Act") and dissolved under
Massachusetts law. As a result of the Reorganization, each Shareholder will
receive that number of full and fractional High Yield Shares equal in value to
such Shareholder's pro rata interest in the net assets of HIAT III transferred
to High Yield. Accordingly, as a result of the Reorganization, each Shareholder
of HIAT III will become a holder of Class D shares of High Yield. Shareholders
holding their shares of HIAT III 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 High Yield; however, such Shareholders will not be able to
redeem, transfer or exchange the High Yield 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.
FOR THE REASONS SET FORTH BELOW UNDER "THE REORGANIZATION -- THE BOARD'S
CONSIDERATION," THE BOARD, INCLUDING THE TRUSTEES WHO ARE NOT "INTERESTED
PERSONS" OF HIAT III ("INDEPENDENT TRUSTEES"), AS THAT TERM IS DEFINED IN THE
1940 ACT, HAS CONCLUDED THAT THE REORGANIZATION IS IN THE BEST INTERESTS OF
HIAT III 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 HIAT III and a Class D shareholder of High Yield may pay if they
buy and hold shares of each respective fund. HIAT III and High Yield each pay a
variety of expenses for management of their assets, distribution of their
shares (High Yield) and other services, and those expenses are reflected in the
net asset value per share of each fund. Class D shares of High Yield do not pay
distribution-related fees; however, the other three Classes offered by High
Yield pay fees for the distribution of their shares. These expenses are
deducted from each respective fund's assets and are based on expenses paid by
HIAT III for its fiscal year ended January 31, 2002 and on expenses paid by
Class D shares of High Yield for its fiscal year ended August 31, 2001. The
table also sets forth pro forma fees for the surviving combined fund (High
Yield) reflecting what the fee schedule would have been on August 31, 2002, if
the Reorganization had been consummated twelve (12) months prior to that date
and assuming Class D fees and expenses.
4
Shareholder Fees
PRO FORMA
COMBINED
HIGH YIELD HIGH YIELD
HIAT III (CLASS D) (CLASS D)
---------- ------------ -----------
MAXIMUM SALES CHARGE (LOAD) IMPOSED ON PURCHASES
(AS A PERCENTAGE OF OFFERING PRICE) .................. none(1) 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(1) none none
EXCHANGE FEE .......................................... none none none
Annual Fund Operating Expenses (expenses that are deducted from fund assets)
PRO FORMA
COMBINED
HIGH YIELD HIGH YIELD
HIAT III (CLASS D) (CLASS D)
---------- ------------ -----------
MANAGEMENT FEES ....................................... 0.75% 0.48% 0.48%
DISTRIBUTION AND SERVICE (12B-1) FEES ................. none none none
OTHER EXPENSES ........................................ 1.04% 0.33% 0.33%
TOTAL ANNUAL FUND OPERATING EXPENSES .................. 1.79% 0.81% 0.81%
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(1) Purchases and sales of HIAT III are made on the New York Stock Exchange
or otherwise through brokers and dealers and are generally subject to
brokerage commissions which vary. Customarily, such commissions may
depend upon the size of the transaction, the broker selected and other
factors.
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 HIAT III or Class D shares of High Yield
or the new combined fund (High Yield), 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.
Expenses Over Time:
1 YEAR 3 YEARS 5 YEARS 10 YEARS
-------- --------- --------- ---------
HIAT III ......................................... $182 $563 $970 $2,105
HIGH YIELD (CLASS D) ............................. $ 83 $259 $450 $1,002
PRO FORMA COMBINED-HIGH YIELD (CLASS D) .......... $ 83 $259 $450 $1,002
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
5
complete description of these costs and expenses, see "Comparison of HIAT III
and High Yield -- Investment Management and Administration Fees, Other
Significant Fees, and Purchases, Exchanges and Redemptions" below.
TAX CONSEQUENCES OF THE REORGANIZATION
As a condition to the Reorganization, HIAT III and High Yield, 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 HIAT III or the
shareholders of HIAT III 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.
REASONS FOR THE REORGANIZATION
The Board of Trustees has determined that the Reorganization is in the
best interests of HIAT III shareholders. In particular, the Reorganization
would afford HIAT III shareholders the opportunity for a continued interest in
a fund which has investment objectives similar to that of HIAT III, and which
is substantially larger and has a significantly lower expense ratio than HIAT
III. The Board of Trustees believes that other potential benefits could be
realized as well. For further information on the reasons for the Board's
decision, see "The Reorganization -- The Board's Consideration," set forth
below.
COMPARISON OF HIAT III AND HIGH YIELD
INVESTMENT OBJECTIVES AND POLICIES. HIAT III and High Yield have similar
investment objectives. As their primary investment objective, HIAT III and High
Yield seek to earn a high level of current income. As their secondary
investment objective, HIAT III and High Yield seek capital appreciation but
only when consistent with their primary investment objective. The respective
investment objectives of HIAT III and High Yield are fundamental and may not be
changed without respective shareholder approval.
High Yield seeks to achieve its primary investment objective by investing
at least 80% of its assets in fixed-income securities rated lower than Baa by
Moody's Investors Service ("Moody's") or lower than BBB by Standard & Poor's
Corporation ("S&P") or in non-rated securities considered by the fund's
investment manager, MS Advisors, to be appropriate investments for the fund.
Securities rated below Baa or BBB are commonly known as "junk bonds." Likewise,
HIAT III seeks to achieve its primary investment objective by investing at
least 80% of its assets in such lower rated and unrated securities.
Other than as set forth above, the investment policies of HIAT III and
High Yield are substantially similar; the principal differences between them
are described under "Comparison of Investment Objectives, Policies and
Restrictions" below.
INVESTMENT MANAGEMENT FEES. Pursuant to an Investment Management
Agreement, HIAT III's investment manager, MS Advisors, provides administrative
services and manages HIAT III's assets, including placing orders for the
purchase and sale of portfolio securities. MS Advisors obtains and evaluates
such information and advice relating to the economy, securities markets and
securities as it deems necessary or useful to manage the assets of HIAT III in
a manner consistent with its objective and policies. As compensation for
advisory services provided to HIAT III, HIAT III pays MS Advisors monthly
compensation calculated weekly by applying the following annual rates to HIAT
III's weekly net assets: 0.75% of the portion of the average weekly assets not
exceeding $250 million; 0.60% of the portion of the average weekly assets
exceeding $250 million and not exceeding $500 million; 0.50% of the portion of
the average weekly assets exceeding $500 million and not
6
exceeding $750 million; 0.40% of the portion of the average weekly assets
exceeding $750 million and not exceeding $1 billion; and 0.30% of the portion
of the average weekly assets exceeding $1 billion. The services provided to
HIAT III under the Investment Management Agreement are comparable to those
provided by MS Advisors to High Yield under its Investment Management Agreement
with MS Advisors. Pursuant to that agreement, High Yield pays MS Advisors,
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:
0.50% of the portion of the daily net assets not exceeding $500 million; 0.425%
of the portion of the daily net assets exceeding $500 million but not exceeding
$750 million; 0.375% of the portion of the daily net assets exceeding $750
million but not exceeding $1 billion; 0.35% of the portion of the daily net
assets exceeding $1 billion but not exceeding $2 billion; and 0.325% of the
portion of the daily net assets exceeding $2 billion but not exceeding $3
billion; and 0.30% of the portion of the daily net assets exceeding $3 billion.
Each class of shares of High Yield is subject to the same management fee rates.
HIAT III is a closed-end investment company and therefore does not have a
distribution plan pursuant to Rule 12b-1 under the 1940 Act ("12b-1 Plan").
High Yield has adopted a 12b-1 Plan for the distribution of its shares,
however, there are no 12b-1 fees applicable to High Yield's Class D shares. For
information relating to the 12b-1 fees applicable to High Yield's Class A, B
and C shares, see the section entitled "Share Class Arrangements" in High
Yield's Prospectus, attached hereto.
OTHER SIGNIFICANT FEES. Both HIAT III and High Yield pay additional fees
in connection with their operations, including legal, auditing, transfer agent,
trustees fees and custodial fees, registration fees in the case of High Yield
and, in the case of HIAT III, listing fees for the listing of its shares on the
New York Stock Exchange ("NYSE"). See "Synopsis -- Fee Table" above for the
percentage of average net assets represented by such "Other Expenses."
PURCHASES, EXCHANGES AND REDEMPTIONS. Class D shares of High Yield are
currently offered at net asset value and such shares may be redeemed for cash
without redemption or other charge at the net asset value per share next
determined. Normally, Class D shares of High Yield are offered only to a
limited group of investors. Subsequent to the Reorganization, all HIAT III
shares will be designated Class D shares of High Yield. However, additional
investments (except for reinvestment of distributions received on shares
acquired as a result of the Reorganization) in Class D shares of High Yield (or
in Class D shares of any other Morgan Stanley Fund) by Shareholders holding
such shares may only be made if those Shareholders are otherwise eligible to
purchase Class D shares. Class D shares acquired in the Reorganization may,
however, be exchanged for Class D shares of another Morgan Stanley Fund
pursuant to Class D's exchange privileges discussed below.
High Yield offers four classes of shares (Class A, Class B, Class C and
Class D) which differ principally in terms of sales charges, distribution and
service fees, and ongoing expenses. For further information relating to each of
the classes of High Yield's shares, see the section entitled "Share Class
Arrangements" in High Yield's Prospectus attached hereto.
Class D shares of High Yield that are held with a broker-dealer that has
entered into a selected dealer agreement with High Yield's distributor (or
shares held directly with High Yield's transfer agent) may be exchanged for
Class D shares of any other Morgan Stanley Fund that offers its shares in more
than one class, or any of Morgan Stanley Limited Duration U.S. Treasury Trust,
Morgan Stanley Limited Term Municipal Trust, Morgan Stanley Limited Duration
Fund and the five Morgan Stanley Funds that are money market funds (the
foregoing funds are collectively referred to as the "Exchange Funds"), without
the imposition of an exchange fee. Exchange privileges will not be available to
Shareholders who hold High Yield shares with broker-dealers that have not
entered into a selected dealer agreement with High Yield's distributor.
7
High Yield shareholders may redeem their High Yield shares on any business
day at the net asset value of such shares. High Yield provides telephone
exchange privileges to its shareholders. For greater details relating to
exchange privileges applicable to High Yield, see the section entitled "How to
Exchange Shares" in High Yield's Prospectus.
High Yield may redeem involuntarily, at net asset value, most accounts
valued at less than $100. However, High Yield offers a reinstatement privilege
whereby a shareholder who has not previously exercised such privilege whose
shares have been redeemed may, within thirty-five days after the date of
redemption, reinstate any portion or all of the proceeds thereof in shares of
the same class from which such shares were redeemed.
Unlike High Yield, HIAT III is a closed-end investment company and does
not redeem its shares or engage in the continuous offering of new shares in the
same manner as an open-end investment company and does not offer to exchange
its shares for shares of other investment companies. Shares of HIAT III are
only purchased and sold on the NYSE.
DIVIDENDS. Both High Yield and HIAT III declare and pay dividends from net
investment income monthly. Both High Yield and HIAT III generally distribute
all of their net realized short-term and long-term capital gains at least once
per year. Each, 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 High Yield, dividends and capital gains distributions are
automatically reinvested in additional shares at net asset value unless the
shareholder elects to receive cash. All persons who become registered holders
of HIAT III are automatically included in HIAT III's automatic dividend
reinvestment plan unless they elect to receive distributions in cash. Under
that plan, Shareholders' dividends are automatically reinvested in shares of
HIAT III at the then current market price of such shares. For more information
on HIAT III's dividend reinvestment plan, see Exhibit C to this Proxy Statement
and Prospectus.
PRINCIPAL RISK FACTORS
The share price or net asset value of High Yield and the market price per
share of HIAT III on the NYSE as well as HIAT III's net asset value 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 economic, market and political factors,
including changes in prevailing interest rates, which cannot be predicted. The
principal risks of an investment in either High Yield or HIAT III are the risks
associated with their respective fixed-income securities which primarily
consist of high yield, high risk securities commonly known as "junk bonds."
Fixed income securities are subject to two types of risks: credit risk and
interest rate risk.
Credit risk refers to the possibility that the issuer of a security will
be unable or unwilling to make interest payments and/or 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.
Junk bonds are subject to greater risk of loss of income and principal
than higher rated securities. 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 funds may incur additional expenses to seek recovery. The
secondary market for junk bonds may be less liquid than the markets for higher
8
quality securities and, as such, may have an adverse effect on the market
prices of certain securities. The Rule 144A securities could have the effect of
increasing the level of fund illiquidity to the extent the funds 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
funds' Directors/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. In addition, periods of economic uncertainty and change probably
would result in an increased volatility of market prices of high yield
securities and a corresponding volatility in the funds' net asset value.
In addition to junk bonds, both High Yield and HIAT III invest up to 20%
of their assets in investment grade fixed-income securities. Some of these
securities have speculative characteristics.
Both High Yield and HIAT III may invest up to 20% of their total assets in
common stocks. In general stock values fluctuate in response to activities
specific to the company as well as general market, economic and political
conditions. These prices can fluctuate widely.
Each fund may invest up to 20% of its assets in foreign securities
including fixed income securities issued by foreign governments and other
foreign issuers (including American depositary receipts or other similar
securities convertible into securities of foreign issuers) but not more than
10% of its total assets in these securities may be denominated in foreign
currencies. The funds' investments in foreign securities involve risks that are
in addition to the risks associated with domestic securities. One additional
risk is currency risk. In particular, the price of securities could be
adversely affected by changes in the exchange rate between U.S. dollars and a
foreign market's local currency. Foreign securities (including depositary
receipts) also have risks related to economic and political developments
abroad, including 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 funds 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
settlements of the funds' trades effected in those markets.
The funds may invest in put and call options and futures on their
portfolio securities, stock indexes and U.S. and foreign currencies. The funds
may use options and futures to protect against a decline in the funds'
securities or in currency prices or an increase in prices of securities or
currencies that may be purchased, as well as to protect against interest rate
changes. If the funds invest in options and/or futures, their participation in
these markets would subject the funds' portfolios to certain risks. If the
Investment Manager's predictions of movements in the direction of the stock or
currency markets are inaccurate, the adverse consequences to the funds (e.g., a
reduction in the funds' net asset value or a reduction in the amount of income
available for distribution) may leave the funds 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 or currencies 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.
The foregoing discussion is a summary of the principal risk factors of
HIAT III and High Yield. For a more complete discussion of the risks of High
Yield, see "Principal Risks" and "Additional Risk Information" in High Yield's
Prospectus attached hereto and incorporated herein by reference.
9
THE REORGANIZATION
THE BOARD'S CONSIDERATION
At a meeting held on July 25, 2002, the Board, including all of the
Independent Trustees, unanimously approved the Reorganization Agreement and
determined to recommend that HIAT III Shareholders approve the Reorganization
Agreement. In reaching this decision, the Board made an extensive inquiry into
a number of factors, particularly the comparative expense ratios of HIAT III
and the Class D shares of High Yield, and the effect on Shareholders of
"open-ending" HIAT III including, for example, the ability to realize the net
asset value of their shares and the potential impact of redemptions on
portfolio management. The Board also considered other factors, including, but
not limited to: comparable investment objectives, policies, restrictions and
portfolios of HIAT III and High Yield; 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 HIAT III and High Yield in connection with the
Reorganization.
In recommending the Reorganization to Shareholders, the Board of HIAT III
considered the following:
1. The expense ratio for the Class D shares of High Yield (0.62% for its
fiscal year end August 31, 2001; 0.81% for its fiscal year end August 31, 2002)
is substantially lower than the expense ratio for HIAT III (1.79% for its
fiscal year end January 31, 2002; 2.25% for the twelve months ended August 31,
2002). This is partially attributable to the fact that High Yield's investment
management fee rate (0.43% of its net assets) was appreciably lower for its
fiscal year end August 31, 2001 (0.48% for its fiscal year end August 31, 2002)
than HIAT III's investment management fee rate (0.75%) paid for the twelve
months ended August 31, 2001 and August 31, 2002. Furthermore, the rate of
other expenses paid by Class D shareholders of High Yield (0.19% of average
daily net assets) for its fiscal year end August 31, 2001 (0.33% for its fiscal
year end August 31, 2002) was significantly lower than the rate of other
expenses paid by HIAT III (1.04% of average daily net assets) for the its last
fiscal year and 1.50% for the twelve months ended August 31, 2002. In addition,
to the extent that the Reorganization would result in Shareholders becoming
shareholders of a combined larger fund, further economies of scale could be
achieved since various fixed expenses (e.g., auditing and legal) can be spread
over a larger number of shares. Therefore, once the Reorganization is
consummated, the expenses which would be borne by Class D shareholders of the
"combined fund" are expected to be significantly lower on a percentage basis
than the expenses per share of HIAT III.
2. HIAT III, has generally traded at a premium, but recently has traded at
a discount to its net asset value and is, as of the date of this Proxy
Statement and Prospectus, trading at a discount. To the extent that HIAT III is
trading at a discount on the date of the Reorganization, the Reorganization at
net asset value would benefit the Shareholders of HIAT III by immediately
eliminating any such discount.
3. Shareholders of HIAT III would have a continued participation in a
portfolio of lower-rated and unrated fixed-income securities.
4. HIAT III does not currently satisfy certain NYSE listing standards.
Therefore, absent the Reorganization, there is a risk that the shares could
become ineligible for trading on the NYSE.
5. Shareholders would have the ability to exchange their Class D shares of
High Yield acquired as a result of the Reorganization into Class D shares of
any Morgan Stanley Multi-Class Fund without the imposition of any sales charge
or additional fees. The Board noted, however, that exchange privileges will not
be available to Shareholders who hold High Yield shares with broker-dealers
that have not entered into a selected dealer agreement with High Yield's
distributor. HIAT III, being a closed-end fund, does not offer any exchange
privileges.
10
6. 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 HIAT III or its Shareholders for Federal income tax purposes as a
result of transactions included in the Reorganization.
7. The Board recognized that if at the time of the Reorganization, HIAT
III is trading at a premium to its net asset value, HIAT III shareholders would
receive High Yield shares with a value less than the amount which could have
been realized through a sale of shares in the open market and no material
adjustments in High Yield's portfolio will be necessary to accommodate the
Reorganization. See "Additional Matters Regarding HIAT III -- History of Public
Trading of HIAT III's Shares" below. The Board concluded, however, that the
potential benefits of the Reorganization outweighed the potential risk of the
elimination of any premium at which the shares trade on the date of the
Reorganization.
The Board of Directors of High Yield, including a majority of the
Independent Directors of High Yield, also have determined that the
Reorganization is in the best interests of High Yield and its shareholders and
that the interests of existing shareholders of High Yield will not be diluted
as a result thereof. The transaction will enable High Yield to acquire
investment securities which are consistent with High Yield's investment
objective, without the costs attendant to the purchase of such securities in
the market. Also, the addition of HIAT III's assets to High Yield's portfolio
may result in a further reduction in High Yield's investment management fee
resulting from the addition of more assets at a lower breakpoint rate in the
management fee schedule and may result also in the economies of scale described
above. The Board also considered any potential liabilities associated with the
pending litigation against HIAT III. See "Additional Information About HIAT III
and High Yield -- Litigation." The Board noted in this regard that in
connection with the Reorganization, the Investment Manager has agreed to
indemnify High Yield against any and all claims, costs and expenses associated
with the HIAT III litigation. Finally, the Board considered that even if the
benefits enumerated above are not realized, the costs to the Fund are
sufficiently minor to warrant taking the opportunity to realize those benefits.
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) HIAT III will transfer all
of its assets, including portfolio securities, cash (other than cash amounts
retained by HIAT III 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 High
Yield on the Closing Date in exchange for the assumption by High Yield of
stated liabilities of HIAT III, including all expenses, costs, charges and
reserves, as reflected on an unaudited statement of assets and liabilities of
HIAT III prepared by the Treasurer of HIAT III, 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
High Yield Shares; (ii) such High Yield Shares would be distributed to
Shareholders on the Closing Date or as soon as practicable thereafter; (iii)
HIAT III would be de-registered as an investment company under the 1940 Act;
(iv) HIAT III would be dissolved as a Massachusetts business trust; and (v) the
outstanding shares of HIAT III would be canceled.
The number of High Yield Shares to be delivered to HIAT III will be
determined by dividing the aggregate net asset value of the shares of HIAT III
acquired by High Yield by the net asset value per share of the Class D shares
of High Yield; 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 HIAT III and High Yield may agree (the "Valuation
11
Date"). As an illustration, assume that on the Valuation Date, the shares of
HIAT III had an aggregate net asset value (not including any Cash Reserve of
HIAT III) of $100,000. If the net asset value per Class D share of High Yield
were $10 per share at the close of business on the Valuation Date, the number of
Class D shares of High Yield to be issued would be 10,000 ($100,000 (divided by)
$10). These 10,000 Class D shares of High Yield would be distributed to the
former shareholders of HIAT III. 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, HIAT III will
distribute pro rata to its Shareholders of record as of the close of business
on the Valuation Date, the High Yield Shares it receives. Each Shareholder will
receive Class D shares of High Yield that corresponds to the shares of HIAT III
currently held by that Shareholder. High Yield will cause its transfer agent to
credit and confirm an appropriate number of High Yield Shares to each
Shareholder. Certificates for High Yield 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 High Yield.
Shareholders who wish to receive certificates representing their High Yield
Shares must, after receipt of their confirmations, make a written request to
High Yield's transfer agent Morgan Stanley Trust, Harborside Financial Center,
Jersey City, New Jersey 07311. Shareholders of HIAT III 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 High Yield;
however, such Shareholders will not be able to redeem, transfer or exchange the
High Yield 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 agreements,
opinions and certificates set forth in Sections 6, 7 and 8 of the
Reorganization Agreement (attached hereto as Exhibit A) and the occurrence of
the events described in those Sections, certain of which may be waived by HIAT
III or High Yield. 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, as
set forth in this Proxy Statement and Prospectus under "Expenses of
Solicitation," by HIAT III, which expenses are expected to approximate
$100,000. HIAT III and High Yield 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 HIAT III, and High Yield. 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 March 31, 2003, 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, HIAT III 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 HIAT III that received High Yield
Shares. HIAT III shall be de-registered as an investment company under the 1940
Act, dissolved under Massachusetts law promptly following the distributions of
shares of High Yield to Shareholders of record of HIAT III.
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 HIAT III (at net asset value on the Valuation Date calculated after
subtracting any Cash Reserve) and reinvest the proceeds in High Yield 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 HIAT III recognizes net
12
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.
Prior to the NYSE's suspension of trading of HIAT III's shares, which is
currently expected to occur on the next business day after the Meeting
(assuming Shareholders of HIAT III approve the Reorganization Agreement at the
Meeting), Shareholders will continue to be able to sell their shares of HIAT
III on the NYSE at the market price of the shares on the NYSE when the sell
order is placed. Following the suspension of trading, Shareholders will no
longer be able to sell their HIAT III shares on the NYSE. On or after the
Closing Date, however, Shareholders will be able to redeem their newly-issued
shares of High Yield.
TAX ASPECTS OF THE REORGANIZATION
At least one but not more than 20 business days prior to the Valuation
Date, HIAT III 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 HIAT III's investment company taxable income for all
periods since the inception of HIAT III through and including the Valuation
Date (computed without regard to any dividends paid deduction), and all of HIAT
III's net capital gain, if any, realized in such periods (after reduction for
any capital loss carryforward).
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, HIAT III and High Yield 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 HIAT III and High Yield (including a representation to the effect that High
Yield has no plan or intention to sell or otherwise dispose of more than 66% of
the assets of HIAT III acquired in the Reorganization except for dispositions
made in the ordinary course of business):
1. The transfer of HIAT III's assets in exchange for the High Yield Shares
and the assumption by High Yield of certain stated liabilities of HIAT III
followed by the distribution by HIAT III of the High Yield Shares to
Shareholders in exchange for their HIAT III 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
HIAT III and High Yield 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 High Yield upon the receipt of
the assets of HIAT III solely in exchange for the High Yield Shares and the
assumption by High Yield of the stated liabilities of HIAT III;
3. No gain or loss will be recognized by HIAT III upon the transfer of the
assets of HIAT III to High Yield in exchange for the High Yield Shares and the
assumption by High Yield of the stated liabilities or upon the distribution of
High Yield Shares to Shareholders in exchange for their HIAT III shares;
4. No gain or loss will be recognized by Shareholders upon the exchange of
the shares of HIAT III for the High Yield Shares;
5. The aggregate tax basis for the High Yield Shares received by each of
the Shareholders pursuant to the Reorganization will be the same as the
aggregate tax basis of the shares in HIAT III held by each such Shareholder
immediately prior to the Reorganization;
13
6. The holding period of the High Yield Shares to be received by each
Shareholder will include the period during which the shares of HIAT III
surrendered in exchange therefor were held (provided such shares in HIAT III
were held as capital assets on the date of the Reorganization);
7. The tax basis of the assets of HIAT III acquired by High Yield will be
the same as the tax basis of such assets of HIAT III immediately prior to the
Reorganization; and
8. The holding period of the assets of HIAT III in the hands of High Yield
will include the period during which those assets were held by HIAT III.
The advice of Counsel is not binding on the Internal Revenue Service or
the courts and neither HIAT III nor High Yield has sought or will seek 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 HIAT III AND HIGH YIELD.
Under the Code, the Reorganization may result in limitations on the
utilization of the capital loss carryovers and built-in losses of HIAT III. The
effect of any such limitations will depend on the existence and amount of HIAT
III's capital loss carryovers and built-in losses at the time of the
Reorganization. A fund will have built-in losses in its assets if its tax basis
in its assets exceeds the fair market value of such assets on the date of the
Reorganization. While the actual amount of such limitation will be determined
at the time of the Reorganization, if, for example, the Reorganization had
occurred on July 19, 2002, each year only approximately $0.7 million of HIAT
III's capital loss carryovers and recognized built-in capital losses would have
been able to be used to offset capital gains of the Combined Fund. The
Reorganization should not have any effect on the capital loss carryovers and
built-in losses of High Yield.
DESCRIPTION OF SHARES OF HIGH YIELD AND HIAT III AND THE ORGANIZATION OF THE
TWO FUNDS
Class D shares of High Yield to be issued pursuant to the Reorganization
Agreement will, when issued, be fully paid and non-assessable by High Yield and
transferable without restrictions and will have no preemptive rights. As stated
above, Class D shares of High Yield are not subject to any sales charge on
purchase or redemption or any 12b-1 fee.
Shares of HIAT III (the only existing class of which is common) are
entitled to one vote for each share held and to vote for the election of
Trustees and on other matters submitted to meetings of shareholders. Shares of
HIAT III have no pre-emptive or conversion rights and the shares, when issued,
are fully paid and non-assessable.
The shareholders of High Yield are entitled to a full vote for each full
common share held. High Yield is authorized to issue an unlimited number of
common shares. All common shares of High Yield are of $0.01 par value and are
equal as to earnings, assets and voting privileges except that each Class will
have exclusive voting privileges with respect to matters relating to
distribution expenses borne solely by such Class or any other matter in which
the interests of one Class differ from the interests of any other Class. In
addition, Class B shareholders will have the right to vote on any proposed
material increase in Class A's expenses, if such proposal is submitted
separately to Class A shareholders. Also, Class A, Class B and Class C bear
expenses related to the distribution of their respective shares.
14
High Yield's Articles of Incorporation permits the Directors 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 Directors have not presently authorized any
such additional series or Classes of shares other than as set forth in High
Yield's Prospectus.
High Yield is not required to hold annual meetings of shareholders and in
ordinary circumstances High Yield does not intend to hold such meetings. The
Directors may call special meetings of shareholders for action by shareholder
vote as may be required by the Investment Company Act or the Articles of
Incorporation. Under certain circumstances, the Directors may be removed by the
actions of the Directors. In addition, under certain circumstances, the
shareholders may call a meeting to remove the Directors and High Yield 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
Directors being selected, while the holders of the remaining shares would be
unable to elect any Directors. HIAT III, whose shares are listed on the NYSE,
does hold annual meetings as required by the rules of the NYSE.
HIAT III is an entity of the type commonly known as a "Massachusetts
business trust." Under Massachusetts law, shareholders of a business trust may,
under certain limited circumstances, be held personally liable as partners for
the obligations of HIAT III. However, the Declaration of Trust contains an
express disclaimer of shareholder liability for acts or obligations of HIAT
III, requires that notice of such HIAT III obligations include such disclaimer,
and provides for indemnification out of the HIAT III's property for any
shareholder held personally liable for the obligations of HIAT III. Thus, the
risk of a shareholder incurring financial loss on account of shareholder
liability is limited to circumstances in which HIAT III itself would be unable
to meet its obligations. High Yield is a Maryland corporation. Shareholders of
a Maryland Corporation are not personally liable for the obligations of the
company.
HIAT III presently has certain anti-takeover provisions in its Declaration
of Trust which could have the effect of limiting the ability of other entities
or persons to acquire control of HIAT III, to cause it to engage in certain
transactions or to modify its structure. The Board of Trustees is divided into
three classes, each having a term of three years. Each year the term of one
class expires. This provision could delay for up to two years the replacement
of a majority of the Board of Trustees. In addition, the affirmative vote or
consent of the holders of 80% of the shares of HIAT III (a greater vote than
that required by the 1940 Act and greater than the required vote applicable to
business corporations under state law) is required to authorize the conversion
of HIAT III from a closed-end to an open-end investment company, or generally
to authorize any of the following transactions:
(i) merger or consolidation of HIAT III with or into any other
corporation;
(ii) issuance of any securities of HIAT III to any person or entity for
cash;
(iii) sale, lease or exchange of all or any substantial part of the assets
of HIAT III, to any entity or person (except assets having an
aggregate fair market value of less than $1,000,000);
(iv) sale, lease or exchange to HIAT III, in exchange for securities of
HIAT III, of any assets of any entity or person (except assets
having an aggregate fair market value of less than $1,000,000)
if such corporation, person or entity is directly, or indirectly through
affiliates, the beneficial owner of 5% or more of the outstanding shares of
HIAT III. However, such 80% vote or consent will not be required with respect
to the foregoing transactions where the Board of Trustees under certain
conditions approves the transaction (as the Board has done with respect to the
Reorganization), in which case, with respect to (i) and
15
(iii) above, a majority shareholder vote or consent will be required, and, with
respect to (ii) and (iv) above, no shareholder vote or consent would be
required. Furthermore, any amendment to the provisions in the Declaration of
Trust requiring an 80% shareholder vote or consent for the foregoing
transactions similarly requires an 80% shareholder vote or consent.
CAPITALIZATION TABLE (UNAUDITED)
The following table sets forth the capitalization of High Yield and HIAT
III as of August 30, 2002 and on a pro forma combined basis as if the
Reorganization had occurred on that date:
NET ASSET
VALUE
NET ASSETS SHARES OUTSTANDING PER SHARE
-------------- -------------------- ----------
HIAT III ............................................ $ 13,441,638 12,782,079 $ 1.05
High Yield
(Class A) .......................................... $ 23,898,234 15,385,078 $ 1.55
(Class B) .......................................... $371,572,357 240,155,149 $ 1.55
(Class C) .......................................... $ 33,990,656 21,926,352 $ 1.55
(Class D) .......................................... $ 86,359,604 55,633,998 $ 1.55
Total High Yield (Class A-D)......................... $515,820,851
Combined Fund (pro forma) (High Yield after the
Reorganization)
(Class A) .......................................... $ 23,898,234 15,385,078 $ 1.55
(Class B) .......................................... $371,572,357 240,155,149 $ 1.55
(Class C) .......................................... $ 33,990,656 21,926,352 $ 1.55
(Class D) .......................................... $ 99,801,242 64,306,023 $ 1.55
Total Combined Fund (pro forma) (High Yield)
(Class A-D) ........................................ $529,262,489
APPRAISAL RIGHTS
Shareholders will have no appraisal rights in connection with the
Reorganization.
COMPARISON OF INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS
INVESTMENT OBJECTIVES AND POLICIES
HIAT III and High Yield have similar investment objectives. Both HIAT III
and High Yield, as a primary investment objective, seek to earn a high level
current income. As a secondary investment objective, HIAT III and High Yield
seek capital appreciation but only to the extent consistent with their primary
objective.
High Yield invests at least 80% of its assets in fixed-income securities
rated lower than Baa by Moody's or lower than BBB by S&P (commonly known as
"junk bonds") or in non-rated securities considered by MS Advisors to be
appropriate investments for the fund. These lower-rated and unrated fixed
income securities may also include "Rule 144A" securities, which are subject to
resale restrictions. There are no minimum quality ratings for investments, and
as such the fund may invest in securities which no longer make payments of
interest or principal. In deciding which securities to buy, hold or sell, MS
Advisors considers an issuer's creditworthiness, economic developments,
interest rate trends and other factors it deems relevant. In evaluating an
issuer's creditworthiness, MS Advisors relies principally on its own analysis.
A security's credit rating is simply one factor that may be considered by MS
Advisors in this regard. High Yield may invest up to 20% of its assets in
16
securities rated Baa or BBB or higher (or, if not rated, determined to be of
comparable quality) when MS Advisors believes that such securities may produce
attractive yields. The fund's fixed-income securities may include zero coupon
securities and payment in kind bonds. Zero coupon securities are purchased at a
discount and either (i) pay no interest, or (ii) accrue interest, but make no
payments until maturity; payment in kind bonds are purchased at the face amount
of the bond and accrue additional principal but make no payments until
maturity. High Yield may also invest in common stocks and foreign securities,
and, may acquire warrants which may or may not be attached to common stock and
may purchase units which combine debt securities with equity securities.
Additionally, High Yield may invest up to 10% of its assets in municipal
obligations that pay interest exempt from federal income tax. Other than its
investment objectives, the foregoing investment policies of High Yield may be
changed without shareholder approval.
HIAT III also invests at least 80% of its assets in the lower-rated and
unrated fixed-income securities previously described, as well as Rule 144A
securities. Fixed-income securities appropriate for HIAT III and High Yield may
include both convertible and nonconvertible debt securities and preferred
stock. Under normal conditions, 20% of HIAT III's total assets may be invested
in higher-rated fixed-income securities and unrated fixed-income securities of
comparable quality and HIAT III also may invest up to 10% of its assets in
municipal obligations. HIAT III may also purchase common stocks, foreign
securities, money market instruments and may acquire warrants and unit
offerings.
Both High Yield and HIAT III may take temporary "defensive" positions that
are inconsistent with each fund's principal investment strategies in attempting
to respond to adverse market conditions. Both High Yield and HIAT III may
invest any amount of their assets in cash or money market instruments in a
defensive posture when MS Advisors believes it is advisable to do so.
Other than its investment objectives, the foregoing investment policies of
HIAT III may be changed without shareholder approval.
Both High Yield and HIAT III may (i) engage in options and futures
transactions, (ii) purchase securities on a when-issued or delayed delivery
basis, (iii) purchase securities on a "when, as and if issued" basis, (iv)
enter into repurchase agreements, (HIAT III may not invest in repurchase
agreements that do not mature within seven days, if any such investments amount
to more than 10% of HIAT III's total assets), (v) invest in private placements
(up to 15% in the case of High Yield and up to 10% in the case of HIAT III),
(vi) lend their portfolio securities (up to 25% in the case of High Yield and
up to 10% in the case of HIAT III), and (vii) invest in public utilities.
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 High Yield's policies, see "Principal Investment Strategies" and
"Additional Investment Strategy Information" in High Yield's Prospectus and
"Description of the Fund and Its Investments and Risks" in High Yield's
Statement of Additional Information.
INVESTMENT RESTRICTIONS
The investment restrictions adopted by HIAT III and High Yield as
fundamental policies are substantially similar. HIAT III's investment
restrictions and their similarities or differences with High Yield's investment
restrictions are summarized below. A full description of High Yield's
investment restrictions can be found under the caption "Description of the Fund
and Its Investments and Risks -- Fund Policies/Investment Restrictions" in High
Yield's Statement 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.
17
HIAT III may not:
1. Acquire common stocks in excess of 20% of its total assets. High Yield
has a similar restriction.
2. As to 75% of its total assets, invest more than 5% 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).
High Yield has a similar restriction but as to 100% of its total assets.
3. As to 75% of its total assets, purchase more than 10% of the voting
securities, or more than 10% of any class of securities of any issuer. For
purposes of this restriction, all outstanding debt securities of an issuer are
considered as one class and all preferred stocks of an issuer are considered as
one class. High Yield has a similar restriction but as to 100% of its total
assets.
4. Invest 25% or more of its total assets in securities of issuers in any
one industry. For purposes of this restriction, gas, electric, water and
telephone utilities will each be treated as being a separate industry. This
restriction does not apply to obligations issued or guaranteed by the United
States Government or its agencies or instrumentalities. High Yield has an
identical restriction.
5. Invest more than 5% of its total assets in securities of companies
having a record, together with predecessors, of less than three years of
continuous operation. This restriction shall not apply to any obligation of the
United States Government, its agencies or instrumentalities. High Yield has an
identical restriction.
6. Invest more than 10% of its total assets in securities which are
restricted as to disposition under the federal securities laws or otherwise.
This restriction shall not apply to securities received as a result of
corporate reorganization or similar transaction affecting readily marketable
securities already held in HIAT III's portfolio; however, HIAT III will attempt
to dispose in an orderly fashion of any securities received under these
circumstances to the extent that such securities exceed 15% of HIAT III's total
assets. High Yield, as an open-end investment company, may not invest more than
15% of its assets in illiquid securities.
7. Invest in securities of any issuer if, to the knowledge of the fund,
any officer or trustee of the fund or any officer or director of the Investment
Manager owns more than 1/2 of 1% of the outstanding securities of such issuer,
and such officers, trustees and directors who own more than 1/2 of 1% own in
the aggregate more than 5% of the outstanding securities of such issuer. High
Yield has an identical restriction.
8. Purchase or sell real estate or interests therein, although it may
purchase securities of issuers which engage in real estate operations and
securities which are secured by real estate or interests therein. High Yield
has an identical restriction.
9. Purchase or sell commodities except that the fund may purchase or sell
financial futures contracts and related options. High Yield has an identical
restriction.
10. Purchase oil, gas or other mineral leases, rights or royalty
contracts, or exploration or development programs, except that the fund may
invest in securities of companies which invest in or sponsor such programs.
High Yield has an identical restriction.
11. Write, purchase or sell puts, calls, or combinations thereof, except
for options on futures contracts or options on debt securities. High Yield has
an identical restriction.
12. Purchase securities of other investment companies, except in
connection with a merger, consolidation, reorganization or acquisition of
assets. High Yield has an identical restriction.
13. Borrow money, except that the fund may borrow from a bank for
temporary or emergency purposes or for repurchase of its shares provided that
immediately after such borrowing the amount borrowed does not
18
exceed 33 1/3% of the value of its total assets (including the amount borrowed)
less its liabilities (not including any borrowings but including the fair
market value at the time of computation of any other senior securities which
are outstanding at the time). High Yield may only borrow for temporary purposes
and only in amounts not exceeding 5% of the value of its total assets (not
including the amount borrowed).
14. Pledge its assets or assign or otherwise encumber them except to
secure borrowings effected within the limitations set forth in Restriction 13.
However, for the purpose of this restriction, collateral arrangements with
respect to the writing of options and collateral arrangements with respect to
initial margin for futures are not deemed to be pledges of assets. High Yield
has a substantially similar restriction.
15. Issue senior securities as defined in the 1940 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; (d) borrowing money in accordance with restrictions
described above; or (e) lending portfolio securities. High Yield is similarly
restricted.
16. Make loans of money or securities, except: (a) by the purchase of debt
obligations in which the fund may invest consistent with its investment
objective and policies; (b) by investment in repurchase agreements; or (c) by
lending its portfolio securities. High Yield has an identical restriction.
17. Make short sales of securities. High Yield has an identical
restriction.
18. Purchase securities on margin, except for such short-term loans as are
necessary for the clearance of purchases of portfolio securities. High Yield
has an identical restriction.
19. Engage in the underwriting of securities, except insofar as the fund
may be deemed an underwriter under the Securities Act of 1933 in disposing of a
portfolio security. High Yield has an identical restriction.
20. Invest for the purpose of exercising control or management of another
company. High Yield has an identical restriction.
ADDITIONAL MATTERS REGARDING HIAT III
This section sets forth additional information about HIAT III which is not
contained elsewhere in this Proxy Statement and Prospectus.
HISTORY OF PUBLIC TRADING OF HIAT III'S SHARES
Shares of HIAT III trade on the New York Stock Exchange under the symbol
"YLH". The following table shows the history of public trading of the shares of
beneficial interest of HIAT III by quarter for the last two fiscal years. The
table sets forth the per share high market price and the per share low market
price on the NYSE for each completed fiscal quarter and the corresponding net
asset value for that market price as well as the discount (expressed as a
percentage of net asset value) represented by the difference between the market
price and its corresponding net asset value:
PERCENTAGE PERCENTAGE
MARKET NET ASSET PREMIUM MARKET NET ASSET PREMIUM
QUARTER ENDED PRICE-HIGH VALUE (DISCOUNT) PRICE-LOW VALUE (DISCOUNT)
- -------------------------- ------------ ----------- ------------ ----------- ----------- -------------
January 31, 2002 ......... $ 1.440 $ 1.29 11.63% $ 1.340 $ 1.26 6.35%
October 31, 2001 ......... $ 1.680 $ 1.62 3.70% $ 1.250 $ 1.39 (10.07)%
July 31, 2001 ............ $ 1.730 $ 1.64 5.49% $ 1.670 $ 1.63 2.45%
April 30, 2001 ........... $ 3.930 $ 2.35 67.23% $ 3.080 $ 2.29 34.50%
19
PERCENTAGE PERCENTAGE
MARKET NET ASSET PREMIUM MARKET NET ASSET PREMIUM
QUARTER ENDED PRICE-HIGH VALUE (DISCOUNT) PRICE-LOW VALUE (DISCOUNT)
- -------------------------- ------------ ----------- ------------ ----------- ----------- ------------
January 31, 2001 ......... $ 3.938 $ 2.33 68.99% $ 2.750 $ 2.36 16.53%
October 31, 2000 ......... $ 4.813 $ 3.30 45.83% $ 3.625 $ 2.89 25.43%
July 31, 2000 ............ $ 4.688 $ 3.54 32.42% $ 4.125 $ 3.61 14.27%
April 30, 2000 ........... $ 4.438 $ 3.82 16.16% $ 4.063 $ 4.05 2.61%
On August 30, 2002, the shares traded at a market price of $1.02 with a
net asset value of $1.05.
INVESTMENT MANAGER
HIAT III's investment manager, MS Advisors, maintains its offices at 1221
Avenue of the Americas, New York, New York 10020. MS Advisors, which was
incorporated in July, 1992 under the name Dean Witter InterCapital Inc., changed
its name to Morgan Stanley Investment Advisors Inc. on June 18, 2001. MS
Advisors together with Morgan Stanley Services Company Inc. ("MS Services"), its
wholly-owned subsidiary, had approximately $125 billion in assets under
management as of August 31, 2002. MS Advisors 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. Morgan Stanley has its offices at 1585
Broadway, New York, New York 10036.
The Principal Executive Officer and Directors of MS Advisors are Mitchell
M. Merin, President and Chief Executive Officer, Ronald E. Robison, Managing
Director and Chief Administrative Officer and Barry Fink, Vice President,
Secretary and General Counsel. Messrs. Merin, Robison and Fink also serve as
officers of HIAT III.
MS Advisors and its wholly-owned subsidiary, MS Services, serve in various
investment management, advisory, management and administrative capacities to
investment companies and pension plans and other institutional and individual
investors.
There are various lawsuits pending against Morgan Stanley involving
material amounts which, in the opinion of its management, will be resolved with
no material effect on the consolidated financial position of the company.
PORTFOLIO MANAGEMENT
HIAT III's portfolio is managed by the High Yield Corporate team of the
Taxable Fixed-Income Group. Current members of the team include Stephen F.
Esser, a Managing Director of HIAT III's Investment Manager, Gordon W. Loery,
an Executive Director of HIAT III's Investment Manager, and Deanna L.
Loughnane, an Executive Director of HIAT III's Investment Manager.
EXPENSES BORNE BY HIAT III
Under the Investment Management Agreement, HIAT III is obligated to bear
all of the costs and expenses of its operation, except those specifically
assumed by the Investment Manager, including, without limitation: charges and
expenses of any registrar, custodian or depository appointed by HIAT III for
the safekeeping of its cash, portfolio securities or commodities and other
property, and any stock transfer or dividend agent or agents appointed by HIAT
III; brokers' commissions chargeable to HIAT III in connection with portfolio
securities transactions to which the Trust is a party; all taxes, including
securities or commodities issuance and
20
transfer taxes, and fees payable by the Trust to Federal, state or other
governmental agencies; costs and expenses of engraving or printing of
certificates representing shares of HIAT III; all costs and expenses in
connection with registration and maintenance of registration of HIAT III and of
its shares with the Securities and Exchange Commission and various states and
other jurisdictions (including filing fees and legal fees and disbursements of
counsel); the costs and expense of preparing, printing, including typesetting,
and distributing prospectuses for such purposes; all expenses of shareholders'
and Trustees' meetings and of preparing, printing and mailing 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 HIAT III's Investment
Manager or any of their corporate affiliates; all expenses incident to the
payment of any dividend or distribution program; charges and expenses of any
outside pricing services; charges and expenses of legal counsel, including
counsel to the Independent Trustees of HIAT III, and independent accountants in
connection with any matter relating to HIAT III (not including compensation or
expenses of attorneys employed by the Investment Manager); membership dues of
industry associations; interest payable on borrowings; fees and expenses
incident to the listing of HIAT III's shares on any stock exchange; postage;
insurance premiums on property or personnel (including officers and Trustees)
of HIAT III which inure to its benefit; extraordinary expenses (including, but
not limited to legal claims, liabilities, litigation costs and any
indemnification related thereto); and all other charges and costs of HIAT III's
operations unless otherwise explicitly provided in the Investment Management
Agreement.
ADDITIONAL INFORMATION ABOUT HIAT III AND HIGH YIELD
GENERAL
HIAT III was organized as a "Massachusetts business trust" under the laws
of the Commonwealth of Massachusetts on November 23, 1988 and commenced
operations as a closed-end registered investment company on February 28, 1989.
For a discussion of the organization and operation of High Yield, see "Fund
Management" and "Investment Objective" in High Yield's Prospectus.
The Board of Trustees of HIAT III and the Board of Directors of High Yield
oversee the management of the funds but do not themselves manage the funds. The
Trustees/Directors review various services provided by or under the direction
of the Investment Manager to ensure that the funds' general investment policies
and programs are properly carried out. The Trustees/Directors also conduct
their review to ensure that administrative services are provided to the funds
in a satisfactory manner.
Under state law, the duties of the Trustees/Directors are generally
characterized as a duty of loyalty and a duty of care. The duty of loyalty
requires a Trustee/Director to exercise his or her powers in the interest of
each fund and not the Trustee's/Director's own interest or the interest of
another person or organization. A Trustee/Director 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/Director reasonably believes to be in the best interest
of each fund and its shareholders.
LITIGATION
Last year, a purported class action lawsuit was filed against HIAT III and
its Investment Manager, among others, in the District Court for the Southern
District of New York alleging that HIAT III violated the federal securities
laws and New York common law by investing more than 25% of its assets in a
single industry or group of industries -- specifically, telecommunications --
without first obtaining shareholder approval. The amended class action
complaint alleges that HIAT III's decline in its net asset value during the
period August 1998
21
through August 2001 was caused by HIAT III overconcentrating its assets in the
telecommunications industry or industries, and further, that HIAT III was not
allowed to concentrate more than 25% of its assets in this single industry or
group of industries under the its Registration Statement and federal securities
laws without first obtaining shareholder approval.
HIAT III and its Investment Manager have filed a motion to dismiss the
amended class action complaint and intend to vigorously defend the allegations
against it. The motion to dismiss is fully briefed and HIAT III is awaiting the
Court's decision on the motion. In order to ensure that High Yield is not,
subsequent to the Merger, adversely affected by the HIAT III litigation, the
Investment Manager has agreed to indemnify High Yield against any and all
claims, costs and expenses associated with the HIAT III litigation.
FINANCIAL INFORMATION
For certain financial information about High Yield, see "Financial
Highlights" and "Past Performance" in High Yield's Prospectus, and for certain
financial information about HIAT III, see HIAT III's Annual Report for its
fiscal year ended January 31, 2002 and succeeding Semi-Annual Report for the
six months ended July 31, 2002.
MANAGEMENT
For information about the respective Board of Directors, Investment
Manager, and the Distributor of High Yield, see "Fund Management" in High
Yield's Prospectus and "Investment Management and Other Services" in High
Yield's Statement of Additional Information and, with respect to HIAT III, see
"Additional Matters Regarding HIAT III" above.
DESCRIPTION OF SECURITIES AND SHAREHOLDER INQUIRIES
For a description of the nature and most significant attributes of shares
of HIAT III and High Yield, and information regarding shareholder inquiries,
see the discussion herein under "The Reorganization--Description of Shares of
High Yield and HIAT III" and "Available Information" as well as "Capital Stock
and Other Securities" in High Yield's Statement of Additional Information.
CUSTODIAN AND TRANSFER AGENT AND DIVIDEND PAYING AGENT
Morgan Stanley Trust is the Transfer Agent for each of HIAT III's and High
Yield's shares and the Dividend Disbursing Agent for payment of dividends and
distributions on their respective shares. The principal business address of the
Transfer Agent is Harborside Financial Center, Plaza Two, Jersey City, New
Jersey 07311. The Bank of New York, 100 Church Street, New York, NY 10007 is
the Custodian of the assets of both HIAT III and High Yield.
DIVIDENDS, DISTRIBUTIONS AND TAXES
For a discussion of High Yield's and HIAT III's policies with respect to
dividends, distributions and taxes, see "Distributions" and "Tax Consequences"
in High Yield's Prospectus and "Dividends and Distributions; Automatic Dividend
Reinvestment Plan" in HIAT III's Prospectus.
PURCHASES AND REDEMPTIONS
For a discussion of how High Yield's shares may be purchased and redeemed,
see "How to Buy Shares," "How to Exchange Shares" and "How to Sell Shares" in
High Yield's Prospectus.
22
MANAGEMENT'S DISCUSSION OF FUND PERFORMANCE
For a discussion of High Yield's performance, see management's letter to
shareholders in its Annual Report for its fiscal year ended August 31, 2002,
accompanying this Proxy Statement and Prospectus. For a discussion of the
performance of HIAT III, see HIAT III's Annual Report for its fiscal year ended
January 31, 2002 and the Semi-Annual Report for the six months ended July 31,
2002.
FINANCIAL STATEMENTS AND EXPERTS
The financial statements of High Yield, for the year ended August 31,
2002, and the financial statements of HIAT III for the year ended January 31,
2002 have been audited by Deloitte & Touche LLP, independent auditors, and 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. These financial statements have been incorporated by
reference in reliance upon such reports given upon the authority of Deloitte &
Touche LLP, as experts in accounting and auditing.
LEGAL MATTERS
Certain legal matters concerning the issuance of shares of High Yield will
be passed upon by Mayer, Brown, Rowe & Maw, New York, New York. Such firm will
rely on Maryland counsel as to matters of Maryland law.
AVAILABLE INFORMATION
Additional information about HIAT III and High Yield is available, as
applicable, in the following documents which are incorporated herein by
reference: (i) High Yield's Prospectus dated September 30, 2002, attached to
this Proxy Statement and Prospectus, which Prospectus forms a part of
Post-Effective Amendment No. 28 to High Yield's Registration Statement on Form
N-1A (File Nos. 2-64782; 811-2932 (ii) High Yield's Annual Report for its
fiscal year ended August 31, 2002, accompanying this Proxy Statement and
Prospectus; and (iii) HIAT III's Annual Report for its fiscal year ended
January 31, 2002 and its succeeding Semi-Annual Report for the six months ended
July 31, 2002. The foregoing documents may be obtained without charge by
calling (800) 869-NEWS (toll-free).
HIAT III and High Yield 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 HIAT III and High Yield which are of public record
can be inspected and copied at public reference facilities maintained by the
Commission at Room 1204, Judiciary Plaza, 450 Fifth Street, NW, Washington,
D.C. 20549 and certain of its regional offices, and copies of such materials
can be obtained at prescribed rates from the Public Reference Branch, Office of
Consumer Affairs and Information Services, Securities and Exchange Commission,
Washington, D.C. 20549.
The shares of beneficial interest of HIAT III are listed on the NYSE and,
in accordance with the requirements of the NYSE, HIAT III files proxy
materials, reports and other information with the NYSE. These materials can be
inspected at the New York Stock Exchange located at 11 Wall Street, New York,
NY 10005 or by telephoning the NYSE at (212) 656-3000.
OTHER BUSINESS
Management of HIAT III 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,
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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
October 3, 2002
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EXHIBIT A
AGREEMENT AND PLAN OF REORGANIZATION
THIS AGREEMENT AND PLAN OF REORGANIZATION ("Agreement") is made as of this
25th day of July, 2002, by and between MORGAN STANLEY HIGH YIELD SECURITIES
INC., a Maryland corporation ("High Yield") and MORGAN STANLEY HIGH INCOME
ADVANTAGE TRUST III, a Massachusetts business trust ("HIAT III").
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 High Yield of substantially all of the assets of HIAT III in
exchange for the assumption by High Yield of all stated liabilities of HIAT III
and the issuance by High Yield of Class D shares of beneficial interest, par
value $0.01 per share (the "High Yield Shares"), to be distributed, after the
Closing Date hereinafter referred to, to the shareholders of HIAT III in
liquidation of HIAT III 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 HIAT III
1.1 Subject to the terms and conditions herein set forth and on the basis
of the representations and warranties contained herein, HIAT III agrees to
assign, deliver and otherwise transfer the HIAT III Assets (as defined in
paragraph 1.2) to High Yield and High Yield agrees in exchange therefor to
assume all of HIAT III stated liabilities on the Closing Date as set forth in
paragraph 1.3(a) and to deliver to HIAT III the number of High Yield Shares,
including fractional High Yield 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 "HIAT III 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 HIAT III, and any deferred or prepaid expenses shown as an
asset on HIAT III's books on the Valuation Date.
(b) On or prior to the Valuation Date, HIAT III will provide High Yield
with a list of all of HIAT III assets to be assigned, delivered and otherwise
transferred to High Yield and of the stated liabilities to be assumed by High
Yield pursuant to this Agreement. HIAT III reserves the right to sell any of
the securities on such list but will not, without the prior approval of High
Yield, acquire any additional securities other than securities of the type in
which High Yield is permitted to invest and in amounts agreed to in writing by
High Yield. High Yield will, within a reasonable time prior to the Valuation
Date, furnish HIAT III with a statement of High Yield'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 High
Yield's investment objective, policies and restrictions. In the event that HIAT
III holds any investments that High Yield is not permitted to hold, HIAT III
will dispose of such securities on or prior to the Valuation Date. In addition,
if it is determined that the portfolios of HIAT III and High Yield, when
aggregated, would contain investments exceeding certain percentage limitations
imposed upon High Yield with respect to such investments, HIAT III if requested
by High Yield will, on or prior to the Valuation Date, dispose 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).
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1.3 (a) HIAT III will endeavor to discharge all of its liabilities and
obligations on or prior to the Valuation Date. High Yield 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 HIAT III prepared by the Treasurer of HIAT III, as of the
Valuation Date in accordance with generally accepted accounting principles
consistently applied from the prior audited period.
(b) On the Valuation Date, HIAT III may establish a cash reserve, which
shall not exceed 5% of HIAT III's net assets as of the close of business on the
Valuation Date ("Cash Reserve") to be retained by HIAT III 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 HIAT III 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, HIAT III 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, HIAT III
will distribute High Yield Shares received by HIAT III pursuant to paragraph
1.1 pro rata to its shareholders of record determined as of the close of
business on the Valuation Date ("HIAT III Shareholders"). Each HIAT III
Shareholder will receive Class D shares of High Yield. Such distribution will
be accomplished by an instruction, signed by the Secretary of HIAT III, to
transfer High Yield Shares then credited to HIAT III's account on the books of
High Yield to open accounts on the books of High Yield in the names of the HIAT
III Shareholders and representing the respective pro rata number of High Yield
Shares due such HIAT III Shareholders. All issued and outstanding shares of
HIAT III simultaneously will be canceled on HIAT III's books; however, share
certificates representing interests in HIAT III will represent a number of High
Yield Shares after the Closing Date as determined in accordance with paragraph
2.3. High Yield will issue certificates representing High Yield Shares in
connection with such exchange only upon the written request of a HIAT III
Shareholder.
1.6 Ownership of High Yield Shares will be shown on the books of High
Yield's transfer agent. High Yield Shares will be issued in the manner
described in High Yield's current Prospectus and Statement of Additional
Information.
1.7 Any transfer taxes payable upon issuance of High Yield Shares in a
name other than the registered holder of High Yield Shares on HIAT III'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 High Yield Shares are to
be issued and transferred.
1.8 Any reporting responsibility of HIAT III is and shall remain the
responsibility of HIAT III up to and including the date on which HIAT III is
dissolved pursuant to paragraph 1.9.
1.9 Within one year after the Closing Date, HIAT III shall pay or make
provision for the payment of all its liabilities and taxes, and distribute to
the shareholders of HIAT III 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 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 HIAT III, 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 HIAT III for federal income tax purposes, or (ii)
be subject to a waiver under
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Section 368(a)(2)(G)(ii) of the complete distribution requirement of Section
368(a)(2)(G)(i) of the Code. HIAT III shall be dissolved under Massachusetts
law, 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 HIAT III in
connection with its obligations under the Investment Company Act of 1940, as
amended (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 High Yield or their designee and High Yield or its designee shall
comply with applicable record retention requirements to which HIAT III is
subject under the 1940 Act.
2. VALUATION
2.1 The value of the HIAT III 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 HIAT III
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 HIAT III's initial registration statement on Form N-2 dated June 17,
1987 which procedures are similar to the valuation procedures in High Yield's
then current Prospectus and Statement of Additional Information.
2.2 The net asset value of a High Yield Share shall be the net asset value
per share computed on the Valuation Date, using the valuation procedures set
forth in High Yield's then current Prospectus and Statement of Additional
Information.
2.3 The number of High Yield Shares (including fractional shares, if any)
to be issued hereunder shall be determined, with respect to each class, by
dividing the aggregate net asset value of HIAT III shares (determined in
accordance with paragraph 2.1) by the net asset value per share of Class D
shares of High Yield (determined in accordance with paragraph 2.2). For
purposes of this paragraph, the aggregate net asset value of the shares of HIAT
III shall not include the amount of the Cash Reserve.
2.4 All computations of value shall be made by Morgan Stanley Services
Company Inc. ("MS Services") in accordance with its regular practice in pricing
High Yield. High Yield shall cause MS 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 on December 16, 2002, or at such other time as the parties may
agree. The Closing shall be held at 1221 Avenue of the Americas, New York, New
York, at the principal offices of HIAT III and High Yield. 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 HIAT III 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 High Yield, for
examination no later than five business days preceding the Valuation Date. Such
portfolio securities (together with any cash or other assets) shall be
delivered by HIAT III to the Custodian for the account of High Yield 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
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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
High Yield Securities Inc."
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 High Yield and HIAT III, accurate
appraisal of the value of the net assets of High Yield or the HIAT III 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, HIAT III shall deliver to High Yield or its designee (a)
at the Closing, a list, certified by its Secretary, of the names, addresses and
taxpayer identification numbers of the HIAT III Shareholders and the number and
percentage ownership of outstanding HIAT III shares owned by each such HIAT III
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 HIAT
III Shareholders' taxpayer identification numbers and their liability for or
exemption from back-up withholding. High Yield shall issue and deliver to such
Secretary a confirmation evidencing delivery of High Yield Shares to be
credited on the Closing Date to HIAT III or provide evidence satisfactory to
HIAT III that such High Yield Shares have been credited to HIAT III's account
on the books of High Yield. 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 HIGH YIELD AND HIAT III
4.1 Except as otherwise expressly provided herein with respect to HIAT
III, High Yield and HIAT III 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 High Yield 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 High Yield Shares
("Registration Statement"). HIAT III will provide High Yield with the Proxy
Materials as described in paragraph 4.3 below, for inclusion in the
Registration Statement. HIAT III will further provide High Yield with such
other information and documents relating to HIAT III as are reasonably
necessary for the preparation of the Registration Statement.
4.3 HIAT III 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. HIAT III will prepare the notice of
meeting, form of proxy and proxy statement (collectively, "Proxy Materials") to
be used in connection with such meeting; provided that High Yield will furnish
HIAT III with its currently effective prospectus for inclusion in the Proxy
Materials and with such other information relating to High Yield as is
reasonably necessary for the preparation of the Proxy Materials.
4.4 HIAT III will assist High Yield in obtaining such information as High
Yield reasonably requests concerning the beneficial ownership of HIAT III
shares.
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4.5 Subject to the provisions of this Agreement, High Yield and HIAT III
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 HIAT III shall furnish or cause to be furnished to High Yield within
30 days after the Closing Date a statement of HIAT III's assets and liabilities
as of the Closing Date, which statement shall be certified by HIAT III'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, HIAT III shall furnish High Yield, in
such form as is reasonably satisfactory to High Yield, a statement certified by
HIAT III's Treasurer of earnings and profits of HIAT III for Federal income tax
purposes that will be carried over to High Yield pursuant to Section 381 of the
Code.
4.7 As soon after the Closing Date as is reasonably practicable, HIAT III
(a) shall prepare and file all Federal and other tax returns and reports of
HIAT III 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 High Yield 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 High Yield represents and warrants to HIAT III as follows:
(a) High Yield is a validly existing Maryland corporation with full power
to carry on its business as presently conducted;
(b) High Yield 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 High Yield 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 High Yield 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
High Yield 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
High Yield 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;
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(e) High Yield is not in, and the execution, delivery and performance of
this Agreement will not result in a, material violation of any provision of
High Yield's Articles of Incorporation or By-Laws or of any agreement,
indenture, instrument, contract, lease or other undertaking to which High
Yield 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 High Yield 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 High Yield 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 August 31, 2002, of High Yield audited by Deloitte & Touche LLP
(copies of which have been furnished to HIAT III), fairly present, in all
material respects, High Yield'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 High
Yield (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 High Yield 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 High Yield's current Statement of Additional Information
incorporated by reference in the Statement of Additional Information to the
Registration Statement. High Yield 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 High Yield, and this
Agreement constitutes a valid and binding obligation of High Yield
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 High
Yield's performance of this Agreement;
(j) High Yield Shares to be issued and delivered to HIAT III, for the
account of the HIAT III 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 High Yield 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 High Yield's current Statement of
Additional Information incorporated by reference in the Statement of
Additional Information to the Registration Statement;
(k) All material Federal and other tax returns and reports of High Yield
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 High Yield'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, High Yield 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 High Yield to continue to meet the
requirements of Subchapter M of the Code;
(m) Since August 31, 2002 there has been no change by High Yield in
accounting methods, principles, or practices, including those required by
generally accepted accounting principles;
(n) The information furnished or to be furnished by High Yield 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 High Yield) 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 HIAT III represents and warrants to High Yield as follows:
(a) HIAT III is a series of a validly existing Massachusetts business
trust with full power to carry on its business as presently conducted;
(b) HIAT III is a duly registered, closed-end, management investment
company, and its registration with the Commission as an investment company
under the 1940 Act is in full force and effect;
(c) All of the issued and outstanding shares of beneficial interest of
HIAT III have been offered and sold in compliance in all material respects
with applicable requirements of the 1933 Act and state securities laws.
Shares of HIAT III 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 HIAT III 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 Registration Statement of HIAT III on Form N-2 conformed in all
material respects to the applicable requirements of the 1933 Act and the
1940 Act and the regulations thereunder and did 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) HIAT III is not, and the execution, delivery and performance of this
Agreement will not result, in a material violation of any provision of HIAT
III's Declaration of Trust or By-Laws or of any agreement, indenture,
instrument, contract, lease or other undertaking to which HIAT III 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 HIAT III 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 HIAT III 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;
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(g) The Statement of Assets and Liabilities, Statement of Operations,
Statement of Changes in Net Assets and Financial Highlights of HIAT III for
the year ended January 31, 2002, audited by Deloitte & Touche LLP (copies
of which have been or will be furnished to High Yield) fairly present, in
all material respects, HIAT III'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 HIAT III
(contingent or otherwise) not disclosed therein that would be required in
accordance with generally accepted accounting principles to be disclosed
therein;
(h) HIAT III 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 HIAT III 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 "The Reorganization --
Description of Shares of High Yield and HIAT III and the Organization of
the Two Funds" in this Proxy Statement and Prospectus. HIAT III 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 High Yield 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 HIAT III, and subject to the approval of HIAT III's
shareholders, this Agreement constitutes a valid and binding obligation of
HIAT III, 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 HIAT III's performance of this Agreement;
(k) All material Federal and other tax returns and reports of HIAT III
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 HIAT
III'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, HIAT III, 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 HIAT III to continue to meet the
requirements of Subchapter M of the Code;
(m) At the Closing Date, HIAT III will have good and valid title to the
HIAT III Assets, subject to no liens (other than the obligation, if any, to
pay the purchase price of portfolio securities purchased by HIAT III which
have not settled prior to the Closing Date), security interests or other
encumbrances, and full right, power and authority to assign, deliver and
otherwise transfer such assets hereunder, and upon delivery and payment for
such assets, High Yield 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 HIAT III's shareholders and on the Closing Date, the Proxy
Materials (exclusive of the currently effective High Yield Prospectus
contained therein) will (i) comply in all material respects with the
provisions of the 1933 Act,
A-8
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 HIAT III 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) HIAT III 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) HIAT III 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) HIAT III is not acquiring High Yield 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 HIAT III
The obligations of HIAT III to consummate the transactions provided for
herein shall be subject, at its election, to the performance by High Yield 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 High Yield 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 High Yield shall have delivered to HIAT III, a certificate of its
President and Treasurer, in a form reasonably satisfactory to HIAT III and
dated as of the Closing Date, to the effect that the representations and
warranties of High Yield 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 HIAT III shall
reasonably request;
6.3 HIAT III shall have received a favorable opinion from Mayer, Brown,
Rowe & Maw, counsel to High Yield, dated as of the Closing Date, to the effect
that:
(a) High Yield is a validly existing Maryland corporation, and has the
power to own all of its properties and assets and to carry on its business
as presently conducted (Maryland counsel may be relied upon in delivering
such opinion); (b) High Yield is a duly registered, open-end, 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 High Yield
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 HIAT III, is a
valid and binding obligation of High Yield enforceable against High Yield
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) High Yield
Shares to be
A-9
issued to HIAT III 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 High Yield's Statement of Additional Information), and
no shareholder of High Yield has any preemptive rights to subscription or
purchase in respect thereof (Maryland 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 High Yield's Articles of Incorporation or By-Laws (Maryland
counsel may be relied upon in delivering such opinion); 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 High Yield 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 from those described in High Yield's Prospectus
dated September 30, 2002 and Statement of Additional Information dated
September 30, 2002.
7. CONDITIONS PRECEDENT TO OBLIGATIONS OF HIGH YIELD
The obligations of High Yield to complete the transactions provided for
herein shall be subject, at its election, to the performance by HIAT III 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 HIAT III 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 HIAT III shall have delivered to High Yield at the Closing a
certificate of its President and its Treasurer, in form and substance
satisfactory to High Yield and dated as of the Closing Date, to the effect that
the representations and warranties of HIAT III 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 High Yield shall reasonably request;
7.3 HIAT III shall have delivered to High Yield a statement of the HIAT
III Assets and its liabilities, together with a list of HIAT III'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 HIAT III;
7.4 HIAT III shall have delivered to High Yield within three business days
after the Closing (a) a letter from PricewaterhouseCoopers LLP with respect to
the taxable year ended January 31, 2000, and a letter from Deloitte & Touche
for the taxable years ended January 31, 2001 and 2002, each dated as of the
Closing Date stating that such respective firm has performed a limited review
of the Federal and state income tax returns of HIAT III 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 HIAT III for the periods covered thereby; (b) a letter from Deloitte &
Touche LLP dated as of the date of the Closing Date stating that for the period
from January 31, 2002 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,
A-10
state and local tax liabilities for the period from January 31, 2002 to and
including the Closing Date. Each respective letter shall contain a statement
that based on such limited reviews, nothing came to their respective attention
that caused them to believe that HIAT III would not qualify as a regulated
investment company for Federal income tax purposes for any such year or period;
7.5 High Yield shall have received at the Closing a favorable opinion from
Mayer, Brown, Rowe & Maw, counsel to HIAT III, dated as of the Closing Date to
the effect that:
(a) HIAT III 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) HIAT III is a duly registered, closed-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 HIAT III 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 High Yield, is a valid and binding obligation
of HIAT III enforceable against HIAT III 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 HIAT III's Declaration of Trust or By-Laws (Massachusetts
counsel may be relied upon in delivering such opinion); 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 HIAT III 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 High Yield shall receive from the Investment Manager an agreement to
indemnify High Yield against any losses, claims and expenses associated with
the litigation that has been initiated against HIAT III in a form reasonably
satisfactory to High Yield.
7.7 On the Closing Date, the HIAT III Assets shall include no assets that
High Yield, by reason of limitations of the fund's Articles of Incorporation or
otherwise, may not properly acquire.
8. FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF HIGH YIELD AND HIAT III
The obligations of HIAT III and High Yield 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
HIAT III in accordance with the provisions of HIAT III's Declaration of Trust,
and certified copies of the resolutions evidencing such approval shall have
been delivered to High Yield;
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;
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 High Yield or HIAT III to permit consummation,
in all material respects, of the transactions
A-11
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 High Yield or HIAT III;
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 HIAT III 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 HIAT
III Shareholders all of HIAT III'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 High Yield and HIAT III, which opinion may be
relied upon by the shareholders of HIAT III, substantially to the effect that,
for Federal income tax purposes:
(a) The transfer of HIAT III's assets in exchange for High Yield Shares
and the assumption by High Yield of certain stated liabilities of HIAT III
followed by the distribution by HIAT III of High Yield Shares to the HIAT
III Shareholders in exchange for their HIAT III 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 HIAT III and High Yield 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 High Yield upon the receipt of
the assets of HIAT III solely in exchange for High Yield Shares and the
assumption by High Yield of the stated liabilities of HIAT III;
(c) No gain or loss will be recognized by HIAT III upon the transfer of
the assets of HIAT III to High Yield in exchange for High Yield Shares and
the assumption by High Yield of the stated liabilities or upon the
distribution of High Yield Shares to the HIAT III Shareholders in exchange
for their HIAT III shares;
(d) No gain or loss will be recognized by the HIAT III Shareholders upon
the exchange of the HIAT III shares for High Yield Shares;
(e) The aggregate tax basis for High Yield Shares received by each HIAT
III Shareholder pursuant to the reorganization will be the same as the
aggregate tax basis of the HIAT III Shares held by each such HIAT III
Shareholder immediately prior to the Reorganization;
(f) The holding period of High Yield Shares to be received by each HIAT
III Shareholder will include the period during which the HIAT III Shares
surrendered in exchange therefor were held (provided such HIAT III Shares
were held as capital assets on the date of the Reorganization);
(g) The tax basis of the assets of HIAT III acquired by High Yield will
be the same as the tax basis of such assets to HIAT III immediately prior
to the Reorganization; and
(h) The holding period of the assets of HIAT III in the hands of High
Yield will include the period during which those assets were held by HIAT
III.
Notwithstanding anything herein to the contrary, neither High Yield nor
HIAT III may waive the conditions set forth in this paragraph 8.6.
A-12
9. FEES AND EXPENSES
9.1 (a) High Yield 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. HIAT III
shall bear, as set forth in the Proxy Statement and Prospectus contained in the
Registration Statement, 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 incurred in
connection with the consummation of the transactions contemplated herein. HIAT
III shall bear any other expenses in connection with the provisions of this
Agreement including certain other legal and accounting fees 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 HIAT III being either unwilling or unable to go forward (other
than by reason of the nonfulfillment or failure of any condition to HIAT III's
obligations specified in this Agreement), HIAT III's only obligation hereunder
shall be to reimburse High Yield for all reasonable out-of-pocket fees and
expenses incurred by High Yield in connection with those transactions.
(c) In the event the transactions contemplated herein are not consummated
by reason of High Yield being either unwilling or unable to go forward (other
than by reason of the nonfulfillment or failure of any condition to High
Yield's obligations specified in this Agreement), High Yield's only obligation
hereunder shall be to reimburse HIAT III for all reasonable out-of-pocket fees
and expenses incurred by HIAT III 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 HIAT III
hereunder shall not survive the dissolution and complete liquidation of HIAT
III 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 HIAT III and High Yield;
(b) by either High Yield or HIAT III 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 March 31, 2003; or
(c) by either High Yield or HIAT III in writing without liability to the
terminating party on account of such termination (provided the terminating
party is not otherwise in material default 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 HIAT
III 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.
A-13
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 High Yield or HIAT III, or the trustees
or officers of High Yield or HIAT III, 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 High Yield or HIAT III, or the trustees or
officers of High Yield or HIAT III, 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 State of Maryland.
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 High Yield hereunder are solely
those of High Yield. It is expressly agreed that no shareholder, nominee,
trustee, officer, agent, or employee of High Yield shall be personally liable
hereunder. The execution and delivery of this Agreement have been authorized by
the trustees of High Yield and signed by authorized officers of High Yield
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 HIAT III hereunder are solely
those of HIAT III. It is expressly agreed that no shareholder, nominee,
trustee, officer, agent, or employee of HIAT III shall be personally liable
hereunder. The execution and delivery of this Agreement have been authorized by
the trustees of HIAT III and signed by authorized officers of HIAT III 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.
A-14
IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement
to be executed by a duly authorized officer.
MORGAN STANLEY HIGH INCOME
ADVANTAGE TRUST III
By: ----------------------------
Name: Charles A. Fiumefreddo
Title: Chairman
MORGAN STANLEY
HIGH YIELD SECURITIES INC.
By: ----------------------------
Name: Barry Fink
Title: Vice President
A-15
EXHIBIT B
[MORGAN STANLEY LOGO]
Morgan Stanley High Yield Securities
A mutual fund whose primary investment
objective is to earn a high level of
current income. As a secondary objective, [COVER PHOTO]
the Fund seeks capital appreciation but
only to the extent consistent with its
primary objective.
Prospectus | September 30, 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 OBJECTIVES............................ 1
PRINCIPAL INVESTMENT STRATEGIES.................. 1
PRINCIPAL RISKS.................................. 2
PAST PERFORMANCE................................. 3
FEES AND EXPENSES................................ 5
ADDITIONAL INVESTMENT STRATEGY INFORMATION....... 6
ADDITIONAL RISK INFORMATION...................... 7
FUND MANAGEMENT.................................. 8
Shareholder Information PRICING FUND SHARES.............................. 9
HOW TO BUY SHARES................................ 9
HOW TO EXCHANGE SHARES........................... 11
HOW TO SELL SHARES............................... 12
DISTRIBUTIONS.................................... 14
TAX CONSEQUENCES................................. 14
SHARE CLASS ARRANGEMENTS......................... 15
Financial Highlights ................................................. 22
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
[ICON] INVESTMENT OBJECTIVES
- --------------------------------------------------------------------------------
Morgan Stanley High Yield Securities Inc. seeks as a primary investment
objective to earn a high level of current income. As a secondary objective, the
Fund seeks capital appreciation but only to the extent consistent with its
primary objective.
[ICON] PRINCIPAL INVESTMENT STRATEGIES
- --------------------------------------------------------------------------------
[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 80% of its assets in fixed-income
securities (including zero coupon securities) rated below Baa by Moody's
Investors Service ("Moody's") or below BBB by Standard & Poor's Corporation
("S&P") or in non-rated securities considered by the Fund's Investment Manager
to be appropriate investments for the Fund. Such securities may also include
"Rule 144A" securities, which are subject to resale restrictions. Shareholders
of the Fund will receive at least 60 days prior notice of any changes in this
policy. Securities rated below Baa or BBB are commonly known as "junk bonds."
There are no minimum quality ratings for investments, and as such the Fund may
invest in securities which no longer make payments of interest or principal.
In deciding which securities to buy, hold or sell, the Investment Manager
considers an issuer's creditworthiness, economic developments, interest rate
trends and other factors it deems relevant. In evaluating an issuer's
creditworthiness, the Investment Manager relies principally on its own analysis.
A security's credit rating is simply one factor that may be considered by the
Investment Manager in this regard.
Fixed-income securities are debt securities such as 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 and payment-in-kind bonds. Zero coupon securities are
purchased at a discount and either (i) pay no interest, or (ii) accrue interest,
but make no payments until maturity; payment-in-kind bonds are purchased at the
face amount of the bond and accrue additional principal but make no payments
until maturity.
The remaining 20% of the Fund's assets may be invested in securities rated Baa
or BBB or higher (or, if not rated, determined to be of comparable quality when
the Investment Manager believes that such securities may produce attractive
yields.) The Fund may also invest in common stocks, asset-backed securities,
convertible securities, warrants and foreign securities.
In pursuing the Fund's investment objectives, 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.
1
[ICON] PRINCIPAL RISKS
- --------------------------------------------------------------------------------
There is no assurance that the Fund will achieve its investment objectives. 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. Principal risks of investing in the Fund are associated
with its junk bond investments. All fixed-income securities, such as junk 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/or 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.) As merely illustrative of the relationship between fixed-income
securities and interest rates, the following table shows how interest rates
affect bond prices.
Price per $100 of a Bond if Interest Rates:
----------------------------------------------
How Interest Rates Affect Bond Prices Increase Decrease
- ------------------------------------------------------------------------------------------
Bond Maturity Yield 1% 2% 1% 2%
- ------------------------------------------------------------------------------------------
1 year 2.04% $99 $98 $101 $102
- ------------------------------------------------------------------------------------------
5 years 4.30% $96 $92 $105 $109
- ------------------------------------------------------------------------------------------
10 years 5.05% $93 $86 $108 $117
- ------------------------------------------------------------------------------------------
30 years 5.65% $87 $77 $115 $135
- ------------------------------------------------------------------------------------------
Yields on Treasury securities are as of December 31, 2001. The table is not
representative of price changes for junk bonds. In addition, the table is an
illustration and does not represent expected yields or share price changes of
any Morgan Stanley mutual fund.
Junk Bonds. Junk bonds are subject to greater risk of loss of income and
principal than higher rated securities. 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. The Rule 144A securities could have
the effect of increasing the level of Fund illiquidity to the extent the 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 Directors 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. In addition, periods of economic uncertainty and change probably
would result in an increased volatility of market prices of high yield
securities and a corresponding volatility in the Fund's net asset value. In
addition to junk bonds, the Fund may also invest in certain investment grade
fixed-income securities. Some of these securities have speculative
characteristics.
2
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
subject to other risks from its permissible investments including the risks
associated with its investments in common stocks, asset-backed securities,
warrants and foreign securities. 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.
[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.
[Sidebar]
ANNUAL TOTAL RETURNS
This chart shows how the performance of the Fund's Class D shares has varied
from year to year over the past 10 calendar years.
[End Sidebar]
ANNUAL TOTAL RETURNS -- Calendar Years
1992 24.22%
'93 31.59%
'94 -7.15%
'95 17.13%
'96 13.27%
'97 12.90%
'98 -2.63%
'99 2.77%
2000 -30.61%
'01 -26.91%
The bar chart reflects the performance of Class D shares; the performance of the
other Classes will differ because the Classes have different ongoing fees. The
performance information in the bar chart does not reflect the deduction of sales
charges; if these amounts were reflected, returns would be less than shown.
Year-to-date total return as of June 30, 2002 was -5.14%.
During the periods shown in the bar chart, the highest return for a calendar
quarter was 17.06% (quarter ended March 31, 1992) and the lowest return for a
calendar quarter was -19.49% (quarter ended December 31, 2000).
3
[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. The Fund's returns include the
maximum applicable sales charge for each Class and assume you sold your shares
at the end of each period (unless otherwise noted).
[End Sidebar]
AVERAGE ANNUAL TOTAL RETURNS (as of December 31, 2001)
- ---------------------------------------------------------------------------------------
Past 1 Year Past 5 Years Past 10 Years
- ---------------------------------------------------------------------------------------
Class A - Returns Before Taxes(1) -30.22% -11.52% 0.76%
- ---------------------------------------------------------------------------------------
Class A - Returns After Taxes on
Distributions(1,4) -34.65% -16.03% -4.05%
- ---------------------------------------------------------------------------------------
Class A - Returns After Taxes on
Distributions and Sale of Fund
Shares(1) -17.91% -9.64% -0.64%
- ---------------------------------------------------------------------------------------
Class B(2) -30.65% -- --
- ---------------------------------------------------------------------------------------
Class C(2) -28.51% -- --
- ---------------------------------------------------------------------------------------
Class D - Returns Before Taxes(3) -26.91% -10.54% 1.44%
- ---------------------------------------------------------------------------------------
Class D - Returns After Taxes on
Distributions(3,4) -31.63% -15.18% -3.49%
- ---------------------------------------------------------------------------------------
Class D - Returns After Taxes on
Distributions and Sale of Fund
Shares(3) -15.88% -8.99% -0.16%
- ---------------------------------------------------------------------------------------
Lehman Brothers U.S. Corporate
High Yield Index(5) 5.28% 3.11% 7.58%
- ---------------------------------------------------------------------------------------
(1) Prior to July 28, 1997 the Fund offered only one class of shares. Because
the distribution arrangement for Class A most closely resembled the
distribution arrangement applicable prior to the implementation of multiple
classes (i.e., Class A is sold with a front-end sales charge), historical
performance information has been restated to reflect the actual maximum
sales charge applicable to Class A (i.e., 4.25%) as compared to the 5.50%
sales charge in effect prior to July 28, 1997. In addition, Class A shares
are now subject to an ongoing 12b-1 fee which is reflected in the restated
performance for that class.
(2) Classes B and C commenced operations on July 28, 1997.
(3) Because all shares of the Fund held prior to July 28, 1997 were designated
Class D shares, the Fund's historical performance has been restated to
reflect the absence of any sales charge.
(4) 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.
(5) The Lehman Brothers U.S. Corporate High Yield Index tracks the performance
of all below investment-grade securities which have at least $100 million
in outstanding issuance, a maturity greater than one year, and are issued
in fixed-rate U.S. dollar denominations. 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's Class A and Class D
Shares. The after tax returns for the Fund's other Classes will vary from the
Class A and Class D shares' returns. 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, and after tax returns are not relevant to investors who hold their
Fund shares through tax-deferred arrangements, such as 401(k) plans or
individual retirement accounts. After tax returns may be higher than before tax
returns due to an assumed benefit from capital losses that would have been
realized had Fund shares been sold at the end of the relevant periods.
4
[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 offers four Classes of shares:
Classes A, B, C and D. Each Class has a different combination of fees, expenses
and other features, which should be considered in selecting a Class of shares.
The Fund does not charge account or exchange fees. See the "Share Class
Arrangements" section for further fee and expense information.
[Sidebar]
SHAREHOLDER FEES
These fees are paid directly from your investment.
ANNUAL FUND OPERATING EXPENSES
These expenses are deducted from the Fund's assets and are based on expenses
paid for the fiscal year ended August 31, 2002.
[End Sidebar]
Class A Class B Class C Class D
- ---------------------------------------------------------------------------------------------------
SHAREHOLDER FEES
- ---------------------------------------------------------------------------------------------------
Maximum sales charge (load) imposed on purchases (as a
percentage of offering price) 4.25%(1) None None None
- ---------------------------------------------------------------------------------------------------
Maximum deferred sales charge (load)
(as a percentage based on the lesser of the offering price
or net asset value at redemption) None(2) 5.00%(3) 1.00%(4) None
- ---------------------------------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES
- ---------------------------------------------------------------------------------------------------
Management fee 0.48% 0.48% 0.48% 0.48%
- ---------------------------------------------------------------------------------------------------
Distribution and service (12b-1) fees 0.18% 0.75% 0.85% None
- ---------------------------------------------------------------------------------------------------
Other expenses 0.33% 0.33% 0.33% 0.33%
- ---------------------------------------------------------------------------------------------------
Total annual Fund operating expenses 0.99% 1.56% 1.66% 0.81%
- ---------------------------------------------------------------------------------------------------
(1) Reduced for purchases of $25,000 and over.
(2) Investments that are not subject to any sales charge at the time of
purchase are subject to a contingent deferred sales charge ("CDSC") of
1.00% that will be imposed if you sell your shares within one year after
purchase, except for certain specific circumstances.
(3) The CDSC is scaled down to 1.00% during the sixth year, reaching zero
thereafter. See "Share Class Arrangements" for a complete discussion of the
CDSC.
(4) Only applicable if you sell your shares within one year after purchase.
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 depending upon whether or not
you sell your shares at the end of each period.
If You SOLD Your Shares: If You HELD Your Shares:
- ----------------------------------------------------- ----------------------------------
1 Year 3 Years 5 Years 10 Years 1 Year 3 Years 5 Years 10 Years
- ----------------------------------------------------- ----------------------------------
Class A $522 $727 $ 949 $1,586 $522 $727 $949 $1,586
- ----------------------------------------------------- ----------------------------------
Class B $659 $793 $1,050 $1,856 $159 $493 $850 $1,856
- ----------------------------------------------------- ----------------------------------
Class C $269 $523 $ 902 $1,965 $169 $523 $902 $1,965
- ----------------------------------------------------- ----------------------------------
Class D $ 83 $259 $ 450 $1,002 $ 83 $259 $450 $1,002
- ----------------------------------------------------- ----------------------------------
5
While Class B and Class C shares do not have any front-end sales charges, their
higher ongoing annual expenses (due to higher 12b-1 fees) mean that over time
you could end up paying more for these shares than if you were to pay front-end
sales charges for Class A shares.
[ICON] ADDITIONAL INVESTMENT STRATEGY INFORMATION
- --------------------------------------------------------------------------------
This section provides additional information relating to the Fund's principal
investment strategies.
Common Stocks. The Fund may invest up to 20% of its assets in common stocks.
Asset-Backed Securities. Asset-backed securities represent an interest in a pool
of assets such as automobile loans and credit card receivables or home equity
loans that have been securitized in pass through structures similar to
mortgage-backed securities. These types of 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 receivables.
Foreign Securities. The Fund may invest up to 20% of its assets in fixed-income
securities issued by foreign governments and other foreign issuers (including
American depositary receipts or other similar securities convertible into
securities of foreign issuers) but not more than 10% of its total assets in
these securities may be denominated in foreign currencies.
Warrants. The Fund may acquire warrants which may or may not be attached to
common stock. Warrants are options to purchase equity securities at a specific
price for a specific period of time.
Unit Offerings/Convertible Securities. The Fund may purchase units which combine
debt securities with equity securities and/or warrants. The Fund may invest in
convertible securities which are securities that generally pay interest and may
be converted into common stock.
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 Investment Manager 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 objectives.
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 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.
6
[ICON] ADDITIONAL RISK INFORMATION
- --------------------------------------------------------------------------------
This section provides additional information relating to the principal risks of
investing in the Fund.
Common Stocks. In general, stock values fluctuate in response to activities
specific to the company as well as general market, economic and political
conditions. These prices can fluctuate widely.
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 card 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.
Foreign Securities. The Fund's investments in foreign securities involve risks
that are in addition to the risks associated with domestic securities. One
additional risk is currency risk. In particular, the price of securities could
be adversely affected by changes in the exchange rate between U.S. dollars and a
foreign market's local currency.
Foreign securities also have risks related to economic and political
developments abroad, including 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 settlements of the Fund's trades effected in those
markets.
Depositary receipts involve substantially identical risks to those associated
with direct investment in foreign securities. In addition, the underlying
issuers of certain depositary receipts, particularly unsponsored or unregistered
depositary receipts, are under no obligation to distribute shareholder
communications to the holders of such receipts, or to pass through to them any
voting rights with respect to the deposited securities.
Unit Offerings/Convertible Securities. Any Fund investments in unit offerings
and/or convertible securities may carry risks associated with both fixed-income
and equity securities.
7
[ICON] FUND MANAGEMENT
- --------------------------------------------------------------------------------
[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 $125 billion in assets under
management as of August 31, 2002.
[End Sidebar]
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's portfolio is managed by the Taxable Fixed-Income team. Current
members of the team include Stephen F. Esser, a Managing Director of the
Investment Manager, Gordon W. Loery, an Executive Director of the Investment
Manager, and Deanna L. Loughnane, an Executive Director 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 August 31, 2002 the Fund
accrued total compensation to the Investment Manager amounting to 0.48% of the
Fund's average daily net assets.
8
Shareholder Information
[ICON] PRICING FUND SHARES
- --------------------------------------------------------------------------------
The price of Fund shares (excluding sales charges), called "net asset value," is
based on the value of the Fund's portfolio securities. While the assets of each
Class are invested in a single portfolio of securities, the net asset value of
each Class will differ because the Classes have different ongoing distribution
fees.
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 Directors. 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
- --------------------------------------------------------------------------------
[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]
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.
Because every investor has different immediate financial needs and long-term
investment goals, the Fund offers investors four Classes of shares: Classes A,
B, C and D. Class D shares are only offered to a limited group of investors.
Each Class of shares offers a distinct structure of sales charges, distribution
and service fees, and other features that are designed to address a variety of
needs. Your Financial Advisor or other authorized financial representative can
help you decide which Class may be most appropriate for you. When purchasing
Fund shares, you must specify which Class of shares you wish to purchase.
9
When you buy Fund shares, the shares are purchased at the next share price
calculated (less any applicable front-end sales charge for Class A shares) 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.
[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.
Investment Options for Certain Institutional and Other Investors/Class D
Shares. To be eligible to purchase Class D shares, you must qualify under one of
the investor categories specified in the "Share Class Arrangements" section of
this PROSPECTUS.
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, the Class of shares you wish to purchase and the investment amount
(which would include any applicable front-end sales charge). The letter
must be signed by the account owner(s).
o Make out a check for the total amount payable to: Morgan Stanley High Yield
Securities Inc.
o Mail the letter and check to Morgan Stanley Trust at P.O. Box 1040, Jersey
City, NJ 07303.
10
[ICON] HOW TO EXCHANGE SHARES
- --------------------------------------------------------------------------------
Permissible Fund Exchanges. You may exchange shares of any Class of the Fund for
the same Class of any other continuously offered Multi-Class Fund, or for shares
of a No-Load Fund, a Money Market Fund, North American Government Income Trust
or Limited Duration U.S. Treasury Trust, without the imposition of an exchange
fee. In addition, Class A shares of the Fund may be exchanged for shares of an
FSC Fund (funds subject to a front-end sales charge). 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 an 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.
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.
11
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.
CDSC Calculations on Exchanges. See the "Share Class Arrangements" section of
this PROSPECTUS for a further discussion of how applicable contingent deferred
sales charges (CDSCs) are calculated for shares of one Morgan Stanley Fund that
are exchanged for shares of another.
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. If you sell Class A,
Class B or Class C shares, your net sale proceeds are reduced by the amount of
any applicable CDSC. 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] o your account number;
o the name of the Fund;
o the dollar amount or the number of shares you wish to
sell;
o the Class of shares you wish to sell; and
o the signature of each owner as it appears on the account.
- --------------------------------------------------------------------------------
12
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 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
[ICON] 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.
------------------------------------------------------------
Amounts withdrawn are subject to any applicable CDSC. A CDSC
may be waived under certain circumstances. See the Class B
waiver categories listed in the "Share Class Arrangements"
section of this PROSPECTUS.
------------------------------------------------------------
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.
Reinstatement Privilege. If you sell Fund shares and have not previously
exercised the reinstatement privilege, you may, within 35 days after the date of
sale, invest any portion of the proceeds in the same Class of Fund shares at
their net asset value and receive a pro rata credit for any CDSC paid in
connection with the 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.
13
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. No CDSC will be imposed on any involuntary sale.
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
- --------------------------------------------------------------------------------
[Sidebar]
TARGETED DIVIDENDS(SM)
You may select to have your Fund distributions automatically invested in other
Classes of Fund shares or Classes of another Morgan Stanley Fund that you own.
Contact your Morgan Stanley Financial Advisor for further information about this
service.
[End Sidebar]
The Fund passes substantially all of its earnings from income and capital gains
along to its investors as "distributions." The Fund earns income from stocks and
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."
The Fund declares income dividends separately for each Class. Distributions paid
on Class A and Class D shares usually will be higher than for Class B and Class
C because distribution fees that Class B and Class C pay are higher. 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 same
Class 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:
o The Fund makes distributions; and
o You sell Fund shares, including an exchange to another Morgan Stanley Fund.
14
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.
[ICON] SHARE CLASS ARRANGEMENTS
- --------------------------------------------------------------------------------
The Fund offers several Classes of shares having different distribution
arrangements designed to provide you with different purchase options according
to your investment needs. Your Morgan Stanley Financial Advisor or other
authorized financial representative can help you decide which Class may be
appropriate for you.
The general public is offered three Classes: Class A shares, Class B shares and
Class C shares, which differ principally in terms of sales charges and ongoing
expenses. A fourth Class, Class D shares, is offered only to a limited category
of investors. Shares that you acquire through reinvested distributions will not
be subject to any front-end sales charge or CDSC -- contingent deferred sales
charge.
Sales personnel may receive different compensation for selling each Class of
shares. The sales charges applicable to each Class provide for the distribution
financing of shares of that Class.
The chart below compares the sales charge and annual 12b-1 fee applicable to
each Class:
MAXIMUM
CLASS SALES CHARGE ANNUAL 12B-1 FEE
- ---------------------------------------------------------------------------------------------
A Maximum 4.25% initial sales charge reduced for purchase of
$25,000 or more; shares sold without an initial sales charge
are generally subject to a 1.0% CDSC during the first year 0.25%
- ---------------------------------------------------------------------------------------------
B Maximum 5.0% CDSC during the first year decreasing to 0%
after six years 0.75%
- ---------------------------------------------------------------------------------------------
C 1.0% CDSC during the first year 0.85%
- ---------------------------------------------------------------------------------------------
D None None
- ---------------------------------------------------------------------------------------------
15
CLASS A SHARES Class A shares are sold at net asset value plus an initial sales
charge of up to 4.25%. The initial sales charge is reduced for purchases of
$25,000 or more according to the schedule below. Investments of $1 million or
more are not subject to an initial sales charge, but are generally subject to a
contingent deferred sales charge, or CDSC, of 1.0% on sales made within one year
after the last day of the month of purchase. The CDSC will be assessed in the
same manner and with the same CDSC waivers as with Class B shares. Class A
shares are also subject to a distribution (12b-1) fee of up to 0.25% of the
average daily net assets of the Class. This fee is lower than the distribution
fee paid by Class B or Class C shares.
The Fund will not accept a purchase order for Class A shares that qualifies for
investment in Class D shares.
The offering price of Class A shares includes a sales charge (expressed as a
percentage of the offering price) on a single transaction as shown in the
following table:
[Sidebar]
FRONT-END SALES CHARGE OR FSC
An initial sales charge you pay when purchasing Class A shares that is based on
a percentage of the offering price. The percentage declines based upon the
dollar value of Class A shares you purchase. We offer three ways to reduce your
Class A sales charges -- the Combined Purchase Privilege, Right of Accumulation
and Letter of Intent.
[End Sidebar]
FRONT-END SALES CHARGE
---------------------------------------------
AMOUNT OF PERCENTAGE OF APPROXIMATE PERCENTAGE
SINGLE TRANSACTION PUBLIC OFFERING PRICE OF NET AMOUNT INVESTED
- ---------------------------------------------------------------------------------------
Less than $25,000 4.25% 4.44%
- ---------------------------------------------------------------------------------------
$25,000 but less than $50,000 4.00% 4.17%
- ---------------------------------------------------------------------------------------
$50,000 but less than $100,000 3.50% 3.63%
- ---------------------------------------------------------------------------------------
$100,000 but less than $250,000 2.75% 2.83%
- ---------------------------------------------------------------------------------------
$250,000 but less than $500,000 2.25% 2.30%
- ---------------------------------------------------------------------------------------
$500,000 but less than $1 million 1.75% 1.78%
- ---------------------------------------------------------------------------------------
$1 million and over 0.00% 0.00%
- ---------------------------------------------------------------------------------------
The reduced sales charge schedule is applicable to purchases of Class A shares
in a single transaction by:
o A single account (including an individual, trust or fiduciary account).
o Family member accounts (limited to husband, wife and children under the age
of 21).
o Pension, profit sharing or other employee benefit plans of companies and
their affiliates.
o Tax-exempt organizations.
o Groups organized for a purpose other than to buy mutual fund shares.
Combined Purchase Privilege. You also will have the benefit of reduced sales
charges by combining purchases of Class A shares of the Fund in a single
transaction with purchases of Class A shares of other Multi-Class Funds and
shares of FSC Funds.
Right of Accumulation. You also may benefit from a reduction of sales charges if
the cumulative net asset value of Class A shares of the Fund purchased in a
single transaction, together with shares of other funds you currently own which
were previously purchased at a price including a front-end sales charge (or
Class A shares purchased at
16
$1 million or more), and shares acquired through reinvestment of distributions,
amounts to $25,000 or more. Also, if you have a cumulative net asset value of
all your Class A and Class D shares equal to at least $5 million (or
$25 million for certain employee benefit plans), you are eligible to purchase
Class D shares of any fund subject to the fund's minimum initial investment
requirement.
You must notify your Morgan Stanley Financial Advisor or other authorized
financial representative (or Morgan Stanley Trust if you purchase directly
through the Fund), at the time a purchase order is placed, that the purchase
qualifies for the reduced sales charge under the Right of Accumulation. Similar
notification must be made in writing when an order is placed by mail. The
reduced sales charge will not be granted if: (i) notification is not furnished
at the time of the order; or (ii) a review of the records of Morgan Stanley DW
Inc. ("Morgan Stanley DW") or other authorized dealer of Fund shares or the
Fund's transfer agent does not confirm your represented holdings.
Letter of Intent. The schedule of reduced sales charges for larger purchases
also will be available to you if you enter into a written "Letter of Intent." A
Letter of Intent provides for the purchase of Class A shares of the Fund or
other Multi-Class Funds or shares of FSC Funds within a thirteen-month period.
The initial purchase under a Letter of Intent must be at least 5% of the stated
investment goal. To determine the applicable sales charge reduction, you may
also include: (1) the cost of shares of other Morgan Stanley Funds which were
previously purchased at a price including a front-end sales charge during the
90-day period prior to the distributor receiving the Letter of Intent, and
(2) the cost of shares of other funds you currently own acquired in exchange for
shares of funds purchased during that period at a price including a front-end
sales charge. You can obtain a Letter of Intent by contacting your Morgan
Stanley Financial Advisor or other authorized financial representative, or by
calling (800) 869-NEWS. If you do not achieve the stated investment goal within
the thirteen-month period, you are required to pay the difference between the
sales charges otherwise applicable and sales charges actually paid, which may be
deducted from your investment.
Other Sales Charge Waivers. In addition to investments of $1 million or more,
your purchase of Class A shares is not subject to a front-end sales charge (or a
CDSC upon sale) if your account qualifies under one of the following categories:
o A trust for which Morgan Stanley Trust provides discretionary trustee
services.
o Persons participating in a fee-based investment program (subject to all of
its terms and conditions, including termination fees, and mandatory sale or
transfer restrictions on termination) approved by the Fund's distributor
pursuant to which they pay an asset-based fee for investment advisory,
administrative and/or brokerage services.
o Qualified state tuition plans described in Section 529 of the Internal
Revenue Code and donor-advised charitable gift funds (subject to all
applicable terms and conditions) and certain other investment programs that
do not charge an asset-based fee and have been approved by the Fund's
distributor.
o Employer-sponsored employee benefit plans, whether or not qualified under
the Internal Revenue Code, for which (i) Morgan Stanley Trust serves as
trustee. (ii) Morgan Stanley's Retirement Plan Services serves as
recordkeeper under a written Recordkeeping Services Agreement or (iii) an
entity independent from Morgan Stanley serves as recordkeeper under an
alliance or similar agreement with Morgan Stanley's Retirement Plan
Services (together, "Morgan Stanley Eligible Plans"), provided that, in the
case of (i) and (ii) above, any such plan has at least 200 eligible
employees.
17
o A Morgan Stanley Eligible Plan whose Class B shares have converted to Class
A shares, regardless of the plan's asset size or number of eligible
employees.
o Insurance company separate accounts that have been approved by the Fund's
distributor.
o A client of a Morgan Stanley Financial Advisor who joined us from another
investment firm within six months prior to the date of purchase of Fund
shares, and who used the proceeds from the sale of shares of a proprietary
mutual fund of that Financial Advisor's previous firm that imposed either a
front-end or deferred sales charge to purchase Class A shares, provided
that: (1) the client sold the shares not more than 60 days prior to the
purchase of Fund shares, and (2) the sale proceeds were maintained in the
interim in cash or a Money Market Fund.
o Current or retired Directors or Trustees of the Morgan Stanley Funds, such
persons' spouses and children under the age of 21, and trust accounts for
which any of such persons is a beneficiary.
o Current or retired directors, officers and employees of Morgan Stanley and
any of its subsidiaries, such persons' spouses and children under the age
of 21, and trust accounts for which any such persons is a beneficiary.
CLASS B SHARES Class B shares are offered at net asset value with no initial
sales charge but are subject to a contingent deferred sales charge, or CDSC, as
set forth in the table below. For the purpose of calculating the CDSC, shares
are deemed to have been purchased on the last day of the month during which they
were purchased.
[Sidebar]
CONTINGENT DEFERRED SALES CHARGE OR CDSC
A fee you pay when you sell shares of certain Morgan Stanley Funds purchased
without an initial sales charge. This fee declines the longer you hold your
shares as set forth in the table.
[End Sidebar]
CDSC AS A PERCENTAGE
YEAR SINCE PURCHASE PAYMENT MADE OF AMOUNT REDEEMED
- --------------------------------------------------------------------------------
First 5.0%
- --------------------------------------------------------------------------------
Second 4.0%
- --------------------------------------------------------------------------------
Third 3.0%
- --------------------------------------------------------------------------------
Fourth 2.0%
- --------------------------------------------------------------------------------
Fifth 2.0%
- --------------------------------------------------------------------------------
Sixth 1.0%
- --------------------------------------------------------------------------------
Seventh and thereafter None
- --------------------------------------------------------------------------------
Each time you place an order to sell or exchange shares, shares with no CDSC
will be sold or exchanged first, then shares with the lowest CDSC will be sold
or exchanged next. For any shares subject to a CDSC, the CDSC will be assessed
on an amount equal to the lesser of the current market value or the cost of the
shares being sold.
The Fund will generally not accept a purchase order for Class B shares in the
amount of $100,000 or more.
CDSC Waivers. A CDSC, if otherwise applicable, will be waived in the case of:
o Sales of shares held at the time you die or become disabled (within the
definition in Section 72(m)(7) of the Internal Revenue Code which relates
to the ability to engage in gainful employment), if the shares are: (i)
registered either in your name (not a trust) or in the names of you and
your spouse as joint tenants with
18
right of survivorship; or (ii) held in a qualified corporate or
self-employed retirement plan, IRA or 403(b) Custodial Account, provided in
either case that the sale is requested within one year of your death or
initial determination of disability.
o Sales in connection with the following retirement plan "distributions": (i)
lump-sum or other distributions from a qualified corporate or self-employed
retirement plan following retirement (or, in the case of a "key employee"
of a "top heavy" plan, following attainment of age 59 1/2); (ii)
distributions from an IRA or 403(b) Custodial Account following attainment
of age 59 1/2; or (iii) a tax-free return of an excess IRA contribution (a
"distribution" does not include a direct transfer of IRA, 403(b) Custodial
Account or retirement plan assets to a successor custodian or trustee).
o Sales of shares held for you as a participant in a Morgan Stanley Eligible
Plan.
o Sales of shares in connection with the Systematic Withdrawal Plan of up to
12% annually of the value of each fund from which plan sales are made. The
percentage is determined on the date you establish the Systematic
Withdrawal Plan and based on the next calculated share price. You may have
this CDSC waiver applied in amounts up to 1% per month, 3% per quarter, 6%
semi-annually or 12% annually. Shares with no CDSC will be sold first,
followed by those with the lowest CDSC. As such, the waiver benefit will be
reduced by the amount of your shares that are not subject to a CDSC. If you
suspend your participation in the plan, you may later resume plan payments
without requiring a new determination of the account value for the 12% CDSC
waiver.
o Sales of shares if you simultaneously invest the proceeds in the Investment
Manager's mutual fund asset allocation program, pursuant to which investors
pay an asset-based fee. Any shares you acquire in connection with the
Investment Manager's mutual fund asset allocation program are subject to
all of the terms and conditions of that program, including termination
fees, and mandatory sale or transfer restrictions on termination.
All waivers will be granted only following the Fund's distributor receiving
confirmation of your entitlement. If you believe you are eligible for a CDSC
waiver, please contact your Financial Advisor or call (800) 869-NEWS.
Distribution Fee. Class B shares are subject to an annual distribution (12b-1)
fee of 0.75% of the average daily net assets of Class B. This fee is higher than
the annual distribution fee paid by Class A.
Conversion Feature. After ten (10) years, Class B shares will convert
automatically to Class A shares of the Fund with no initial sales charge. The
ten year period runs from the last day of the month in which the shares were
purchased, or in the case of Class B shares acquired through an exchange, from
the last day of the month in which the original Class B shares were purchased;
the shares will convert to Class A shares based on their relative net asset
values in the month following the ten year period. At the same time, an equal
proportion of Class B shares acquired through automatically reinvested
distributions will convert to Class A shares on the same basis.
In the case of Class B shares held in a Morgan Stanley Eligible Plan, the plan
is treated as a single investor and all Class B shares will convert to Class A
shares on the conversion date of the Class B shares of a Morgan Stanley Fund
purchased by that plan.
Currently, the Class B share conversion is not a taxable event; the conversion
feature may be cancelled if it is deemed a taxable event in the future by the
Internal Revenue Service.
19
If you exchange your Class B shares for shares of a Money Market Fund, a No-Load
Fund, North American Government Income Trust or Limited Duration U.S. Treasury
Trust, the holding period for conversion is frozen as of the last day of the
month of the exchange and resumes on the last day of the month you exchange back
into Class B shares.
Exchanging Shares Subject to a CDSC. There are special considerations when you
exchange Fund shares that are subject to a CDSC. 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 a fund that does not
charge a CDSC will not be counted. Thus, in effect the "holding period" for
purposes of calculating the CDSC is frozen upon exchanging into a fund that does
not charge a CDSC.
For example, if you held Class B shares of the Fund for one year, exchanged to
Class B of another Morgan Stanley Multi-Class Fund for another year, then sold
your shares, a CDSC rate of 4% would be imposed on the shares based on a two
year holding period -- one year for each fund. However, if you had exchanged the
shares of the Fund for a Money Market Fund (which does not charge a CDSC)
instead of the Multi-Class Fund, then sold your shares, a CDSC rate of 5% would
be imposed on the shares based on a one year holding period. The one year in the
Money Market Fund would not be counted. Nevertheless, if shares subject to a
CDSC are exchanged for a fund that does not charge a CDSC, 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 that fund up to the amount of any applicable
CDSC.
In addition, shares that are exchanged into or from a Morgan Stanley Fund
subject to a higher CDSC rate will be subject to the higher rate, even if the
shares are re-exchanged into a fund with a lower CDSC rate.
CLASS C SHARES Class C shares are sold at net asset value with no initial sales
charge but are subject to a CDSC of 1.0% on sales made within one year after the
last day of the month of purchase. The CDSC will be assessed in the same manner
and with the same CDSC waivers as with Class B shares. The Fund will not accept
a purchase order for Class C shares in the amount of $1 million or more.
Distribution Fee. Class C shares are subject to an annual distribution (12b-1)
fee of up to 0.85% of the average daily net assets of that Class. This fee is
higher than the annual distribution fee paid by Class A. Unlike Class B shares,
Class C shares have no conversion feature and, accordingly, an investor that
purchases Class C shares may be subject to distribution (12b-1) fees applicable
to Class C shares for an indefinite period.
CLASS D SHARES Class D shares are offered without any sales charge on purchases
or sales and without any distribution (12b-1) fee. Class D shares are offered
only to investors meeting an initial investment minimum of $5 million ($25
million for Morgan Stanley Eligible Plans) and the following investor
categories:
o Investors participating in the Investment Manager's mutual fund asset
allocation program (subject to all of its terms and conditions, including
termination fees, and mandatory sale or transfer restrictions on
termination) pursuant to which they pay an asset-based fee.
o Persons participating in a fee-based investment program (subject to all of
its terms and conditions, including termination fees, and mandatory sale or
transfer restrictions on termination) approved by the Fund's distributor
20
pursuant to which they pay an asset-based fee for investment advisory,
administrative and/or brokerage services. With respect to Class D shares
held through the Morgan Stanley Choice Program, at such time as those Fund
shares are no longer held through the program, the shares will be
automatically converted into Class A shares (which are subject to higher
expenses than Class D shares) based on the then current relative net asset
values of the two Classes.
o Certain investment programs that do not charge an asset-based fee and have
been approved by the Fund's distributor.
o Employee benefit plans maintained by Morgan Stanley or any of its
subsidiaries for the benefit of certain employees of Morgan Stanley and its
subsidiaries.
o Certain unit investment trusts sponsored by Morgan Stanley DW.
o Certain other open-end investment companies whose shares are distributed by
the Fund's distributor.
o Investors who were shareholders of the Dean Witter Retirement Series on
September 11, 1998 for additional purchases for their former Dean Witter
Retirement Series accounts.
A purchase order meeting the requirements for investment in Class D will only be
accepted for Class D shares.
Class D shares are not offered for investments made through Section 529 plans,
donor-advised charitable gift funds and insurance company separate accounts that
have been approved by the Fund's distributor (regardless of the size of the
investment).
Meeting Class D Eligibility Minimums. To meet the $5 million ($25 million for
Morgan Stanley Eligible Plans) initial investment to qualify to purchase
Class D shares you may combine: (1) purchases in a single transaction of
Class D shares of the Fund and other Morgan Stanley Multi-Class Funds; and/or
(2) previous purchases of Class A and Class D shares of Multi-Class Funds and
shares of FSC Funds you currently own, along with shares of Morgan Stanley Funds
you currently own that you acquired in exchange for those shares.
NO SALES CHARGES FOR REINVESTED CASH DISTRIBUTIONS If you receive a cash payment
representing an income dividend or capital gain and you reinvest that amount in
the applicable Class of shares by returning the check within 30 days of the
payment date, the purchased shares would not be subject to an initial sales
charge or CDSC.
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 with respect to the distribution of Class A, Class B and Class C shares.
(Class D shares are offered without any distribution fee.) The Plan allows the
Fund to pay distribution fees for the sale and distribution of these shares. It
also allows the Fund to pay for services to shareholders of Class A, Class B and
Class C shares. 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 in
these Classes and may cost you more than paying other types of sales charges.
21
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.
Class A Shares
- ---------------------------------------------------------------------------------------------------------------------------------
For the Year Ended August 31,
--------------------------------------------------------------------------
2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------------------
SELECTED PER SHARE DATA:
- ---------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of period $ 2.32 $ 4.35 $ 5.51 $ 6.16 $ 6.82
- ---------------------------------------------------------------------------------------------------------------------------------
Income (loss) from investment operations:
Net investment income[+/+] 0.26(2) 0.47 0.69 0.72 0.76
Net realized and unrealized loss (0.73)(2) (1.99) (1.13) (0.63) (0.71)
------- ------- ------- ------- -------
Total income (loss) from investment operations (0.47) (1.52) (0.44) 0.09 0.05
- ---------------------------------------------------------------------------------------------------------------------------------
Less dividends and distributions from:
Net investment income (0.27) (0.51) (0.72) (0.74) (0.71)
Paid-in-capital (0.03) -- -- -- --
------- ------- ------- ------- -------
Total dividends and distributions (0.30) (0.51) (0.72) (0.74) (0.71)
- ---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $ 1.55 $ 2.32 $ 4.35 $ 5.51 $ 6.16
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN+ (21.70)% (37.05)% (8.88)% 1.47% 0.40%
- ---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS(1):
- ---------------------------------------------------------------------------------------------------------------------------------
Expenses 0.99% 0.77% 0.70% 0.68% 0.75%
- ---------------------------------------------------------------------------------------------------------------------------------
Net investment income 13.76%(2) 15.17% 13.62% 12.42% 11.30%
- ---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
- ---------------------------------------------------------------------------------------------------------------------------------
Net assets, end of period, in thousands $23,879 $36,762 $57,273 $68,667 $30,678
- ---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate 39% 49% 20% 36% 66%
- ---------------------------------------------------------------------------------------------------------------------------------
[+/+] The per share amounts were computed using an average number of shares
outstanding during the period.
+ Does not reflect the deduction of sales charge. Calculated based on the
net asset value as of the last business day of the period.
(1) Reflects overall Fund ratios for investment income and non-class specific
expenses.
(2) Effective September 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 August 31, 2002 was to increase net investment
income per share and increase net realized and unrealized loss per share
by $0.01 and to increase the ratio of net investment income to average
net assets by 0.74%. The Financial Highlights data presented in this
table for prior periods has not been restated to reflect this change.
22
Class B Shares
- --------------------------------------------------------------------------------------------------------------------------------
For the Year Ended August 31,
----------------------------------------------------------------------------
2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------------------------
SELECTED PER SHARE DATA:
- --------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of period $ 2.32 $ 4.34 $ 5.50 $ 6.15 $ 6.82
- --------------------------------------------------------------------------------------------------------------------------------
Income (loss) from investment operations:
Net investment income[+/+] 0.25(2) 0.46 0.66 0.69 0.73
Net realized and unrealized loss (0.73)(2) (1.99) (1.13) (0.64) (0.72)
-------- -------- ---------- ---------- ----------
Total income (loss) from investment operations (0.48) (1.53) (0.47) 0.05 0.01
- --------------------------------------------------------------------------------------------------------------------------------
Less dividends and distributions from:
Net investment income (0.26) (0.49) (0.69) (0.70) (0.68)
Paid-in-capital (0.03) -- -- -- --
-------- -------- ---------- ---------- ----------
Total dividends and distributions (0.29) (0.49) (0.69) (0.70) (0.68)
- --------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $ 1.55 $ 2.32 $ 4.34 $ 5.50 $ 6.15
- --------------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN+ (22.00)% (37.27)% (9.39)% 0.92% (0.23)%
- --------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS(1):
- --------------------------------------------------------------------------------------------------------------------------------
Expenses 1.56% 1.37% 1.25% 1.24% 1.25%
- --------------------------------------------------------------------------------------------------------------------------------
Net investment income 13.19%(2) 14.57% 13.07% 11.86% 10.80%
- --------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
- --------------------------------------------------------------------------------------------------------------------------------
Net assets, end of period, in thousands $371,399 $664,706 $1,381,008 $1,927,186 $1,761,147
- --------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate 39% 49% 20% 36% 66%
- --------------------------------------------------------------------------------------------------------------------------------
[+/+] The per share amounts were computed using an average number of shares
outstanding during the period.
+ Does not reflect the deduction of sales charge. Calculated based on the
net asset value as of the last business day of the period.
(1) Reflects overall Fund ratios for investment income and non-class specific
expenses.
(2) Effective September 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 August 31, 2002 was to increase net investment
income per share and increase net realized and unrealized loss per share
by $0.01 and to increase the ratio of net investment income to average
net assets by 0.74%. The Financial Highlights data presented in this
table for prior periods has not been restated to reflect this change.
23
Class C Shares
- ---------------------------------------------------------------------------------------------------------------------------------
For the Year Ended August 31,
--------------------------------------------------------------------------
2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------------------
SELECTED PER SHARE DATA:
- ---------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of period $ 2.32 $ 4.34 $ 5.51 $ 6.15 $ 6.82
- ---------------------------------------------------------------------------------------------------------------------------------
Income (loss) from investment operations:
Net investment income[+/+] 0.25(2) 0.45 0.66 0.68 0.72
Net realized and unrealized loss (0.73)(2) (1.98) (1.14) (0.62) (0.72)
------- ------- ------- -------- -------
Total income (loss) from investment operations (0.48) (1.53) (0.48) 0.06 0.00
- ---------------------------------------------------------------------------------------------------------------------------------
Less dividends and distributions from:
Net investment income (0.26) (0.49) (0.69) (0.70) (0.67)
Paid-in-capital (0.03) -- -- -- --
------- ------- ------- -------- -------
Total dividends and distributions (0.29) (0.49) (0.69) (0.70) (0.67)
- ---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $ 1.55 $ 2.32 $ 4.34 $ 5.51 $ 6.15
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN+ (22.11)% (37.24)% (9.66)% 0.99% (0.34)%
- ---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS(1):
- ---------------------------------------------------------------------------------------------------------------------------------
Expenses 1.66% 1.47% 1.35% 1.34% 1.36%
- ---------------------------------------------------------------------------------------------------------------------------------
Net investment income 13.09%(2) 14.47% 12.97% 11.76% 10.69%
- ---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
- ---------------------------------------------------------------------------------------------------------------------------------
Net assets, end of period, in thousands $33,978 $49,818 $86,951 $109,142 $56,626
- ---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate 39% 49% 20% 36% 66%
- ---------------------------------------------------------------------------------------------------------------------------------
[+/+] The per share amounts were computed using an average number of shares
outstanding during the period.
+ Does not reflect the deduction of sales charge. Calculated based on the
net asset value as of the last business day of the period.
(1) Reflects overall Fund ratios for investment income and non-class specific
expenses.
(2) Effective September 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 August 31, 2002 was to increase net investment
income per share and increase net realized and unrealized loss per share
by $0.01 and to increase the ratio of net investment income to average
net assets by 0.74%. The Financial Highlights data presented in this
table for prior periods has not been restated to reflect this change.
24
Class D Shares
- ---------------------------------------------------------------------------------------------------------------------------------
For the Year Ended August 31,
--------------------------------------------------------------------------
2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------------------
SELECTED PER SHARE DATA:
- ---------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of period $ 2.32 $ 4.35 $ 5.51 $ 6.16 $ 6.82
- ---------------------------------------------------------------------------------------------------------------------------------
Income (loss) from investment operations:
Net investment income[+/+] 0.26(2) 0.48 0.70 0.74 0.78
Net realized and unrealized loss (0.73)(2) (1.99) (1.13) (0.64) (0.71)
------- -------- -------- -------- --------
Total income (loss) from investment operations. (0.47) (1.51) (0.43) 0.10 0.07
- ---------------------------------------------------------------------------------------------------------------------------------
Less dividends and distributions from:
Net investment income (0.27) (0.52) (0.73) (0.75) (0.73)
Paid-in-capital (0.03) -- -- -- --
------- -------- -------- -------- --------
Total dividends and distributions (0.30) (0.52) (0.73) (0.75) (0.73)
- ---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $ 1.55 $ 2.32 $ 4.35 $ 5.51 $ 6.16
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN+ (21.45)% (36.95)% (8.69)% 1.67% 0.63%
- ---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS(1):
- ---------------------------------------------------------------------------------------------------------------------------------
Expenses 0.81% 0.62% 0.50% 0.49% 0.51%
- ---------------------------------------------------------------------------------------------------------------------------------
Net investment income 13.94%(2) 15.32% 13.82% 12.61% 11.54%
- ---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
- ---------------------------------------------------------------------------------------------------------------------------------
Net assets, end of period, in thousands $86,436 $137,319 $246,941 $333,714 $400,582
- ---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate 39% 49% 20% 36% 66%
- ---------------------------------------------------------------------------------------------------------------------------------
[+/+] The per share amounts were computed using an average number of shares
outstanding during the period.
+ Does not reflect the deduction of sales charge. Calculated based on the
net asset value as of the last business day of the period.
(1) Reflects overall Fund ratios for investment income and non-class specific
expenses.
(2) Effective September 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 August 31, 2002 was to increase net investment
income per share and increase net realized and unrealized loss per share
by $0.01 and to increase the ratio of net investment income to average
net assets by 0.74%. The Financial Highlights data presented in this
table for prior periods has not been restated to reflect this change.
25
Notes
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26
Notes
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27
Notes
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28
Morgan Stanley Funds
- --------------------------------------------------------------------------------
o GLOBAL/INTERNATIONAL FUNDS
European Growth Fund
Fund of Funds - International Portfolio
Global Advantage Fund
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
Biotechnology Fund
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
Small-Mid Special Value Fund
Special 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
Fundamental Value Fund
Income Builder Fund
Real Estate Fund
S&P 500 Index 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)
Limited Duration U.S. Treasury Trust
Liquid Asset Fund (MM)
North American Government Income 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 or terminated 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 Limited Duration 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.
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 SYMBOLS:
Class A: HYLAX Class C: HYLCX
- --------------------- ---------------------
Class B: HYLBX Class D: HYLDX
- --------------------- ---------------------
[MORGAN STANLEY LOGO]
Morgan Stanley
High Yield Securities
A mutual fund whose primary
investment objective is to earn
a high level of current income.
as a secondary objective, the [COVER PHOTO]
fund seeks capital appreciation
but only to the extent consistent
with its primary objective.
Prospectus | September 30, 2002
(THE FUND'S INVESTMENT COMPANY ACT FILE NO. IS 811-2932)
Morgan Stanley High Yield Securities Inc.
LETTER TO THE SHAREHOLDERS o AUGUST 31, 2002
DEAR SHAREHOLDER:
The 12 months ended August 31, 2002 were extremely volatile for the high-yield
market. The tragic events of September 11th had a profound effect on the economy
as well as the high-yield and equity markets. A flight-to-quality mentality
emerged, pushing equities and high-yield security prices sharply lower. After
the September decline, the high-yield market bounced back over the next seven
months. The economic recovery early in 2002 contributed to the improved tone of
the market. Strong flows of about $9 billion into the high-yield asset class in
January through May pushed prices higher.
However, the high-yield market weakened again during the balance of the review
period as the economy slowed and accounting scandals at WorldCom and other
companies shocked market participants. As you may be aware, WorldCom reported
that it had misclassified nearly $3.9 billion in costs (and later announced
additional improprieties). This announcement caused the market to fall
significantly in late June as investor confidence eroded. Strong inflows into
the high-yield asset class stopped as investors withdrew approximately $2
billion in June and July. The size of net redemptions led to sales of portfolio
holdings by mutual funds and dealers, further lowering prices. There was a
modest improvement in the second half of August, but it is too early to know if
the improvement will be sustained.
On balance, credit spreads in the high-yield market relative to U.S. Treasury
securities widened to historically wide levels. Spreads especially widened
within the lower-rated portion of the high-yield market as investors continued
to prefer investments in the relatively higher-quality end of the marketplace.
In addition, bonds in sectors related to telecommunications, cable and utilities
performed poorly as investors continued to be concerned about accounting
scandals and slower economic growth going forward.
PERFORMANCE AND PORTFOLIO STRATEGY
During the 12-month period ended August 31, 2002, Morgan Stanley High Yield
Securities' Class A and D shares produced returns of -21.70 percent and -21.45
percent, respectively. The Fund underperformed the Lehman Brothers U.S.
Corporate High Yield Index, which returned -7.65 percent. For the same period,
the Fund's Class B and C shares had total returns of -22.00 percent and -22.11
percent, respectively. The performance of the Fund's four share classes varies
because of differing expenses. Total return figures shown assume the
reinvestment of all distributions but do not reflect the deduction of any
applicable sales charges. If sales charges were included, performance would be
lower. The accompanying chart compares the Fund's performance to that of the
Lehman Index.
The past three years have been one of the most difficult periods for the
high-yield market. As a result of the substantial weakness in the market,
high-yield bond prices have declined sharply and yields have risen over much of
this period. The Fund's positions in the lower-rated portion of the market and
in
Morgan Stanley High Yield Securities Inc.
LETTER TO THE SHAREHOLDERS o AUGUST 31, 2002 CONTINUED
communications-related industries have been adversely affected. The last four
months represented an extension of these difficulties.
The Fund's allocations in the fixed-line communications, wireless communications
and cable industries contributed to its disappointing performance during the
review period. Fixed-line communications and cable were down by more than 30
percent and wireless was down 25 percent over the past 12 months,
underperforming the rest of the high-yield market. These industries experienced
slower revenue growth, higher default rates and many rating downgrades, factors
which led to lower prices for most bonds in these industries. Despite the Fund's
investments in these industries having been reduced over the past year,
allocations remained above market weights, thus adversely affecting performance.
Performance was helped by the higher-quality bonds added to the portfolio over
the past year, particularly those in the housing and health-care sectors. These
sectors performed better than most others in the high-yield market. Finally, an
underweighting of the utilities sector helped mitigate losses when this sector
came under pressure as a result of accounting concerns.
Over the course of the fiscal year, the Fund's portfolio management team
continued to reposition the portfolio for the current market environment. New
positions were initiated in many companies, including Starwood Hotels, Collins
and Aikman, Venetian Casino, Intermet, Metaldyne and Foamex. The team increased
the Fund's overall credit quality by buying BB-rated and BBB-rated securities
and decreasing exposure to telecommunications-related industries.
At fiscal year-end the Fund was overweighted toward wireline communications,
cable, wireless communications and media, as well as manufacturing and housing.
Underweighted positions included consumer products and retail. The Fund's
portfolio management team believes that consumer spending is likely to lag the
growth of the overall economy. The Fund also is underweighted toward aerospace,
as a result of slow demand in travel.
LOOKING AHEAD
June and July were two of the worst back-to-back months in the history of the
high-yield market. The market recovered modestly during the second half of
August. Although the spread widening that has occurred over the last few months
makes the market look attractive, it is uncertain how long it will take to
restore investor confidence. To some extent the market's returns will depend on
whether the economy continues its recovery without an intervening contraction.
2
Morgan Stanley High Yield Securities Inc.
LETTER TO THE SHAREHOLDERS o AUGUST 31, 2002 CONTINUED
We believe that the economy will continue on the path of recovery and that
investor confidence will recover with it over the coming months. Although timing
the high-yield market's turnaround is hard to predict, our long-term outlook for
the asset class remains positive.
We appreciate your ongoing support of Morgan Stanley High Yield Securities 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.
3
Morgan Stanley High Yield Securities Inc.
FUND PERFORMANCE o AUGUST 31, 2002
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
GROWTH OF $10,000 -- CLASS A AND D SHARES
($ in Thousands)
CLASS A CLASS D LEHMAN(4)
August 1992 $9,575 $10,000 $10,000
August 1993 $11,680 $12,229 $11,480
August 1994 $11,760 $12,343 $11,858
August 1995 $13,136 $13,821 $13,500
August 1996 $14,553 $15,351 $14,804
August 1997 $16,698 $17,656 $17,020
August 1998 $16,765 $17,767 $17,568
August 1999 $17,011 $18,064 $18,288
August 2000 $15,501 $16,494 $18,495
August 2001 $9,758 $10,399 $18,536
August 2002 $7,640 (3) $8,168 (3) $17,118
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. PERFORMANCE FOR CLASS A, CLASS B, CLASS C, AND CLASS D SHARES WILL
VARY DUE TO DIFFERENCES IN SALES CHARGES AND EXPENSES.
AVERAGE ANNUAL TOTAL RETURNS -- PERIOD ENDED AUGUST 31, 2002
-----------------------------------------------------------------------------------------------------
CLASS A SHARES* CLASS B SHARES**
------------------------------------------------- --------------------------------------------------
1 Year (21.70)%(1) (25.03)%(2) 1 Year (22.00)%(1) (25.34)%(2)
5 Years (14.48) (1) (15.21) (2) 5 Years (14.89) (1) (15.07) (2)
10 Years (2.23) (1) (2.66) (2) Since Inception (7/28/97) (14.54) (1) (14.63) (2)
CLASS C SHARES+ CLASS D SHARES++
------------------------------------------------- --------------------------------------------------
1 Year (22.11)%(1) (22.78)%(2) 1 Year (21.45)%(1)
5 Years (15.00) (1) (15.00) (2) 5 Years (14.29) (1)
Since Inception (7/28/97) (14.64) (1) (14.64) (2) 10 Years (2.00) (1)
PRIOR TO JULY 28, 1997 THE FUND OFFERED ONLY ONE CLASS OF SHARES. BECAUSE THE
DISTRIBUTION ARRANGEMENT FOR CLASS A MOST CLOSELY RESEMBELED THE DISTRIBUTION
ARRANGEMENT APPLICABLE PRIOR TO THE IMPLEMENTATION OF MULTIPLE CLASSES (I.E.,
CLASS A IS SOLD WITH A FRONT-END SALES CHARGE), HISTORICAL PERFORMANCE
INFORMATION HAS BEEN RESTATED TO REFLECT THE ACTUAL MAXIMUM SALES CHARGE
APPLICABLE TO CLASS A (I.E., 4.25%) AS COMPARED TO THE 5.50% SALES CHARGE IN
EFFECT PRIOR TO JULY 28, 1997. IN ADDITION, CLASS A SHARES ARE NOW SUBJECT TO AN
ONGOING 12B-1 FEE WHICH IS REFLECTED IN THE RESTATED PERFORMANCE FOR THAT CLASS.
BECAUSE ALL SHARES OF THE FUND HELD PRIOR TO JULY 28, 1997 WERE DESIGNATED CLASS
D SHARES, THE FUND'S HISTORICAL PERFORMANCE HAS BEEN RESTATED TO REFLECT THE
ABSENCE OF ANY SALES CHARGE.
- ---------------------
(1) Figure shown assumes reinvestment of all distributions and does not reflect
the deduction of any sales charges.
(2) Figure shown assumes reinvestment of all distributions and the deduction of
the maximum applicable sales charge. See the Fund's current prospectus for
complete details on fees and sales charges.
(3) Closing value assuming a complete redemption on august 31, 2002.
(4) The Lehman Brothers U.S. Corporate High Yield Index tracks the performance
of all below investment-grade securities which have at least $100 million
in outstanding issuance, a maturity greater than one year, and are issued
in fixed-rate U.S. Dollar denominations. The Index does not include any
expenses, fees or charges. The Index is unmanaged and should not be
considered an investment.
* The maximum front-end sales charge for Class A is 4.25%.
** The maximum contingent deferred sales charge (CDSC) for Class B is 5.0%.
The CDSC declines to 0% after six years.
+ The maximum contingent deferred sales charge for Class C is 1% for shares
redeemed within one year of purchase.
++ Class D has no sales charge.
4
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------
Corporate Bonds (89.0%)
Advertising/Marketing Services (0.6%)
$ 3,340 Interep National Radio Sales, Inc. (Series B)..... 10.00% 07/01/08 $ 2,989,300
------------
Aerospace & Defense (0.5%)
9,385 Loral Space & Communications Ltd.................. 9.50 01/15/06 2,346,250
------------
Airlines (0.8%)
6,450 Air Canada Corp. (Canada)......................... 10.25 03/15/11 4,128,000
------------
Alternative Power Generation (0.4%)
3,735 Calpine Corp...................................... 8.50 02/15/11 1,960,875
------------
Auto Parts: O.E.M. (4.6%)
1,630 Arvinmeritor, Inc................................. 8.75 03/01/12 1,726,848
1,365 Collins & Aikman Products Co...................... 11.50 04/15/06 1,286,512
3,700 Collins & Aikman Products Co...................... 10.75 12/31/11 3,644,500
5,155 Dana Corp......................................... 9.00 08/15/11 4,923,025
2,300 Dura Operating Corp. (Series B)................... 8.625 04/15/12 2,334,500
3,385 Intermet Corp. - 144A*............................ 9.75 06/15/09 3,435,775
1,310 Lear Corp. (Series B)............................. 8.11 05/15/09 1,372,225
2,890 Metaldyne Corp. - 144A*........................... 11.00 06/15/12 2,535,975
2,260 Stoneridge, Inc................................... 11.50 05/01/12 2,327,800
------------
23,587,160
------------
Broadcast/Media (1.4%)
10,000 Tri-State Outdoor Media Group, Inc. (b)........... 11.00 05/15/08 7,200,000
------------
Broadcasting (1.6%)
3,785 Salem Communications Holdings Corp................ 9.00 07/01/11 3,889,087
1,795 XM Satellite Radio Inc............................ 14.00 03/15/10 614,787
4,245 Young Broadcasting Inc............................ 10.00 03/01/11 3,884,175
------------
8,388,049
------------
Cable/Satellite TV (5.3%)
50,687 Australis Holdings Property Ltd. (Australia) (a)
(b).............................................. 15.00 11/01/02 0
3,620 British Sky Broadcasting Group PLC (United
Kingdom)......................................... 6.875 02/23/09 3,462,856
2,950 British Sky Broadcasting Group PLC (United
Kingdom)......................................... 8.20 07/15/09 2,966,343
9,805 Callahan Nordrhein Westfalen (Germany) (a) (b).... 14.00 07/15/10 232,869
3,540 Charter Communications Holdings, Inc.............. 13.50++ 01/15/11 1,345,200
7,060 Charter Communications Holdings/Charter Capital... 11.75++ 05/15/11 2,647,500
19,000 Diva Systems Corp. (Series B) (a) (d)............. 12.625++ 03/01/08 2,351,250
6,145 Echostar DBS Corp. - 144A*........................ 9.125 01/15/09 5,991,375
16,510 Knology Holdings, Inc............................. 11.875++ 10/15/07 5,283,200
6,600 Ono Finance PLC (United Kingdom).................. 13.00 05/01/09 1,320,000
915 Pegasus Communications Corp. (Series B)........... 9.75 12/01/06 432,337
7,355 Telewest Communications PLC (United Kingdom)...... 9.875 02/01/10 1,103,250
See Notes to Financial Statements
5
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------
$ 11,525 United Pan Europe Communications N.V. (Series B)
(Netherlands) (b)................................ 10.875% 08/01/09 $ 403,375
------------
27,539,555
------------
Casino/Gaming (3.1%)
22,000 Aladdin Gaming Holdings/Capital Corp. (Series
B)............................................... 13.50++ 03/01/10 440,000
2,400 Harrah's Operating Co., Inc....................... 8.00 02/01/11 2,633,362
4,850 Park Place Entertainment Corp..................... 8.875 09/15/08 5,019,750
24,035 Resort At Summerlin LP (Series B) (a) (b)......... 13.00 12/15/07 0
4,725 Station Casinos, Inc.............................. 8.375 02/15/08 4,914,000
2,970 Venetian Casino/LV Sands - 144A*.................. 11.00 06/15/10 2,981,137
------------
15,988,249
------------
Cellular Telephone (1.9%)
2,230 Dobson/Sygnet Communications Co................... 12.25 12/15/08 1,404,900
29,800 Dolphin Telecom PLC (Series B) (United Kingdom)
(a) (d).......................................... 14.00++ 05/15/09 2,980
25,025 Dolphin Telecom PLC (United Kingdom) (a) (d)...... 11.50++ 06/01/08 2,502
11,050 Nextel Partners, Inc.............................. 14.00++ 02/01/09 4,751,500
4,258 Tritel PCS, Inc................................... 12.75++ 05/15/09 3,491,560
------------
9,653,442
------------
Chemicals: Major Diversified (1.8%)
3,665 Equistar Chemical/Funding......................... 10.125 09/01/08 3,518,400
6,705 Huntsman ICI Chemicals LLC........................ 10.125 07/01/09 5,967,450
------------
9,485,850
------------
Chemicals: Specialty (2.4%)
2,560 Acetex Corp. (Canada)............................. 10.875 08/01/09 2,662,400
850 ISP Chemco, Inc. (Series B)....................... 10.25 07/01/11 850,000
4,710 ISP Holdings, Inc. (Series B)..................... 10.625 12/15/09 4,050,600
2,930 Lyondell Chemical Co. (Series B).................. 9.875 05/01/07 2,900,700
1,725 Millennium America, Inc........................... 9.25 06/15/08 1,794,000
------------
12,257,700
------------
Commercial Printing/Forms (1.1%)
3,935 Mail-Well I Corp. - 144A*......................... 9.625 03/15/12 2,715,150
13,000 Premier Graphics, Inc. (b)........................ 11.50 12/01/05 406,250
2,490 Quebecor Media, Inc. (Canada)..................... 11.125 07/15/11 2,079,150
935 Quebecor Media, Inc. (Canada)..................... 13.75++ 07/15/11 444,125
------------
5,644,675
------------
Consumer/Business Services (3.1%)
13,000 Comforce Operating, Inc........................... 12.00 12/01/07 7,540,000
4,249 MDC Communications Corp. (Canada)................. 10.50 12/01/06 3,526,670
6,085 Muzak LLC/Muzak Finance Corp...................... 9.875 03/15/09 5,080,975
------------
16,147,645
------------
See Notes to Financial Statements
6
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------
Containers/Packaging (1.8%)
$ 10,000 LLS Corp. (b)..................................... 11.625% 08/01/09 $ 900,000
7,540 Owens-Illinois, Inc............................... 7.80 05/15/18 6,032,000
2,235 Pliant Corp....................................... 13.00 06/01/10 2,246,175
------------
9,178,175
------------
Diversified Manufacturing (2.3%)
9,755 Eagle-Picher Industries, Inc...................... 9.375 03/01/08 7,608,900
7,750 Jordan Industries, Inc. (Series B)................ 10.375 08/01/07 4,495,000
------------
12,103,900
------------
Drugstore Chains (0.7%)
2,000 Rite Aid Corp..................................... 6.875 08/15/13 1,160,000
2,025 Rite Aid Corp..................................... 7.70 02/15/27 1,113,750
2,000 Rite Aid Corp. - 144A*............................ 6.125 12/15/08 1,160,000
------------
3,433,750
------------
Electric Utilities (0.7%)
3,620 PG&E National Energy Group, Inc................... 10.375 05/16/11 1,339,400
3,050 PSEG Energy Holdings - 144A*...................... 8.625 02/15/08 2,287,500
------------
3,626,900
------------
Electronic Components (0.3%)
1,585 Flextronics International Ltd. (Singapore)........ 9.875 07/01/10 1,640,475
------------
Electronic Distributors (0.9%)
4,280 BRL Universal Equipment Corp...................... 8.875 02/15/08 4,333,500
20,000 CHS Electronics, Inc. (a) (b)..................... 9.875 04/15/05 175,000
------------
4,508,500
------------
Electronic Equipment/Instruments (0.6%)
8,280 High Voltage Engineering, Inc..................... 10.75 08/15/04 2,980,800
------------
Electronics/Appliances (0.0%)
84,930 International Semi-Tech Microelectronics, Inc.
(Canada) (a) (b)................................. 11.50 08/15/03 8,493
------------
Engineering & Construction (0.1%)
2,310 Encompass Services Corp........................... 10.50 05/01/09 231,000
6,575 Metromedia Fiber Network, Inc. (a) (b)............ 10.00 12/15/09 32,875
7,000 Metromedia Fiber Network, Inc. (Series B) (a)
(b).............................................. 10.00 11/15/08 35,000
------------
298,875
------------
Environmental Services (1.7%)
6,025 Allied Waste North America, Inc. (Series B)....... 10.00 08/01/09 5,934,625
3,025 Waste Management, Inc. (Series A)................. 7.375 08/01/10 3,079,598
------------
9,014,223
------------
Financial Conglomerates (0.4%)
2,100 Case Credit Corp.................................. 6.125 02/15/03 2,028,417
------------
See Notes to Financial Statements
7
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------
Food Distributors (0.9%)
$ 4,905 Volume Services America, Inc...................... 11.25% 03/01/09 $ 4,647,487
------------
Food: Meat/Fish/Dairy (1.9%)
4,455 Michael Foods, Inc. (Series B).................... 11.75 04/01/11 4,878,225
5,200 Smithfield Foods, Inc............................. 7.625 02/15/08 4,810,000
------------
9,688,225
------------
Forest Products (2.1%)
4,290 Louisiana Pacific Corp............................ 10.875 11/15/08 4,509,862
1,615 Louisiana Pacific Corp............................ 8.875 08/15/10 1,689,744
4,800 Tembec Industries, Inc. (Canada).................. 8.50 02/01/11 4,836,000
------------
11,035,606
------------
Gas Distributors (0.2%)
3,595 Dynegy Holdings, Inc.............................. 6.875 04/01/11 1,222,300
------------
Home Building (2.9%)
5,610 Schuler Homes, Inc................................ 9.375 07/15/09 5,652,075
405 Schuler Homes, Inc................................ 10.50 07/15/11 407,025
2,445 Tech Olympic USA, Inc. - 144A*.................... 9.00 07/01/10 2,304,412
2,305 Tech Olympic USA, Inc. - 144A*.................... 10.375 07/01/12 2,114,838
4,400 Toll Corp......................................... 8.25 02/01/11 4,356,000
------------
14,834,350
------------
Hospital/Nursing Management (0.8%)
3,600 HCA, Inc.......................................... 7.875 02/01/11 3,933,421
------------
Hotels/Resorts/Cruiselines (3.6%)
1,455 Hilton Hotels Corp................................ 7.95 04/15/07 1,482,773
4,800 HMH Properties, Inc. (Series B)................... 7.875 08/01/08 4,560,000
4,890 Horseshoe Gaming Holding Corp. (Series B)......... 8.625 05/15/09 5,073,375
3,990 Prime Hospitalty Corp. (Series B)................. 8.375 05/01/12 3,810,450
410 Starwood Hotels & Resorts Worldwide, Inc. -
144A*............................................ 7.375 05/01/07 400,775
3,480 Starwood Hotels & Resorts Worldwide, Inc. -
144A*............................................ 7.875 05/01/12 3,401,700
------------
18,729,073
------------
Industrial Conglomerates (0.4%)
2,250 Tyco International Group S.A. (Luxembourg)........ 6.75 02/15/11 1,856,250
------------
Industrial Specialties (3.7%)
4,935 Cabot Safety Corp................................. 12.50 07/15/05 5,033,700
1,430 Foamex LP/Capital Corp. - 144A*................... 10.75 04/01/09 1,315,600
7,163 International Wire Group, Inc..................... 11.75 06/01/05 5,927,383
1,660 Johnsondiversey, Inc. - 144A*..................... 9.625 05/15/12 1,643,400
840 Tekni-Plex, Inc. (Series B)....................... 12.75 06/15/10 835,800
See Notes to Financial Statements
8
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------
$ 1,125 Tekni-Plex, Inc. - 144A*.......................... 12.75% 06/15/10 $ 1,119,375
3,285 UCAR Finance, Inc................................. 10.25 02/15/12 3,301,425
------------
19,176,683
------------
Internet Software/Services (1.8%)
12,020 Exodus Communications, Inc. (a) (b)............... 11.625 07/15/10 721,200
33,200 Globix Corp. (a) (b).............................. 12.50 02/01/10 5,976,000
11,000 PSINet, Inc. (a) (b).............................. 10.50 12/01/06 1,072,500
14,500 PSINet, Inc. (a) (b).............................. 11.00 08/01/09 1,413,750
------------
9,183,450
------------
Managed Health Care (1.4%)
4,000 Aetna, Inc........................................ 7.875 03/01/11 4,240,784
2,690 Health Net, Inc................................... 8.375 04/15/11 3,048,687
------------
7,289,471
------------
Media Conglomerates (1.4%)
3,280 AOL Time Warner, Inc.............................. 6.875 05/01/12 2,955,070
4,260 Nextmedia Operating, Inc.......................... 10.75 07/01/11 4,110,900
------------
7,065,970
------------
Medical Distributors (0.9%)
4,320 Amerisource Bergen Corp........................... 8.125 09/01/08 4,492,800
------------
Medical/Nursing Services (0.8%)
4,865 Fresenius Medical Care Capital Trust.............. 7.875 06/15/11 4,013,625
------------
Metal Fabrications (0.5%)
2,800 Trimas Corp. - 144A*.............................. 9.875 06/15/12 2,772,000
------------
Movies/Entertainment (1.5%)
4,755 Alliance Atlantis Communications, Inc. (Canada)... 13.00 12/15/09 5,028,413
3,140 Six Flags, Inc.................................... 8.875 02/01/10 2,723,950
------------
7,752,363
------------
Office Equipment/Supplies (0.0%)
22,000 Mosler, Inc. (a) (b).............................. 11.00 04/15/03 0
------------
Oil & Gas Production (2.9%)
4,260 Chesapeake Energy Corp............................ 8.125 04/01/11 4,174,800
1,820 Magnum Hunter Resources, Inc. - 144A*............. 9.60 03/15/12 1,856,400
2,375 Stone Energy Corp................................. 8.25 12/15/11 2,404,688
7,080 Vintage Petroleum, Inc............................ 7.875 05/15/11 6,584,400
------------
15,020,288
------------
Oil Refining/Marketing (1.6%)
4,000 Husky Oil Ltd. (Canada)........................... 8.90 08/15/28 4,440,712
4,980 Tesoro Petroleum Corp. - 144A*.................... 9.625 04/01/12 3,660,300
------------
8,101,012
------------
See Notes to Financial Statements
9
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------
Oilfield Services/Equipment (0.9%)
$ 2,515 Hanover Equipment Trust - 144A*................... 8.50% 09/01/08 $ 2,338,950
2,410 Hanover Equipment Trust - 144A*................... 8.75 09/01/11 2,217,200
------------
4,556,150
------------
Other Metals/Minerals (0.8%)
3,310 Murrin Murrin Holdings Property Ltd.
(Australia)...................................... 9.375 08/31/07 997,138
3,100 Phelps Dodge Corp................................. 8.75 06/01/11 3,213,996
------------
4,211,134
------------
Publishing: Books/Magazines (0.7%)
4,720 PRIMEDIA, Inc..................................... 8.875 05/15/11 3,681,600
------------
Publishing: Newspapers (0.7%)
4,261 Hollinger Participation Trust (Canada) - 144A*.... 12.125+ 11/15/10 3,558,221
------------
Pulp & Paper (0.8%)
4,310 Norske Skog Canada Ltd. (Canada).................. 8.625 06/15/11 4,223,800
------------
Real Estate Development (0.8%)
4,890 CB Richard Ellis Services, Inc.................... 11.25 06/15/11 4,327,650
------------
Real Estate Investment Trusts (0.6%)
3,005 Istar Financial, Inc.............................. 8.75 08/15/08 3,076,594
------------
Recreational Products (0.9%)
4,430 International Game Technology..................... 8.375 05/15/09 4,762,250
------------
Restaurants (1.5%)
141,992 American Restaurant Group Holdings, Inc. - 144A*
(c).............................................. 0.00 12/15/05 4,344,955
34,207 FRD Acquisition Corp. (Series B) (a) (b).......... 12.50 07/15/04 3,249,665
------------
7,594,620
------------
Retail - Specialty (0.1%)
9,000 Mrs. Fields Holdings Co........................... 14.00++ 12/01/05 270,000
------------
Semiconductors (0.5%)
2,210 Fairchild Semiconductors Corp..................... 10.50 02/01/09 2,331,550
------------
Services to the Health Industry (2.1%)
3,045 Anthem Insurance - 144A*.......................... 9.125 04/01/10 3,521,826
3,465 Healthsouth Corp. - 144A*......................... 7.625 06/01/12 2,775,673
4,600 Omnicare, Inc. (Series B)......................... 8.125 03/15/11 4,784,000
------------
11,081,499
------------
Specialty Stores (0.6%)
2,975 AutoNation, Inc................................... 9.00 08/01/08 3,108,875
------------
Specialty Telecommunications (3.8%)
4,535 American Tower Corp............................... 9.375 02/01/09 2,811,700
11,500 Birch Telecom, Inc. (a) (b)....................... 14.00 06/15/08 115,000
14,370 DTI Holdings, Inc. (Series B) (a) (d)............. 12.50++ 03/01/08 1,437
See Notes to Financial Statements
10
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------
$ 17,085 Esprit Telecom Group PLC (United Kingdom) (b)..... 11.50% 12/15/07 $ 1,709
29,088 Esprit Telecom Group PLC (United Kingdom) (b)..... 10.875 06/15/08 2,909
47,000 Firstworld Communications, Inc. (a) (d)........... 13.00++ 04/15/08 4,582,500
10,000 Global Crossing Holdings, Ltd. (Bermuda) (a)
(b).............................................. 8.70 08/01/07 112,500
3,490 Global Crossing Holdings, Ltd. (Bermuda) (a)
(b).............................................. 9.50 11/15/09 39,263
23,050 GT Group Telecom, Inc. (Canada) (a) (d)........... 13.25++ 02/01/10 28,813
8,400 Primus Telecommunications Group, Inc.............. 12.75 10/15/09 4,032,000
2,000 RSL Communications PLC (United Kingdom) (a) (b)... 9.125 03/01/08 40,000
9,000 RSL Communications PLC (United Kingdom) (a) (b)... 10.50 11/15/08 180,000
3,000 RSL Communications PLC (United Kingdom) (a) (b)... 9.875 11/15/09 60,000
13,000 Tele1 Europe BV (Netherlands)..................... 13.00 05/15/09 1,430,000
12,000 Versatel Telecom BV (Netherlands)
(Issued 05/27/98) (a) (b)........................ 13.25 05/15/08 3,465,000
3,000 Versatel Telecom BV (Netherlands)
(Issued 12/03/98) (a) (b)........................ 13.25 05/15/08 866,250
31,445 Viatel Inc. (b)................................... 11.25 04/15/08 157,225
14,200 Viatel Inc. (Issued 03/19/99) (b)................. 11.50 03/15/09 71,000
29,393 Viatel Inc. (Issued 12/08/99) (b)................. 11.50 03/15/09 146,965
32,545 World Access, Inc. (a) (b) (c).................... 13.25 01/15/08 1,505,206
11,500 Worldwide Fiber, Inc. (Canada) (a) (b)............ 12.00 08/01/09 1,150
------------
19,650,627
------------
Steel (0.3%)
1,715 Oregon Steel Mills, Inc. - 144A*.................. 10.00 07/15/09 1,768,594
------------
Telecommunication Equipment (1.2%)
7,025 SBA Communications Corp........................... 12.00++ 03/01/08 3,863,750
10,500 Spectrasite Holdings, Inc......................... 12.00++ 07/15/08 1,890,000
3,500 Spectrasite Holdings, Inc......................... 11.25++ 04/15/09 595,000
------------
6,348,750
------------
Telecommunications (1.0%)
61,075 e. Spire Communications, Inc. (a) (b)............. 13.75 07/15/07 6,108
18,752 Focal Communications Corp. (Series B)............. 12.125++ 02/15/08 1,500,160
15,000 Hyperion Telecommunication, Inc. (Series B) (b)... 12.25 09/01/04 600,000
1,500 NEXTLINK Communications LLC (a) (b)............... 12.50 04/15/06 15,000
17,500 NEXTLINK Communications, Inc. (a) (b)............. 9.00 03/15/08 175,000
4,180 NEXTLINK Communications, Inc. (a) (b)............. 10.75 11/15/08 41,800
775 NEXTLINK Communications, Inc. (a) (b)............. 10.75 06/01/09 7,750
2,505 NTL Communications Corp. (Series B) (a) (b)....... 11.875 10/01/10 400,800
27,850 Rhythms Netconnections, Inc. (a) (b).............. 12.75 04/15/09 661,438
14,965 Rhythms Netconnections, Inc. (Series B) (a) (d)... 13.50++ 05/15/08 224,475
13,850 Startec Global Communications Corp. (a) (b)....... 12.00 05/15/08 1,385
2,100 WorldCom, Inc. (a) (b)............................ 7.50 05/15/11 288,750
See Notes to Financial Statements
11
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------
$ 1,725 WorldCom, Inc. (a) (b)............................ 6.95% 08/15/28 $ 237,188
6,100 WorldCom, Inc. (a) (b)............................ 8.25 05/15/31 838,750
------------
4,998,604
------------
Trucks/Construction/Farm Machinery (2.3%)
1,930 Case Corp. (Series B)............................. 6.25 12/01/03 1,852,790
7,215 J.B. Poindexter & Co., Inc........................ 12.50 05/15/04 6,484,481
2,180 Manitowoc Co., Inc. (The) - 144A*................. 10.50 08/01/12 2,250,850
1,370 NMHG Holding Co. - 144A*.......................... 10.00 05/15/09 1,383,700
------------
11,971,821
------------
Wholesale Distributors (1.4%)
4,000 Burhmann US, Inc.................................. 12.25 11/01/09 4,005,000
2,540 Fisher Scientific International, Inc.............. 7.125 12/15/05 2,546,350
560 Fisher Scientific International, Inc.............. 9.00 02/01/08 579,600
------------
7,130,950
------------
Wireless Telecommunications (0.6%)
3,675 American Cellular Corp............................ 9.50 10/15/09 496,125
2,919 Arch Wireless Holdings, Inc....................... 10.00 05/15/07 1,809,846
1,544 Arch Wireless Holdings, Inc....................... 12.00 05/15/09 185,280
65,300 CellNet Data Systems, Inc. (a) (d)................ 14.00++ 10/01/07 6,530
19,610 Globalstar LP/Capital Corp. (a) (b)............... 10.75 11/01/04 686,350
33,000 WinStar Communications, Inc. (a) (d).............. 14.75++ 04/15/10 3,300
11,400 WinStar Communications, Inc. (a) (b).............. 12.75 04/15/10 1,140
------------
3,188,571
------------
Total Corporate Bonds
(COST $1,486,695,632)....................................................... 458,795,492
------------
Convertible Bonds (1.5%)
Electronic Components (0.7%)
8,830 Solectron Corp.................................... 0.00 11/20/20 3,841,050
------------
Hotels/Resorts/Cruiselines (0.0%)
1,643 Premier Cruises Ltd. - 144A*...................... 10.00+ 08/15/05 0
------------
Telecommunication Equipment (0.8%)
9,420 Corning Inc....................................... 0.00 11/08/15 4,097,700
------------
Total Convertible Bonds
(COST $11,229,282).......................................................... 7,938,750
------------
See Notes to Financial Statements
12
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
NUMBER OF
SHARES VALUE
- ------------------------------------------------------------------------------
Common Stocks (d) (2.3%)
Aerospace & Defense (0.1%)
85,242 Orbital Sciences Corp. (c)........................ $ 318,807
------------
Apparel/Footwear Retail (0.0%)
2,621,192 County Seat Stores, Inc. (c)...................... 0
------------
Casino/Gaming (0.0%)
207,312 Fitzgerald Gaming Corp............................ 0
------------
Consumer/Business Services (1.5%)
440,700 Anacomp, Inc. (Class A) (c)....................... 7,712,250
------------
Entertainment & Leisure (0.1%)
15,308 AMF Bowling Worldwide, Inc........................ 420,970
------------
Food: Specialty/Candy (0.0%)
10,908 SFAC New Holdings, Inc. (c)....................... 0
2,005 SFFB Holdings, Inc. (c)........................... 0
574,725 Specialty Foods Acquisition Corp. - 144A*......... 0
------------
0
------------
Hotels/Resorts/Cruiselines (0.0%)
981,277 Premier Holdings, Inc. (c)........................ 0
781,421 Vagabond Inns, Inc. (Class D)..................... 0
------------
0
------------
Medical Specialties (0.1%)
48,816 MEDIQ, Inc. (c)................................... 265,071
------------
Medical/Nursing Services (0.0%)
1,151,324 Raintree Healthcare Corp. (c)..................... 0
------------
Motor Vehicles (0.0%)
709 Northern Holdings Industrial Corp. (c)*........... 0
------------
Restaurants (0.0%)
38,057 American Restaurant Group Holdings, Inc. -
144A*............................................ 0
------------
Specialty Telecommunications (0.1%)
2,171,896 Mpower Holding Corp. (c).......................... 325,784
264,189 Song Networks Holding AB (ADR) (Sweden)........... 15,851
40,557 Versatel Telecom International N.V. (ADR)
(Netherlands).................................... 137,894
94,263 World Access, Inc. (c)............................ 141
------------
479,670
------------
Telecommunication Equipment (0.0%)
196,000 FWT, Inc. (Class A) (c)........................... 1,960
------------
See Notes to Financial Statements
13
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
NUMBER OF
SHARES VALUE
- -----------------------------------------------------------------------------
Telecommunications (0.1%)
520,697 Covad Communications Group, Inc. (c).............. $ 562,353
105,656 Focal Communications Corp. (c).................... 108,826
------------
671,179
------------
Textiles (0.0%)
1,754,730 United States Leather, Inc. (c)................... 0
------------
Wireless Telecommunications (0.3%)
224,719 Arch Wireless, Inc. (c)........................... 143,820
1,454,105 Motient Corp. (c)................................. 1,599,516
274,390 Vast Solutions, Inc. (Class B1) (c)............... 0
274,390 Vast Solutions, Inc. (Class B2) (c)............... 0
274,390 Vast Solutions, Inc. (Class B3) (c)............... 0
------------
1,743,336
------------
Total Common Stocks
(COST $290,861,374).............................. 11,613,243
------------
Preferred Stocks (3.3%)
Broadcasting (0.7%)
570 Paxson Communications Corp.+...................... 3,422,820
------------
Cellular Telephone (0.9%)
4,806 Dobson Communications Corp.+...................... 1,057,320
5,780 Nextel Communications, Inc. (Series D)+........... 3,583,705
------------
4,641,025
------------
Electric Utilities (0.9%)
5,076 TNP Enterprises, Inc. (Series D)+................. 4,568,400
------------
Publishing: Books/Magazines (0.0%)
6,625 PRIMEDIA, Inc..................................... 238,500
------------
Restaurants (0.4%)
6,007 American Restaurant Group Holdings, Inc. (Series
B)............................................... 1,045,288
1,071 FRD Acquisition Co. (Units)[+/+].................. 1,071,000
------------
2,116,288
------------
Specialty Telecommunications (0.2%)
7,333 Broadwing Communications, Inc. (Series B)......... 714,968
1 Crown Castle International Corp.+................. 357
1,691 Intermedia Communications, Inc. (Series B)+....... 67,624
47,064 McLeodUSA, Inc. (Series A) $0.44 (Conv.).......... 104,953
180,721 XO Communications, Inc............................ 1,807
------------
889,709
------------
See Notes to Financial Statements
14
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
NUMBER OF
SHARES VALUE
- -----------------------------------------------------------------------------------------
Telecommunication Equipment (0.2%)
2,244,200 FWT, Inc (Series A) (c)...................................... $ 1,009,890
------------
Total Preferred Stocks
(COST $52,459,703).......................................... 16,886,632
------------
NUMBER OF EXPIRATION
WARRANTS DATE
- --------- ----------
Warrants (d) (0.1%)
Aerospace & Defense (0.0%)
9,000 Sabreliner Corp. - 144A*.......................... 04/15/03.. 0
------------
Broadcasting (0.0%)
5,700 XM Satellite Radio, Inc. - 144A*.................. 03/15/10.. 3,420
------------
Cable/Satellite TV (0.0%)
57,000 Diva Systems Corp. - 144A*........................ 03/01/08.. 0
6,600 Ono Finance PLC (United Kingdom) - 144A*.......... 05/31/09.. 660
------------
660
------------
Casino/Gaming (0.0%)
220,000 Aladdin Gaming Holdings LLC - 144A*............... 03/01/10.. 0
20,000 Resort At Summerlin LP - 144A*.................... 12/15/07.. 0
------------
0
------------
Electric Utilities (0.0%)
1,040 TNP Enterprises, Inc. - 144A*..................... 04/01/11.. 26,000
------------
Entertainment & Leisure (0.1%)
36,019 AMF Bowling Worldwide, Inc. (Series A)............ 03/09/09.. 216,114
35,191 AMF Bowling Worldwide, Inc. (Series B)............ 03/09/09.. 175,955
------------
392,069
------------
Internet Software/Services (0.0%)
47,000 Verado Holdings, Inc. - 144A*..................... 04/15/08.. 0
------------
Restaurants (0.0%)
3,500 American Restaurant Group Holdings, Inc. -
144A*............................................ 08/15/08.. 0
------------
Retail - Specialty (0.0%)
9,000 Mrs. Fields Holding, Inc. - 144A*................. 12/01/05.. 0
------------
Specialty Telecommunications (0.0%)
11,500 Birch Telecom, Inc................................ 06/15/08.. 0
23,050 GT Group Telecom, Inc. (Canada) - 144A*........... 02/01/10.. 2,305
104,289 McLeodUSA, Inc.................................... 04/16/07.. 9,386
------------
11,691
------------
See Notes to Financial Statements
15
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
NUMBER OF EXPIRATION
WARRANTS DATE VALUE
- -----------------------------------------------------------------------------------------------------------------------
Telecommunications (0.0%)
11,850 Startec Global Communications Corp. - 144A*..................................... 05/15/08 $ 0
------------
Wireless Telecommunications (0.0%)
10,000 Metricom, Inc................................................................... 02/15/10 0
18,250 Motient Corp. - 144A*........................................................... 04/01/08 182
------------
182
------------
Total Warrants
(Cost $6,104,595).......................................................................... 434,022
------------
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE
- --------- ---- ----
Short-Term Investment (0.5%)
Repurchase Agreement
$ 2,850 Joint repurchase agreement account (dated
08/30/02; proceeds $2,850,594) (e)
(Cost $2,850,000)................................. 1.875% 09/03/02 2,850,000
----------------
Total Investments
(Cost $1,850,200,586) (f)........................................... 96.7% 498,518,139
Other Assets in Excess of Liabilities............................... 3.3 17,174,020
------------------ ----------------
Net Assets.......................................................... 100.0% $ 515,692,159
================== ================
- ---------------------
ADR American Depository Receipt.
* Resale is restricted to qualified institutional investors.
+ Payment-in-kind security.
++ Currently a zero coupon bond and is scheduled to pay interest at the
rate shown at a future specified date.
[+/+] Consists of one or more class of securities traded together as a unit;
preferred stocks with attached warrants.
(a) Issuer in bankruptcy.
(b) Non-income producing security; bond in default.
(c) Acquired through exchange offer.
(d) Non-income producing securities.
(e) Collateralized by federal agency and U.S. Treasury obligations.
(f) The aggregate cost for federal income tax purposes approximates the
aggregate cost for book purposes. The aggregate gross unrealized
appreciation is $7,620,178 and the aggregate gross unrealized
depreciation is $1,359,302,625, resulting in net unrealized depreciation
of $1,351,682,447.
See Notes to Financial Statements
16
Morgan Stanley High Yield Securities Inc.
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
August 31, 2002
Assets:
Investments in securities, at value (cost
$1,850,200,586).................................. $ 498,518,139
Receivable for:
Interest........................................ 12,441,151
Investments sold................................ 6,327,777
Capital stock sold.............................. 551,144
Prepaid expenses and other assets................. 54,789
--------------
Total Assets.................................. 517,893,000
--------------
Liabilities:
Payable for:
Investments purchased........................... 865,033
Capital stock redeemed.......................... 427,364
Distribution fee................................ 269,100
Investment management fee....................... 219,183
Payable to bank................................... 228,794
Accrued expenses and other payables............... 191,367
--------------
Total Liabilities............................. 2,200,841
--------------
Net Assets.................................... $ 515,692,159
==============
Composition of Net Assets:
Paid-in-capital................................... 2,780,173,995
Net unrealized depreciation....................... (1,351,682,447)
Dividends in excess of net investment income...... (17,405,768)
Accumulated net realized loss..................... (895,393,621)
--------------
Net Assets.................................... $ 515,692,159
==============
Class A Shares:
Net Assets........................................ $23,879,067
Shares Outstanding (500,000,000 authorized, $.01
par value)....................................... 15,369,470
Net Asset Value Per Share..................... $1.55
=====
Maximum Offering Price Per Share,
(net asset value plus 4.44% of net asset
value)....................................... $1.62
=====
Class B Shares:
Net Assets........................................ $371,398,868
Shares Outstanding (500,000,000 authorized, $.01
par value)....................................... 239,992,793
Net Asset Value Per Share..................... $1.55
=====
Class C Shares:
Net Assets........................................ $33,977,953
Shares Outstanding (500,000,000 authorized, $.01
par value)....................................... 21,913,543
Net Asset Value Per Share..................... $1.55
=====
Class D Shares:
Net Assets........................................ $86,436,271
Shares Outstanding (500,000,000 authorized, $.01
par value)....................................... 55,671,724
Net Asset Value Per Share..................... $1.55
=====
See Notes to Financial Statements
17
Morgan Stanley High Yield Securities Inc.
FINANCIAL STATEMENTS continued
Statement of Operations
For the year ended August 31, 2002
Net Investment Income:
Income
Interest.......................................... $ 99,363,134
Dividend.......................................... 753,719
-------------
100,116,853
-------------
Expenses
Distribution fee (Class A shares)................. 48,012
Distribution fee (Class B shares)................. 3,747,816
Distribution fee (Class C shares)................. 349,455
Investment management fee......................... 3,258,237
Transfer agent fees and expenses.................. 1,381,858
Professional fees................................. 251,733
Shareholder reports and notices................... 160,601
Registration fees................................. 97,084
Custodian fees.................................... 30,503
Directors' fees and expenses...................... 18,833
Other............................................. 321,757
-------------
Total Expenses................................ 9,665,889
-------------
Net Investment Income......................... 90,450,964
-------------
Net Realized and Unrealized Gain (Loss):
Net realized loss................................. (375,136,573)
Net change in unrealized depreciation............. 111,513,872
-------------
Net Loss...................................... (263,622,701)
-------------
Net Decrease...................................... $(173,171,737)
=============
See Notes to Financial Statements
18
Morgan Stanley High Yield Securities Inc.
FINANCIAL STATEMENTS continued
Statement of Changes in Net Assets
FOR THE YEAR FOR THE YEAR
ENDED ENDED
AUGUST 31, 2002 AUGUST 31, 2001
--------------- ---------------
Increase (Decrease) in Net Assets:
Operations:
Net investment income................... $ 90,450,964 $ 182,819,538
Net realized loss....................... (375,136,573) (282,975,609)
Net change in unrealized depreciation... 111,513,872 (513,181,124)
------------- --------------
Net Decrease........................ (173,171,737) (613,337,195)
------------- --------------
Dividends and Distributions to
Shareholders from:
Net Investment Income:
Class A shares........................ (3,878,089) (7,002,632)
Class B shares........................ (69,129,555) (150,569,611)
Class C shares........................ (5,647,596) (10,293,101)
Class D shares........................ (16,092,318) (29,754,002)
Paid-in-Capital
Class A shares........................ (425,216) --
Class B shares........................ (7,579,753) --
Class C shares........................ (619,234) --
Class D shares........................ (1,764,452) --
------------- --------------
Total Dividends and Distributions... (105,136,213) (197,619,346)
------------- --------------
Net decrease from capital stock
transactions........................... (94,605,170) (72,611,177)
------------- --------------
Net Decrease........................ (372,913,120) (883,567,718)
Net Assets:
Beginning of period..................... 888,605,279 1,772,172,997
------------- --------------
End of Period
(Including dividends in excess of net
investment income of $17,405,768 and
$17,487,233, respectively)............. $ 515,692,159 $ 888,605,279
============= ==============
See Notes to Financial Statements
19
Morgan Stanley High Yield Securities Inc.
NOTES TO FINANCIAL STATEMENTS o AUGUST 31, 2002
1. Organization and Accounting Policies
Morgan Stanley High Yield Securities Inc. (the "Fund") is registered under the
Investment Company Act of 1940, as amended, (the "Act") as a diversified,
open-end management investment company. The Fund's primary investment objective
is to earn a high level of current income and, as a secondary objective, capital
appreciation, but only when consistent with its primary objective. The Fund was
incorporated in Maryland on June 14, 1979 and commenced operations on
September 26, 1979. On July 28, 1997, the Fund converted to a multiple class
share structure.
The Fund offers Class A shares, Class B shares, Class C shares and Class D
shares. The four classes are substantially the same except that most Class A
shares are subject to a sales charge imposed at the time of purchase and some
Class A shares, and most Class B shares and Class C shares are subject to a
contingent deferred sales charge imposed on shares redeemed within one year, six
years and one year, respectively. Class D shares are not subject to a sales
charge. Additionally, Class A shares, Class B shares and Class C shares incur
distribution expenses.
The 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) 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 securities are traded on more than one exchange, the securities are valued
on the exchange designated as the primary market pursuant to procedures adopted
by the Directors); (2) all other portfolio securities for which over-the-counter
market quotations are readily available are valued at the latest available bid
price; (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 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 Directors (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); (4) certain portfolio securities may be
valued by an outside pricing service approved by the Directors. The pricing
service may utilize a matrix system incorporating security quality, maturity and
20
Morgan Stanley High Yield Securities Inc.
NOTES TO FINANCIAL STATEMENTS o AUGUST 31, 2002 continued
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 time of purchase
are valued on a mark-to-market basis until sixty days prior to maturity and
thereafter at amortized cost based on their value on the 61st day. Short-term
debt securities having a maturity date of sixty days or less at the time of
purchase are valued at amortized cost.
B. Accounting for Investments -- Security transactions are accounted for on the
trade date (date the order to buy or sell is executed). Realized gains and
losses on security transactions are determined by the identified cost method.
Dividend income and other distributions are recorded on the ex-dividend date.
Discounts are accreted and premiums are amortized over the respective life of
the securities. Interest income is accrued daily except where collection is not
expected.
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 and are collateralized by
cash, or U.S. Treasury or federal agency obligations.
D. Multiple Class Allocations -- Investment income, expenses (other than
distribution fees), and realized and unrealized gains and losses are allocated
to each class of shares based upon the relative net asset value on the date such
items are recognized. Distribution fees are charged directly to the respective
class.
E. 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
21
Morgan Stanley High Yield Securities Inc.
NOTES TO FINANCIAL STATEMENTS o AUGUST 31, 2002 continued
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 Agreement
Pursuant to an Investment Management Agreement, the Fund pays the Investment
Manager a management fee, calculated 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: 0.50% to the portion of daily net assets not exceeding
$500 million; 0.425% to the portion of daily net assets exceeding $500 million
but not exceeding $750 million; 0.375% to the portion of daily net assets
exceeding $750 million but not exceeding $1 billion; 0.35% to the portion of
daily net assets exceeding $1 billion but not exceeding $2 billion; 0.325% to
the portion of daily net assets exceeding $2 billion but not exceeding
$3 billion; and 0.30% to the portion of daily net assets exceeding $3 billion.
3. Plan of Distribution
Shares of the Fund are distributed by Morgan Stanley Distributors Inc. (the
"Distributor"), an affiliate of the Investment Manager. The Fund has adopted a
Plan of Distribution (the "Plan") pursuant to Rule 12b-1 under the Act. The Plan
provides that the Fund pay the Distributor a fee which is accrued daily and paid
monthly at the following annual rates: (i) Class A -- up to 0.25% of the average
daily net assets of Class A; (ii) Class B -- 0.75% of the average daily net
assets of Class B; and (iii) Class C -- up to 0.85% of the average daily net
assets of Class C.
In the case of Class B shares, provided that the Plan continues in effect, any
cumulative expenses incurred by the Distributor but not yet recovered may be
recovered through the payment of future distribution fees from the Fund pursuant
to the Plan and contingent deferred sales charges paid by investors upon
redemption of Class B shares. Although there is no legal obligation for the Fund
to pay expenses incurred in excess of payments made to the Distributor under the
Plan and the proceeds of contingent deferred sales charges paid by investors
upon redemption of shares, if for any reason the Plan is terminated, the
Directors will consider at that time the manner in which to treat such expenses.
The Distributor has advised the Fund that such excess amounts totaled
$60,068,745 at August 31, 2002.
In the case of Class A shares and Class C shares, expenses incurred pursuant to
the Plan in any calendar year in excess of 0.25% or 0.85% of the average daily
net assets of Class A or Class C, respectively, will not be reimbursed by the
Fund through payments in any subsequent year, except that expenses representing
a
22
Morgan Stanley High Yield Securities Inc.
NOTES TO FINANCIAL STATEMENTS o AUGUST 31, 2002 continued
gross sales credit to Morgan Stanley Financial Advisors or other selected
broker-dealer representatives may be reimbursed in the subsequent calendar year.
For the year ended August 31, 2002, the distribution fee was accrued for
Class A shares and Class C shares at the annual rate of 0.18% and 0.85%,
respectively.
The Distributor has informed the Fund that for the year ended August 31, 2002,
it received contingent deferred sales charges from certain redemptions of the
Fund's Class A Shares, Class B shares and Class C shares of $26,842, $1,519,542
and $29,347, respectively and received $135,390 in front-end sales charges from
sales of the Fund's Class A shares. The respective shareholders pay such charges
which are not an expense of the Fund.
4. Security Transactions and Transactions with Affiliates
The cost of purchases and proceeds from sales of portfolio securities, excluding
short-term investments, for the year ended August 31, 2002, aggregated
$252,783,370 and $375,196,197, respectively.
Morgan Stanley Trust, an affiliate of the Investment Manager and Distributor, is
the Fund's transfer agent. At August 31, 2002, the Fund had transfer agent fees
and expenses payable of approximately $24,000.
The Fund has an unfunded noncontributory defined benefit pension plan covering
all independent Directors of the Fund who will have served as independent
Directors for at least five years at the time of retirement. Benefits under this
plan are based on years of service and compensation during the last five years
of service. Aggregate pension costs for the year ended August 31, 2002 included
in Directors' fees and expenses in the Statement of Operations amounted to
$7,230. At August 31, 2002, the Fund had an accrued pension liability of $58,619
which is included in accrued expenses in the Statement of Assets and
Liabilities.
5. Federal Income Tax Status
At August 31, 2002, the Fund had a net capital loss carryover of approximately
$530,730,000, which may be used to offset future capital gains to the extent
provided by regulations, which is available through August 31 in the following
years:
AMOUNT IN THOUSANDS
- -----------------------------------------------------------------------
2003 2004 2005 2006 2007 2008 2009 2010
- ------- ------- ------- ------- ------- ------- ------- --------
$50,599 $23,296 $39,319 $12,603 $24,919 $69,857 $89,299 $220,838
======= ======= ======= ======= ======= ======= ======= ========
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 $363,679,000 during fiscal 2002.
23
Morgan Stanley High Yield Securities Inc.
NOTES TO FINANCIAL STATEMENTS o AUGUST 31, 2002 continued
As of August 31, 2002, the Fund had temporary book/tax differences primarily
attributable to post-October losses, capital loss deferrals on wash sales, book
amortization of discounts on debt securities and interest and amortization of
discounts on bonds in default. The Fund had permanent book/tax differences
primarily attributable to an expired capital loss carryover and tax adjustments
on debt securities sold by the Fund. To reflect reclassifications arising from
the permanent differences, paid-in-capital was charged $172,175,337, dividends
in excess of net investment income was charged $948,800 and accumulated net
realized loss was credited $173,124,137.
6. Capital Stock
Transactions in capital stock were as follows:
FOR THE YEAR FOR THE YEAR
ENDED ENDED
AUGUST 31, 2002 AUGUST 31, 2001
--------------------------- ---------------------------
SHARES AMOUNT SHARES AMOUNT
------------ ------------- ------------ -------------
CLASS A SHARES
Sold.......................... 10,201,614 $ 20,177,481 19,209,128 $ 63,780,578
Reinvestment of dividends..... 1,119,515 2,083,474 1,049,177 3,186,287
Redeemed...................... (11,782,958) (23,700,021) (17,600,601) (59,066,199)
------------ ------------- ------------ -------------
Net increase (decrease) --
Class A...................... (461,829) (1,439,066) 2,657,704 7,900,666
------------ ------------- ------------ -------------
CLASS B SHARES
Sold.......................... 39,306,397 74,811,260 87,486,847 281,384,559
Reinvestment of dividends..... 14,993,853 27,953,825 17,505,252 53,772,493
Redeemed...................... (101,220,067) (190,557,689) (136,458,377) (426,230,286)
------------ ------------- ------------ -------------
Net decrease -- Class B....... (46,919,817) (87,792,604) (31,466,278) (91,073,234)
------------ ------------- ------------ -------------
CLASS C SHARES
Sold.......................... 7,565,119 14,251,142 13,531,056 45,899,890
Reinvestment of dividends..... 1,601,530 2,981,218 1,676,677 5,136,460
Redeemed...................... (8,724,288) (16,164,050) (13,756,797) (45,459,076)
------------ ------------- ------------ -------------
Net increase -- Class C....... 442,361 1,068,310 1,450,936 5,577,274
------------ ------------- ------------ -------------
CLASS D SHARES
Sold.......................... 13,842,546 25,568,899 20,506,858 63,372,986
Reinvestment of dividends..... 6,026,961 11,290,465 5,852,214 17,880,440
Redeemed...................... (23,300,211) (43,301,174) (24,049,991) (76,269,309)
------------ ------------- ------------ -------------
Net increase (decrease) --
Class D...................... (3,430,704) (6,441,810) 2,309,081 4,984,117
------------ ------------- ------------ -------------
Net decrease in Fund.......... (50,369,989) $ (94,605,170) (25,048,557) $ (72,611,177)
============ ============= ============ =============
24
Morgan Stanley High Yield Securities Inc.
NOTES TO FINANCIAL STATEMENTS o AUGUST 31, 2002 continued
7. Change in Accounting Policy
Effective September 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
$5,326,859 increase in the cost of securities and a corresponding increase in
undistributed net investment income based on securities held as of August 31,
2001.
The effect of this change for the year ended August 31, 2002 was to increase net
investment income by $4,981,336; increase unrealized depreciation by $3,780,819;
and increase net realized losses by $1,200,517. The statement of changes in net
assets and the financial highlights for prior periods have not been restated to
reflect this change.
8. Merger
On July 25, 2002, the Trustees of Morgan Stanley High Income Advantage Trust
("HIAT"), Morgan Stanley High Income Advantage Trust II ("HIAT II") and Morgan
Stanley High Income Advantage Trust III ("HIAT III") approved plans of
reorganization whereby HIAT, HIAT II and HIAT III would be merged into the Fund.
The plans of reorganization are subject to the consent of HIAT's, HIAT II's and
HIAT III's shareholders at separate meetings to be held on December 10, 2002. If
approved, the assets of HIAT, HIAT II and HIAT III would be combined with the
assets of the Fund and shareholders of HIAT, HIAT II and HIAT III would become
Class D shareholders of the Fund, receiving Class D shares of the Fund equal to
the value of their holdings in HIAT, HIAT II and HIAT III, respectively.
25
Morgan Stanley High Yield Securities Inc.
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of capital stock outstanding
throughout each period:
FOR THE YEAR ENDED AUGUST 31,
---------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
Class A Shares
Selected Per Share Data:
Net asset value,
beginning of period..... $ 2.32 $ 4.35 $ 5.51 $ 6.16 $ 6.82
------ ------ ------ ------ ------
Income (loss) from
investment operations:
Net investment
income[+/+]........... 0.26(2) 0.47 0.69 0.72 0.76
Net realized and
unrealized loss....... (0.73)(2) (1.99) (1.13) (0.63) (0.71)
------ ------ ------ ------ ------
Total income (loss) from
investment operations... (0.47) (1.52) (0.44) 0.09 0.05
------ ------ ------ ------ ------
Less dividends and
distributions from:
Net investment
income................ (0.27) (0.51) (0.72) (0.74) (0.71)
Paid-in-capital........ (0.03) - - - -
------ ------ ------ ------ ------
Total dividends and
distributions........... (0.30) (0.51) (0.72) (0.74) (0.71)
------ ------ ------ ------ ------
Net asset value, end of
period.................. $ 1.55 $ 2.32 $ 4.35 $ 5.51 $ 6.16
====== ====== ====== ====== ======
Total Return+............ (21.70)% (37.05)% (8.88)% 1.47% 0.40%
Ratios to Average Net
Assets(1):
Expenses................. 0.99 % 0.77 % 0.70 % 0.68% 0.75%
Net investment income.... 13.76 %(2) 15.17 % 13.62 % 12.42% 11.30%
Supplemental Data:
Net assets, end of
period, in thousands.... $23,879 $36,762 $57,273 $68,667 $30,678
Portfolio turnover
rate.................... 39 % 49 % 20 % 36% 66%
- ---------------------
[+/+] The per share amounts were computed using an average number of shares
outstanding during the period.
+ Does not reflect the deduction of sales charge. Calculated based on the
net asset value as of the last business day of the period.
(1) Reflects overall Fund ratios for investment income and non-class
specific expenses.
(2) Effective September 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 August 31, 2002 was to increase net investment
income per share and increase net realized and unrealized loss per share
by $0.01 and to increase the ratio of net investment income to average
net assets by 0.74%. The Financial Highlights data presented in this
table for prior periods has not been restated to reflect this change.
See Notes to Financial Statements
26
Morgan Stanley High Yield Securities Inc.
FINANCIAL HIGHLIGHTS continued
FOR THE YEAR ENDED AUGUST 31,
-------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------- ------------- ------------- ------------- -------------
Class B Shares
Selected Per Share Data:
Net asset value,
beginning of period..... $ 2.32 $ 4.34 $ 5.50 $ 6.15 $ 6.82
------ ------ ------ ------ ------
Income (loss) from
investment operations:
Net investment
income[+/+]........... 0.25(2) 0.46 0.66 0.69 0.73
Net realized and
unrealized loss....... (0.73)(2) (1.99) (1.13) (0.64) (0.72)
------ ------ ------ ------ ------
Total income (loss) from
investment operations... (0.48) (1.53) (0.47) 0.05 0.01
------ ------ ------ ------ ------
Less dividends and
distributions from:
Net investment
income................ (0.26) (0.49) (0.69) (0.70) (0.68)
Paid-in-capital........ (0.03) - - - -
------ ------ ------ ------ ------
Total dividends and
distributions........... (0.29) (0.49) (0.69) (0.70) (0.68)
------ ------ ------ ------ ------
Net asset value, end of
period.................. $ 1.55 $ 2.32 $ 4.34 $ 5.50 $ 6.15
====== ====== ====== ====== ======
Total Return+............ (22.00)% (37.27)% (9.39)% 0.92% (0.23)%
Ratios to Average Net
Assets(1):
Expenses................. 1.56 % 1.37 % 1.25 % 1.24% 1.25 %
Net investment income.... 13.19 %(2) 14.57 % 13.07 % 11.86% 10.80 %
Supplemental Data:
Net assets, end of
period, in thousands.... $371,399 $664,706 $1,381,008 $1,927,186 $1,761,147
Portfolio turnover
rate.................... 39 % 49 % 20 % 36% 66 %
- ---------------------
[+/+] The per share amounts were computed using an average number of shares
outstanding during the period.
+ Does not reflect the deduction of sales charge. Calculated based on the
net asset value as of the last business day of the period.
(1) Reflects overall Fund ratios for investment income and non-class
specific expenses.
(2) Effective September 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 August 31, 2002 was to increase net investment
income per share and increase net realized and unrealized loss per share
by $0.01 and to increase the ratio of net investment income to average
net assets by 0.74%. The Financial Highlights data presented in this
table for prior periods has not been restated to reflect this change.
See Notes to Financial Statements
27
Morgan Stanley High Yield Securities Inc.
FINANCIAL HIGHLIGHTS continued
FOR THE YEAR ENDED AUGUST 31,
----------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ------------ ----------- ----------- -----------
Class C Shares
Selected Per Share Data:
Net asset value,
beginning of period..... $ 2.32 $ 4.34 $ 5.51 $ 6.15 $ 6.82
------ ------ ------ ------ ------
Income (loss) from
investment operations:
Net investment
income[+/+]........... 0.25(2) 0.45 0.66 0.68 0.72
Net realized and
unrealized loss....... (0.73)(2) (1.98) (1.14) (0.62) (0.72)
------ ------ ------ ------ ------
Total income (loss) from
investment operations... (0.48) (1.53) (0.48) 0.06 0.00
------ ------ ------ ------ ------
Less dividends and
distributions from:
Net investment
income................ (0.26) (0.49) (0.69) (0.70) (0.67)
Paid-in-capital........ (0.03) - - - -
------ ------ ------ ------ ------
Total dividends and
distributions........... (0.29) (0.49) (0.69) (0.70) (0.67)
------ ------ ------ ------ ------
Net asset value, end of
period.................. $ 1.55 $ 2.32 $ 4.34 $ 5.51 $ 6.15
====== ====== ====== ====== ======
Total Return+............ (22.11)% (37.24)% (9.66)% 0.99% (0.34)%
Ratios to Average Net
Assets(1):
Expenses................. 1.66 % 1.47 % 1.35 % 1.34% 1.36 %
Net investment income.... 13.09 %(2) 14.47 % 12.97 % 11.76% 10.69 %
Supplemental Data:
Net assets, end of
period, in thousands.... $33,978 $49,818 $86,951 $109,142 $56,626
Portfolio turnover
rate.................... 39 % 49 % 20 % 36% 66 %
- ---------------------
[+/+] The per share amounts were computed using an average number of shares
outstanding during the period.
+ Does not reflect the deduction of sales charge. Calculated based on the
net asset value as of the last business day of the period.
(1) Reflects overall Fund ratios for investment income and non-class
specific expenses.
(2) Effective September 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 August 31, 2002 was to increase net investment
income per share and increase net realized and unrealized loss per share
by $0.01 and to increase the ratio of net investment income to average
net assets by 0.74%. The Financial Highlights data presented in this
table for prior periods has not been restated to reflect this change.
See Notes to Financial Statements
28
Morgan Stanley High Yield Securities Inc.
FINANCIAL HIGHLIGHTS continued
FOR THE YEAR ENDED AUGUST 31,
------------------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------ ------------ ----------- -----------
Class D Shares
Selected Per Share Data:
Net asset value,
beginning of period..... $ 2.32 $ 4.35 $ 5.51 $ 6.16 $ 6.82
------ ------ ------ ------ ------
Income (loss) from
investment operations:
Net investment
income[+/+]........... 0.26(2) 0.48 0.70 0.74 0.78
Net realized and
unrealized loss....... (0.73)(2) (1.99) (1.13) (0.64) (0.71)
------ ------ ------ ------ ------
Total income (loss) from
investment
operations.............. (0.47) (1.51) (0.43) 0.10 0.07
------ ------ ------ ------ ------
Less dividends and
distributions from:
Net investment
income................ (0.27) (0.52) (0.73) (0.75) (0.73)
Paid-in-capital........ (0.03) - - - -
------ ------ ------ ------ ------
Total dividends and
distributions........... (0.30) (0.52) (0.73) (0.75) (0.73)
------ ------ ------ ------ ------
Net asset value, end of
period.................. $ 1.55 $ 2.32 $ 4.35 $ 5.51 $ 6.16
====== ====== ====== ====== ======
Total Return+............ (21.45)% (36.95)% (8.69)% 1.67% 0.63%
Ratios to Average Net
Assets(1):
Expenses................. 0.81 % 0.62 % 0.50 % 0.49% 0.51%
Net investment income.... 13.94 %(2) 15.32 % 13.82 % 12.61% 11.54%
Supplemental Data:
Net assets, end of
period, in thousands.... $86,436 $137,319 $246,941 $333,714 $400,582
Portfolio turnover
rate.................... 39 % 49 % 20 % 36% 66%
- ---------------------
[+/+] The per share amounts were computed using an average number of shares
outstanding during the period.
+ Does not reflect the deduction of sales charge. Calculated based on the
net asset value as of the last business day of the period.
(1) Reflects overall Fund ratios for investment income and non-class
specific expenses.
(2) Effective September 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 August 31, 2002 was to increase net investment
income per share and increase net realized and unrealized loss per share
by $0.01 and to increase the ratio of net investment income to average
net assets by 0.74%. The Financial Highlights data presented in this
table for prior periods has not been restated to reflect this change.
See Notes to Financial Statements
29
Morgan Stanley High Yield Securities Inc.
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors of
Morgan Stanley High Yield Securities Inc.:
We have audited the accompanying statement of assets and liabilities of Morgan
Stanley High Yield Securities Inc. (the "Fund"), including the portfolio of
investments, as of August 31, 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 August 31, 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 High Yield Securities Inc. as of August 31, 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
September 23, 2002
30
Morgan Stanley High Yield Securities Inc.
DIRECTOR AND OFFICER INFORMATION
Independent Directors:
Number of
Portfolios
Term of in Fund
Position(s) Office and Complex
Name, Age and Address of Held with Length of Overseen
Independent Director Registrant Time Served* Principal Occupation(s) During Past 5 Years by Director**
- ------------------------- ----------- --------------- ------------------------------------------- ---------------------
Michael Bozic (61) Director Director 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) Director Director 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) Director Director 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 Director Other Directorships Held by Director
- ------------------------- ------------------------------------
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 loan
201 S. Main Street corporation), United Space Alliance
Salt Lake City, UT (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
31
Morgan Stanley High Yield Securities Inc.
DIRECTOR 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 Director Registrant Time Served* Principal Occupation(s) During Past 5 Years by Director**
- ------------------------- ----------- -------------- ------------------------------------------- ---------------------
Dr. Manuel H. Johnson Director Director 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 (66) Director Director 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).
Name, Age and Address of
Independent Director Other Directorships Held by Director
- ------------------------- ------------------------------------
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 (66) Director of various business
c/o Triumph Capital, L.P. organizations.
237 Park Avenue
New York, NY
32
Morgan Stanley High Yield Securities Inc.
DIRECTOR AND OFFICER INFORMATION continued
Interested Directors:
Term of
Position(s) Office and
Name, Age and Address of Held with Length of
Interested Director Registrant Time Served* Principal Occupation(s) During Past 5 Years
- ------------------------- ------------------- --------------- -------------------------------------------
Charles A. Fiumefreddo Chairman and Director since Chairman and Director or Trustee of the
(69) Director or Trustee July 1991 Morgan Stanley Funds and the TCW/DW Term
c/o Morgan Stanley Trust Trusts; formerly Chairman, Chief Executive
Harborside Financial Officer and Director of the Investment
Center, Manager, the Distributor and Morgan Stanley
Plaza Two, Services, Executive Vice President and
Jersey City, NJ 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) and
Chief Executive Officer of the Morgan
Stanley Funds and the TCW/ DW Term Trusts
(until September 2002).
James F. Higgins (54) Director Director 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) Director Director 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 Director by Director** Other Directorships Held by Director
- ------------------------- --------------------- ------------------------------------
Charles A. Fiumefreddo 129 None
(69)
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 Director 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.).
33
Morgan Stanley High Yield Securities Inc.
DIRECTOR 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 (49) President and Chief Executive President since May 1999 and Chief
1221 Avenue of the Americas Officer Executive Officer since September
New York, NY 2002
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
Ronald E. Robison (63) Vice President Since October 1998
1221 Avenue of the Americas
New York, NY
Joseph J. McAlinden (59) Vice President Since July 1995
1221 Avenue of the Americas
New York, NY
Francis Smith (37) Vice President and Chief Financial Since September 2002
c/o Morgan Stanley Trust Officer
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 (49) 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
(since June 1998) and Director (since
January 1998) of the Transfer Agent;
Director of various Morgan Stanley
subsidiaries; President (since May 1999)
and Chief Executive Officer (since
September 2002) of the Morgan Stanley Funds
and TCW/DW Term Trusts; 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
Ronald E. Robison (63) Managing Director, Chief Administrative
1221 Avenue of the Americas Officer and Director (since February 1999)
New York, NY of the Investment Manager and Morgan
Stanley Services and Chief Executive
Officer and Director of the Transfer Agent;
previously Managing Director of the TCW
Group Inc.
Joseph J. McAlinden (59) Managing Director and Chief Investment
1221 Avenue of the Americas Officer of the Investment Manager, Morgan
New York, NY Stanley Investment Management Inc. and
Morgan Stanley Investments LP; Director of
the Transfer Agent, Chief Investment
Officer of the Van Kampen Funds.
Francis Smith (37) Vice President and Chief Financial Officer
c/o Morgan Stanley Trust of the Morgan Stanley Funds and the TCW/DW
Harborside Financial Center Term Trusts (since September 2002);
Plaza Two, Executive Director of the Investment
Jersey City, NJ Manager and Morgan Stanley Services (since
December 2001). Formerly, Vice President of
the Investment Manager and Morgan Stanley
Services (August 2000-November 2001),
Senior Manager at PricewaterhouseCoopers
LLP (January 1998-August 2000) and
Associate-Fund Administration at BlackRock
Financial Management (July 1996-December
1997).
- ----------------------------
* Each officer serves an indefinite term, until his or her successor is
elected.
34
(This page has been left blank intentionally.)
DIRECTORS
Michael Bozic
Charles A. Fiumefreddo
Edwin J. Garn
Wayne E. Hedien
James F. Higgins
Dr. Manuel H. Johnson
Michael E. Nugent
Philip J. Purcell
OFFICERS
Charles A. Fiumefreddo
Chairman
Mitchell M. Merin
President and Chief Executive Officer
Barry Fink
Vice President, Secretary and General Counsel
Joseph J. McAlinden
Vice President
Ronald E. Robison
Vice President
Thomas F. Caloia
Treasurer
Francis Smith
Vice President and Chief Financial Officer
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
This report is submitted for the general information of the shareholders of
the Fund. For more detailed information about the Fund, its fees and expenses
and other pertinent information, please read its Prospectus. The Fund's
Statement of Additional Information contains additional information about the
Fund, including its trustees. It is available, without charge, by calling
(800) 869-NEWS.
This report is not authorized for distribution to prospective investors in
the Fund unless preceded or accompanied by an effective Prospectus. Read the
Prospectus carefully before investing.
Investments and services offered through Morgan Stanley DW Inc., member SIPC.
Morgan Stanley Funds are distributed by Morgan Stanley Distributors Inc.
Morgan Stanley Distributors Inc., member NASD.
[MORGAN STANLEY LOGO]
37915RPT 8136I02 ANS 9/02
[MORGAN STANLEY LOGO]
[COVER PHOTO]
MORGAN STANLEY
HIGH YIELD SECURITIES
ANNUAL REPORT
AUGUST 31, 2002
Morgan Stanley High Income Advantage Trust III
LETTER TO THE SHAREHOLDERS - JULY 31, 2002
Dear Shareholder:
After the sharp decline in September 2002, the high-yield market bounced back
over the next seven months. The signs of potential economic recovery early in
2002 and strong flows into the high-yield asset class contributed to the
improved tone of the market. However, the high-yield market weakened again
during the balance of the review period as the economy slowed and accounting
scandals at WorldCom and other companies shocked market participants. WorldCom
reported that it had misclassified nearly $3.9 billion in costs. This
announcement caused the market to fall significantly in late June as investor
confidence eroded. Strong inflows into the high-yield asset class -- totaling
nearly $9 billion from January through May -- stopped as investors withdrew
approximately $2 billion in June and July. The size of net redemptions led to
sales by mutual funds and dealers, resulting in lower prices.
On balance, credit spreads in the high-yield market relative to U.S. Treasury
securities widened to historically wide levels. Spreads also widened within the
lower-rated portion of the high-yield market as investors continued to prefer
investments in the relatively higher-quality end of the marketplace. In
addition, bonds in sectors related to telecommunications, cable and utilities
performed poorly as investors continued to be concerned about accounting
scandals and slower economic growth going forward.
Performance and Portfolio Strategy
For the 6-month period ended July 31, 2002, Morgan Stanley High Income Advantage
Trust III's net asset value (NAV) declined from $1.25 per share on January 31,
2002, to $1.07 per share on July 31, 2002. Based on this change, plus the
reinvestment of distributions totaling $0.072 per share, the Trust produced a
total return of -9.18 percent. For the same period, the Trust's market price on
the New York Stock Exchange (NYSE) declined from $1.27 per share on January 31,
2002, to $1.01 per share on July 31, 2002. Based on this change, plus the
reinvestment of distributions, the Trust produced a total return of -15.62
percent.
As noted, the past three years have been one of the most difficult periods for
the high-yield market. As a result of the substantial weakness in the market,
high-yield bond prices have declined sharply and yields have risen over much of
this period. The Trust's positions in the lower-rated portion of the market and
in communications-related industries have been adversely affected. The last
three months represented an extension of these difficulties.
The Trust's allocations in the fixed-line communications, wireless
communications and cable industries contributed to its disappointing performance
during the review period. These industries
Morgan Stanley High Income Advantage Trust III
LETTER TO THE SHAREHOLDERS - JULY 31, 2002 continued
were down by more than 30 percent over the past six months, thereby
underperforming the rest of the high-yield market. Accompanied by slower revenue
growth, higher default rates and many rating downgrades, these factors led
prices lower for most bonds in these industries. Despite the Trust's investments
in a number or these industries having been reduced over the past year,
allocations remained above market weights, thus adversely affecting performance.
Performance was helped by the higher-quality bonds added to the portfolio over
the past year, particularly those in the housing and health-care sectors. These
sectors performed better than most others in the high-yield market. Finally, an
underweighting of the utilities sector helped mitigate losses when this sector
came under pressure as a result of accounting concerns.
Over the course of the fiscal year, the Trust's portfolio management team
continued to reposition the portfolio for the current market environment. New
positions were initiated in many companies, including Starwood Hotels, Venetian,
Intermet, Metaldyne and Foamex.. The team increased the Trust's overall credit
quality by buying BB-rated securities and decreasing exposure to
telecommunications-related industries.
At fiscal year-end the Trust was overweighted toward wireline communications,
cable, wireless communications and media, as well as manufacturing and housing.
Underweighted positions included consumer products and retail. The Trust's
portfolio management team believes that consumer spending is likely to lag the
growth of the overall economy. The Trust also is underweighted toward utilities,
because of accounting concerns, and aerospace, as a result of slow demand.
Looking Ahead
June and July were two of the worst back-to-back months in the history of the
high-yield market. Although the spread widening that has occurred over the last
few months makes the market look attractive, it is uncertain how long it will
take to restore investor confidence. We anticipate that the economy may grow
moderately over the next 18 months. We believe this growth, if realized, should
help corporate balance sheets, which may in turn help to lower defaults among
high-yield issuers.
We also believe that the high-yield market may benefit from a structural shift
in its makeup that has occurred over the past year. One of the greatest excesses
of the late 1990s occurred when more and more lower-quality companies were able
to tap the high-yield market for financing. This wave of lower-quality companies
helped drag down the market's overall credit quality and was a large contributor
to the climbing default rates of the past two years. In our view, this trend
2
Morgan Stanley High Income Advantage Trust III
LETTER TO THE SHAREHOLDERS - JULY 31, 2002 continued
has reversed in the past year as lower-quality companies have been all but shut
out of the market for new issuance. We anticipate that this shift upward in
quality should also help reduce broader market default rates from their recent
elevated levels back to their historical averages.
Plan of Reorganization
On July 25, 2002, the Board of Trustees of the Trust and the Board of Directors
of Morgan Stanley High Yield Securities approved a proposed plan of
reorganization of the Trust into Morgan Stanley High Yield Securities, an
open-end investment company.
Pursuant to an Agreement and Plan of Reorganization, substantially all the
assets of the Trust would be combined with the assets of Morgan Stanley High
Yield Securities, effectively open-ending the Trust. Shareholders of the Trust
would receive Class D shares of Morgan Stanley High Yield Securities with a
value equal to the net asset value of their respective holdings in the Trust. If
shareholders of the Trust approve the Agreement and Plan of Reorganization, they
would become Class D shareholders of Morgan Stanley High Yield Securities and
the shares of the Trust will no longer be listed or traded on the New York Stock
Exchange. The approval of shareholders of Morgan Stanley High Yield Securities
is not required.
The Agreement and Plan of Reorganization will be submitted to shareholders of
the Trust at a Special Meeting presently scheduled to take place in December
2002. A proxy statement formally detailing the Agreement and Plan of
Reorganization will be mailed to shareholders in September. Morgan Stanley High
Income Advantage Trust III and Morgan Stanley High Yield Securities are managed
by Morgan Stanley Investment Advisors Inc.'s High Yield team.
We would like to remind you that the Trustees have approved a procedure whereby
the Trust may, when appropriate, repurchase shares in the open market or in
privately negotiated transactions at a price not above market value or net asset
value, whichever is lowest at the time of purchase.
3
Morgan Stanley High Income Advantage Trust III
LETTER TO THE SHAREHOLDERS - JULY 31, 2002 continued
We appreciate your ongoing support of Morgan Stanley High Income Advantage Trust
III 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
4
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JULY 31, 2002 (UNAUDITED)
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------------
Corporate Bonds (86.3%)
Advertising/Marketing Services (1.3%)
$ 180 Interep National Radio Sales, Inc. ..................... 10.00% 07/01/08 $ 159,300
-----------
Aerospace & Defense (0.5%)
225 Loral Space & Communications Ltd. ...................... 9.50 01/15/06 72,000
-----------
Airlines (0.7%)
155 Air Canada Corp. (Canada)............................... 10.25 03/15/11 100,750
-----------
Alternative Power Generation (0.4%)
95 Calpine Corp. .......................................... 8.50 02/15/11 48,450
-----------
Auto Parts: O.E.M. (4.6%)
35 Arvinmeritor, Inc. ..................................... 8.75 03/01/12 37,773
40 Collins & Aikman Products Co. .......................... 11.50 04/15/06 36,200
95 Collins & Aikman Products Co. .......................... 10.75 12/31/11 93,813
180 Dana Corp. ............................................. 9.00 08/15/11 172,800
55 Dura Operating Corp. ................................... 8.625 04/15/12 55,137
60 Intermet Corp. - 144A*.................................. 9.75 06/15/09 60,000
35 Lear Corp. (Series B)................................... 8.11 05/15/09 36,050
75 Metaldyne Corp. - 144A*................................. 11.00 06/15/12 69,000
60 Stoneridge, Inc. ....................................... 11.50 05/01/12 61,050
-----------
621,823
-----------
Broadcast/Media (1.4%)
270 Tri-State Outdoor Media Group, Inc. (b)................. 11.00 05/15/08 197,100
-----------
Broadcasting (1.7%)
125 Salem Communications Holdings Corp. .................... 9.00 07/01/11 125,625
60 XM Satellite Radio, Inc. ............................... 14.00 03/15/10 20,400
100 Young Broadcasting, Inc. ............................... 10.00 03/01/11 88,500
-----------
234,525
-----------
Cable/Satellite TV (4.8%)
3,750 Australis Holdings Property Ltd. (Australia) (a)(b)..... 15.00 11/01/02 0
60 British Sky Broadcasting Group PLC (United Kingdom)..... 6.875 02/23/09 54,718
150 British Sky Broadcasting Group PLC (United Kingdom)..... 8.20 07/15/09 144,910
225 Callahan Nordrhein Westfalen (Germany) (a)(b)........... 14.00 07/15/10 6,750
275 Charter Communications Holdings Corp. .................. 11.75++ 05/15/11 89,375
155 Echostar DBS Corp. - 144A*.............................. 9.125 01/15/09 142,600
See Notes to Financial Statements
5
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JULY 31, 2002 (UNAUDITED) continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------------
$ 375 Knology Holdings, Inc. ................................. 11.875++% 10/15/07 $ 127,500
155 Ono Finance PLC (United Kingdom)........................ 14.00 02/15/11 26,350
25 Pegasus Communications Corp. (Series B)................. 9.75 12/01/06 11,750
185 Telewest Communications PLC (United Kingdom)............ 9.875 02/01/10 37,000
355 United Pan-Europe Communications N.V. (Series B)
(Netherlands) (b)..................................... 10.875 08/01/09 18,194
-----------
659,147
-----------
Casino/Gaming (2.9%)
950 Aladdin Gaming Holdings Corp. (Series B)................ 13.50++ 03/01/10 19,000
55 Harrah's Operating Co., Inc. ........................... 8.00 02/01/11 59,130
110 Park Place Entertainment Corp. ......................... 8.875 09/15/08 111,650
600 Resort At Summerlin LP (Series B) (a)(b)................ 13.00 12/15/07 0
130 Station Casinos, Inc. .................................. 9.875 07/01/10 137,150
75 Venetian Casino/LV Sands - 144A*........................ 11.00 06/15/10 74,812
-----------
401,742
-----------
Cellular Telephone (0.7%)
50 Dobson/Sygnet Communications Co. ....................... 12.25 12/15/08 26,000
700 Dolphin Telecom PLC (Series B) (United Kingdom)
(a)(d)................................................ 14.00++ 05/15/09 70
3,200 Dolphin Telecom PLC (United Kingdom) (a)(d)............. 11.50++ 06/01/08 320
90 Tritel PCS, Inc. ....................................... 12.75++ 05/15/09 65,700
-----------
92,090
-----------
Chemicals: Major Diversified (1.6%)
86 Equistar Chemical/Funding............................... 10.125 09/01/08 78,475
160 Huntsman ICI Chemicals LLC.............................. 10.125 07/01/09 140,800
-----------
219,275
-----------
Chemicals: Specialty (2.2%)
60 Acetex Corp. (Canada)................................... 10.875 08/01/09 61,200
15 ISP Chemco, Inc. (Series B)............................. 10.25 07/01/11 14,625
125 ISP Holdings, Inc. (Series B)........................... 10.625 12/15/09 111,875
70 Lyondell Chemical Co. (Series B)........................ 9.875 05/01/07 65,625
40 Millennium America, Inc. ............................... 9.25 06/15/08 41,000
-----------
294,325
-----------
Commercial Printing/Forms (1.1%)
100 Mail-Well I Corp. - 144A*............................... 9.625 03/15/12 77,000
500 Premier Graphics, Inc. (b).............................. 11.50 12/01/05 15,625
20 Quebecor Media, Inc. (Canada)........................... 13.75++ 07/15/11 10,250
60 Quebecor Media, Inc. (Canada)........................... 11.125 07/15/11 52,800
-----------
155,675
-----------
See Notes to Financial Statements
6
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JULY 31, 2002 (UNAUDITED) continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------------
Consumer/Business Services (2.8%)
$ 622 Comforce Corp. (Series B)............................... 15.00+% 12/01/09 $ 186,480
94 MDC Communication Corp. (Canada)........................ 10.50 12/01/06 77,080
145 Muzak LLC/Muzak Finance Corp. .......................... 9.875 03/15/09 121,981
-----------
385,541
-----------
Containers/Packaging (2.3%)
220 Owens-Illinois, Inc. ................................... 7.80 05/15/18 173,800
55 Pliant Corp. ........................................... 13.00 06/01/10 56,375
80 Riverwood International Corp. .......................... 10.875 04/01/08 82,200
-----------
312,375
-----------
Diversified Manufacturing (1.3%)
225 Eagle-Picher Industries, Inc. .......................... 9.375 03/01/08 174,375
-----------
Electric Utilities (1.1%)
75 Mirant Americas General, Inc. .......................... 8.30 05/01/11 39,000
85 PG&E National Energy Group, Inc. ....................... 10.375 05/16/11 62,900
75 PSEG Energy Holdings - 144A*............................ 8.625 02/15/08 48,228
-----------
150,128
-----------
Electronic Components (1.0%)
20 Flextronics International Ltd. (Series B) (Singapore)... 9.875 07/01/10 20,200
255 Soletron Corp. (Conv.).................................. 0.00 11/20/20 111,881
-----------
132,081
-----------
Electronic Distributors (1.0%)
125 BRL Universal Equipment Corp. .......................... 8.875 02/15/08 124,375
1,000 CHS Electronics, Inc. (a)(b)............................ 9.875 04/15/05 8,750
-----------
133,125
-----------
Electronic Equipment/Instruments (0.5%)
190 High Voltage Engineering, Inc. ......................... 10.75 08/15/04 68,400
-----------
Electronics/Appliances (0.0%)
5,000 International Semi-Tech Microelectronics, Inc. (Canada)
(a)(b)................................................ 11.50 08/15/03 500
-----------
Engineering & Construction (0.1%)
55 Encompass Services Corp. ............................... 10.50 05/01/09 13,750
300 Metromedia Fiber Network, Inc. (a)(b)................... 10.00 12/15/09 3,000
-----------
16,750
-----------
See Notes to Financial Statements
7
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JULY 31, 2002 (UNAUDITED) continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------------
Environmental Services (1.8%)
$ 150 Allied Waste North America, Inc. (Series B)............. 10.00% 08/01/09 $ 135,000
110 WMX Technologies, Inc. ................................. 7.00 10/15/06 116,642
-----------
251,642
-----------
Finance/Rental/Leasing (0.3%)
10 CIT Group, Inc. ........................................ 6.50 02/07/06 9,899
25 CIT Group, Inc. ........................................ 5.625 05/17/04 24,946
-----------
34,845
-----------
Financial Conglomerates (0.3%)
45 Case Credit Corp. ...................................... 6.125 02/15/03 44,236
-----------
Food Distributors (0.9%)
125 Volume Services America, Inc. .......................... 11.25 03/01/09 118,750
-----------
Food: Meat/Fish/Dairy (2.2%)
105 Michael Foods, Inc. (Series B).......................... 11.75 04/01/11 114,975
115 Smithfield Foods, Inc. ................................. 7.625 02/15/08 112,700
70 Smithfield Foods, Inc. (Series B)....................... 8.00 10/15/09 70,350
-----------
298,025
-----------
Forest Products (2.1%)
40 Louisiana Pacific Corp. ................................ 8.875 08/15/10 43,321
110 Louisiana Pacific Corp. ................................ 10.875 11/15/08 114,950
130 Tembec Industries, Inc. (Canada)........................ 8.50 02/01/11 130,650
-----------
288,921
-----------
Gas Distributors (0.3%)
90 Dynegy Holdings, Inc. .................................. 6.875 04/01/11 34,200
-----------
Home Building (2.7%)
145 Schuler Homes, Inc. .................................... 9.375 07/15/09 145,725
55 Tech Olympic USA, Inc. - 144A*.......................... 9.00 07/01/10 51,769
60 Tech Olympic USA, Inc. - 144A*.......................... 10.375 07/01/12 57,075
110 Toll Corp. ............................................. 8.25 02/01/11 107,800
-----------
362,369
-----------
Hospital/Nursing Management (1.2%)
145 HCA Inc. ............................................... 8.75 09/01/10 161,664
-----------
See Notes to Financial Statements
8
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JULY 31, 2002 (UNAUDITED) continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------------
Hotels/Resorts/Cruiselines) (3.6%)
$ 45 Hilton Hotels Corp. .................................... 7.95% 04/15/07 $ 45,852
120 HMH Properties, Inc. (Series B)......................... 7.875 08/01/08 113,100
135 Horseshoe Gaming Holding Corp.(Series B)................ 8.625 05/15/09 137,025
100 Prime Hospitality Corp. - 144A*......................... 8.375 05/01/12 96,500
25 Starwood Hotels & Resorts Worldwide, Inc. - 144A*....... 7.375 05/01/07 23,875
85 Starwood Hotels & Resorts Worldwide, Inc. - 144A*....... 7.875 05/01/12 80,325
-----------
496,677
-----------
Industrial Conglomerates (0.4%)
75 Tyco International Group S.A. (Luxembourg).............. 6.75 02/15/11 56,250
-----------
Industrial Specialties (1.3%)
35 Foamex LP/Capital Corp. - 144A*......................... 10.75 04/01/09 35,613
25 Johnsondiversey, Inc. - 144A*........................... 9.625 05/15/12 25,875
20 Tekni-Plex, Inc. (Series B)............................. 12.75 06/15/10 19,600
25 Tekni-Plex, Inc. - 144A*................................ 12.75 06/15/10 24,500
70 UCAR Finance Inc. ...................................... 10.25 02/15/12 70,000
-----------
175,588
-----------
Internet Software/Services (1.3%)
230 Exodus Communications, Inc. (a)(b)...................... 11.625 07/15/10 14,375
500 Globix Corp. (a)(b)..................................... 12.50 02/01/10 85,000
250 PSINet, Inc. (a)(b)..................................... 10.50 12/01/06 24,688
600 PSINet, Inc. (a)(b)..................................... 11.00 08/01/09 59,250
-----------
183,313
-----------
Managed Health Care (2.1%)
195 Aetna, Inc. ............................................ 7.875 03/01/11 209,131
70 Healthnet, Inc. ........................................ 8.375 04/15/11 77,233
-----------
286,364
-----------
Media Conglomerates (1.2%)
80 AOL Time Warner, Inc. .................................. 6.875 05/01/12 66,734
100 Nextmedia Operating, Inc. .............................. 10.75 07/01/11 97,500
-----------
164,234
-----------
Medical Distributors (0.7%)
90 Amerisource Bergen Corp. ............................... 8.125 09/01/08 91,800
-----------
Medical/Nursing Services (1.0%)
160 Fresenius Medical Care Capital Trust.................... 7.875 06/15/11 136,000
-----------
See Notes to Financial Statements
9
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JULY 31, 2002 (UNAUDITED) continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------------
Metal Fabrications (0.6%)
$ 85 Trimas Corp. - 144A*.................................... 9.875% 06/15/12 $ 83,300
-----------
Movies/Entertainment (1.6%)
135 Alliance Atlantis Communications, Inc. (Canada)......... 13.00 12/15/09 144,619
80 Six Flags, Inc. ........................................ 8.875 02/01/10 77,800
-----------
222,419
-----------
Office Equipment/Supplies (0.0%)
1,300 Mosler, Inc. (a)(b)..................................... 11.00 04/15/03 0
-----------
Oil & Gas Pipelines (0.3%)
100 Williams Companies, Inc. (Series A)..................... 7.50 01/15/31 43,500
-----------
Oil & Gas Production (2.8%)
160 Chesapeake Energy Corp. ................................ 8.125 04/01/11 156,200
20 Magnum Hunter Resources, Inc.- 144A*.................... 9.60 03/15/12 20,100
55 Stone Energy Corp. ..................................... 8.25 12/15/11 55,138
170 Vintage Petroleum, Inc. ................................ 7.875 05/15/11 153,000
-----------
384,438
-----------
Oil Refining/Marketing (1.4%)
95 Husky Oil Ltd. (Canada)................................. 8.90 08/15/28 104,086
120 Tesoro Petroleum Corp. - 144A*.......................... 9.625 04/01/12 89,400
-----------
193,486
-----------
Oilfield Services/Equipment (0.7%)
60 Hanover Equipment Trust - 144A*......................... 8.50 09/01/08 50,400
55 Hanover Equipment Trust - 144A*......................... 8.75 09/01/11 45,650
-----------
96,050
-----------
Other Metals/Minerals (0.9%)
80 Murrin Murrin Holdings Property Ltd. (Australia)........ 9.375 08/31/07 22,400
100 Phelps Dodge Corp. ..................................... 8.75 06/01/11 105,438
-----------
127,838
-----------
Publishing: Books/Magazines (0.8%)
145 PRIMEDIA, Inc. ......................................... 8.875 05/15/11 104,400
-----------
Publishing: Newspapers (0.6%)
95 Holliner Participation Trust (Canada) - 144A*........... 12.125+ 11/15/10 85,464
-----------
See Notes to Financial Statements
10
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JULY 31, 2002 (UNAUDITED) continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------------
Pulp & Paper (0.8%)
$ 110 Norske Skog Canada Ltd. (Canada)........................ 8.625% 06/15/11 $ 110,825
-----------
Real Estate Development (0.7%)
120 CB Richard Ellis Services, Inc. ........................ 11.25 06/15/11 97,200
-----------
Real Estate Investment Trusts (0.5%)
65 Istar Financial, Inc. .................................. 8.75 08/15/08 65,653
-----------
Recreational Products (1.2%)
150 International Game Technology........................... 8.375 05/15/09 157,125
-----------
Restaurants (2.6%)
6,251 American Restaurant Group Holdings, Inc. - 144A* (c).... 0.00 12/15/05 191,271
1,500 FRD Acquisition Corp. (Series B) (a)(b)................. 12.50 07/15/04 165,000
-----------
356,271
-----------
Savings Banks (0.2%)
25 GS Escrow Corp. ........................................ 7.125 08/01/05 26,713
-----------
Semiconductors (0.5%)
25 Fairchild Semiconductors Corp. ......................... 10.375 10/01/07 26,125
45 Fairchild Semiconductors Corp. ......................... 10.50 02/01/09 47,925
-----------
74,050
-----------
Services to the Health Industry (2.1%)
75 Anthem Insurance - 144A*................................ 9.125 04/01/10 86,369
100 Healthsouth Corp. - 144A*............................... 7.625 06/01/12 88,927
110 Omnicare, Inc. (Series B)............................... 8.125 03/15/11 113,575
-----------
288,871
-----------
Specialty Stores (0.6%)
75 AutoNation, Inc. ....................................... 9.00 08/01/08 77,438
-----------
Specialty Telecommunications (3.5%)
110 American Tower Corp. ................................... 9.375 02/01/09 58,300
1,000 Birch Telecom, Inc. (a)(b).............................. 14.00 06/15/08 10,000
300 DTI Holdings, Inc. (Series B) (a)(d).................... 12.50++ 03/01/08 375
500 Esprit Telecom Group PLC (United Kingdom) (b)........... 10.875 06/15/08 50
950 Esprit Telecom Group PLC (United Kingdom) (b)........... 11.50 12/15/07 95
1,800 Firstworld Communications, Inc. (a)(d).................. 13.00++% 04/15/08 166,500
See Notes to Financial Statements
11
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JULY 31, 2002 (UNAUDITED) continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------------
$ 110 Global Crossing Holdings Ltd. (Bermuda) (a)(b).......... 9.50% 11/15/09 $ 1,100
225 Global Crossing Holdings Ltd. (Bermuda) (a)(b).......... 8.70 08/01/07 2,250
510 GT Group Telecom, Inc. (Canada) (a)(d).................. 13.25++ 02/01/10 1,275
300 Primus Telecommunications Group, Inc. (Series B)........ 9.875 05/15/08 147,000
250 Versatel Telecom International N.V. (Netherlands)
(a)(b)................................................ 13.25 05/15/08 75,000
200 Viatel Inc. (d)......................................... 12.50++ 04/15/08 1,000
700 Viatel Inc. (b)......................................... 11.25 04/15/08 3,500
300 Viatel Inc. (issued 12/08/99) (b)....................... 11.50 03/15/09 1,500
250 Viatel Inc. (issued 03/19/99) (b)....................... 11.50 03/15/09 1,250
735 World Access, Inc. (a)(b)(c)............................ 13.25 01/15/08 7,350
250 Worldwide Fiber, Inc. (Canada) (a)(b)................... 12.00 08/01/09 25
-----------
476,570
-----------
Steel (0.3%)
35 Oregon Steel Mills, Inc. - 144A*........................ 10.00 07/15/09 35,525
-----------
Telecommunication Equipment (0.8%)
230 Corning, Inc. (Conv.)................................... 0.00 11/08/15 105,800
-----------
Telecommunications (1.9%)
1,300 e. Spire Communications, Inc. (a)(b).................... 13.75 07/15/07 3,250
390 Focal Communications Corp. (Series B)................... 12.125++ 02/15/08 35,100
250 Hyperion Telecommunication, Inc. (Series B) (b)......... 12.25 09/01/04 12,500
250 MGC Communications, Inc. (a)(b)......................... 13.00 04/01/10 10,000
500 NEXTLINK Communications LLC (a)(b)...................... 12.50 04/15/06 5,000
390 NTL Communications Corp. (Series B) (a)(b).............. 11.875 10/01/10 66,300
900 Rhythms Netconnections, Inc. (b)........................ 12.75 04/15/09 22,500
1,500 Rhythms Netconnections, Inc. (b)........................ 14.00 02/15/10 37,500
250 Startec Global Communications Corp. (a)(b).............. 12.00 05/15/08 25
115 Talton Holdings, Inc. (Series B)........................ 11.00 06/30/07 34,500
49 WorldCom, Inc. (a,b).................................... 6.95 08/15/28 6,248
205 WorldCom, Inc. (a,b).................................... 8.25 05/15/31 26,138
-----------
259,061
-----------
Trucks/Construction/Farm Machinery (1.7%)
45 Case Corp. (Series B)................................... 6.25 12/01/03 43,993
170 J.B. Poindexter & Co., Inc. ............................ 12.50 05/15/04 153,213
30 NMHG Holding Co. - 144A*................................ 10.00 05/15/09 30,300
-----------
227,506
-----------
12
See Notes to Financial Statements
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JULY 31, 2002 (UNAUDITED) continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------------
Wholesale Distributors (1.1%)
$ 90 Burhmann US, Inc. ...................................... 12.25% 11/01/09 $ 91,800
60 Fisher Scientific International , Inc. ................. 7.125 12/15/05 60,000
-----------
151,800
-----------
Wireless Telecommunications (0.7%)
150 American Cellular Corp. ................................ 9.50 10/15/09 21,000
40 Arch Wireless Holdings, Inc. ........................... 12.00 05/15/09 6,000
79 Arch Wireless Holdings, Inc. ........................... 10.00 05/15/07 52,930
4,000 CellNet Data Systems, Inc. (a)(d)....................... 14.00++ 10/01/07 400
500 Globalstar LP/Capital Corp. (a)(b)...................... 10.75 11/01/04 20,000
500 WinStar Communications, Inc. (a)(b)..................... 12.75 04/15/10 50
-----------
100,380
-----------
Total Corporate Bonds (Cost $43,367,158)........................................... 11,766,038
-----------
NUMBER OF
SHARES
- ---------
Preferred Stocks (4.4%)
Broadcasting (0.6%)
13 Paxson Communications Corp.+....................................................... 77,160
-----------
Cellular Telephone (0.7%)
60 Dobson Communications Corp.+....................................................... 18,000
164 Nextel Communications, Inc.(Series D)+............................................. 82,105
-----------
100,105
-----------
Electric Utilities (1.0%)
149 TNP Enterprises, Inc. (Series D)+.................................................. 134,100
-----------
Publishing: Books/Magazines (0.0%)
130 PRIMEDIA, Inc. .................................................................... 4,160
-----------
Restaurants (0.3%)
47 FRD Acquisition Co. (Units) ++..................................................... 47,000
-----------
13
See Notes to Financial Statements
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JULY 31, 2002 (UNAUDITED) continued
NUMBER OF
SHARES VALUE
- -------------------------------------------------------------------------------------------------------------
Specialty Telecommunications (0.2%)
171 Broadwing Communications, Inc. (Series B).......................................... $ 17,100
1 Crown Castle International Corp.+.................................................. 494
40 Intermedia Communications, Inc. (Series B)+........................................ 2,226
1,055 McLeodUSA, Inc. (Series A) $0.44 (Conv.)........................................... 3,852
4,102 XO Communications, Inc. ........................................................... 82
-----------
23,754
-----------
Telecommunication Equipment (1.6%)
470,213 FWT, Inc. (Series A) (c)........................................................... 211,596
-----------
Total Preferred Stocks (Cost $2,573,889)........................................... 597,875
-----------
Common Stocks (d) (2.5%)
Aerospace & Defense (0.1%)
3,056 Orbital Sciences Corp. (c)......................................................... 11,888
-----------
Apparel/Footwear Retail (0.0%)
551,830 County Seat Stores, Inc. (c)....................................................... 0
-----------
Consumer/Business Services (1.3%)
9,750 Anacomp, Inc. (Class A) (c)........................................................ 170,625
-----------
Food: Specialty/Candy (0.0%)
453 SFAC New Holdings, Inc. (c)........................................................ 0
83 SFFB Holdings, Inc. (c)............................................................ 0
90,000 Specialty Foods Acquisition Corp. - 144A*.......................................... 0
-----------
0
-----------
Medical Specialties (0.1%)
1,658 MEDIQ, Inc. (c).................................................................... 9,003
-----------
Medical/Nursing Services (0.0%)
104,665 Raintree Healthcare Corp. (c)...................................................... 0
-----------
Restaurants (0.0%)
4,750 American Restaurant Group Holdings, Inc. - 144A*................................... 0
-----------
See Notes to Financial Statements
14
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JULY 31, 2002 (UNAUDITED) continued
NUMBER OF
SHARES VALUE
- -------------------------------------------------------------------------------------------------------------
Specialty Telecommunications (0.0%)
555 Versatel Telecom International N.V. (ADR) (Netherlands)............................ $ 1,887
3,142 World Access, Inc. (c)............................................................. 6
-----------
1,893
-----------
Telecommunication Equipment (0.0%)
41,066 FWT, Inc. (Class A) (c)............................................................ 411
-----------
Telecommunications (0.1%)
24,260 Covad Communications Group, Inc. (c)............................................... 28,384
2,197 Focal Communications Corp. (c)..................................................... 2,900
-----------
31,284
-----------
Textiles (0.0%)
112,296 United States Leather, Inc. (c).................................................... 0
-----------
Wireless Telecommunications (0.9%)
5,767 Arch Wireless, Inc. (c)............................................................ 3,056
21,268 Motient Corp. (c).................................................................. 116,974
8,393 Vast Solutions, Inc. (Class B1) (c)................................................ 0
8,393 Vast Solutions, Inc. (Class B2) (c)................................................ 0
8,393 Vast Solutions, Inc. (Class B3) (c)................................................ 0
-----------
120,030
-----------
Total Common Stocks (Cost $12,378,412)............................................. 345,134
-----------
NUMBER OF EXPIRATION
WARRANTS DATE
- --------- ----------
Warrants (d) (0.0%)
Aerospace & Defense (0.0%)
2,500 Sabreliner Corp. - 144A*........................................... 04/15/03 0
-----------
Broadcasting (0.0%)
130 XM Satellite Radio, Inc. - 144A*................................... 03/15/10 325
-----------
Cable/Satellite TV (0.0%)
155 ONO Finance PLC (United Kingdom) - 144A*........................... 03/16/11 15
-----------
See Notes to Financial Statements
15
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JULY 31, 2002 (UNAUDITED) continued
NUMBER OF EXPIRATION
WARRANTS DATE VALUE
- -------------------------------------------------------------------------------------------------------------
Casino/Gaming (0.0%)
17,750 Aladdin Gaming Enterprises, Inc. - 144A*........................... 03/01/10 $ 0
500 Resort At Summerlin LP - 144A*..................................... 12/15/07 0
-----------
0
-----------
Electric Utilities (0.0%)
150 TNP Enterprises, Inc. - 144A*...................................... 04/01/11 3,750
-----------
Internet Software/Services (0.0%)
1,800 Varado Holdings, Inc. - 144A*...................................... 04/15/08 0
-----------
Specialty Telecommunications (0.0%)
1,000 Birch Telecom, Inc. - 144A*........................................ 06/15/08 0
510 GT Group Telecom, Inc. - 144A* (Canada)............................ 02/01/10 51
2,338 McLeodUSA, Inc. ................................................... 04/16/07 398
-----------
449
-----------
Telecommunications (0.0%)
250 Startec Global Communications Corp. - 144A*........................ 05/15/08 0
-----------
Wireless Telecommunications (0.0%)
300 Motient Corp. - 144A*.............................................. 04/01/08 3
-----------
Total Warrants (Cost $123,977)..................................................... 4,542
-----------
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE
- --------- ------ ----------
Short-Term Investment (4.2%)
Repurchase Agreement
$ 570 Joint repurchase agreement account (dated 07/31/02;
proceeds $570,029) (e) (Cost $570,000).................. 1.84% 08/01/02 570,000
-----------
Total Investments (Cost $59,013,436) (f).................. 97.4 % 13,283,589
Other Assets in Excess of Liabilities..................... 2.6 361,132
---- -----------
Net Assets................................................ 100.0% $13,644,721
===== ===========
See Notes to Financial Statements
16
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JULY 31, 2002 (UNAUDITED) continued
- ---------------------
ADR American Depository Receipt.
* Resale is restricted to qualified institutional investors.
+ Payment-in-kind security.
++ Currently a zero coupon bond that is scheduled to pay
interest at the rate shown at a future specified date.
[+/+] Consists of one or more classes of securities traded
together as a unit; preferred stocks with attached warrants.
(a) Issuer in bankruptcy.
(b) Non-income producing security; bond in default.
(c) Acquired through exchange offer.
(d) Non-income producing securities.
(e) Collateralized by federal agency and U.S. Treasury
obligations.
(f) The aggregate cost for federal income tax purposes
approximates the aggregate cost for book purposes. The
aggregate gross unrealized appreciation is $181,634 and the
aggregate gross unrealized depreciation is $45,911,481,
resulting in net unrealized depreciation of $45,729,847.
See Notes to Financial Statements
17
Morgan Stanley High Income Advantage Trust III
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
July 31, 2002 (unaudited)
Assets:
Investments in securities, at value
(cost $59,013,436)........................................ $13,283,589
Receivable for:
Interest................................................ 316,325
Investments sold........................................ 51,397
Prepaid expenses and other assets........................... 46,909
------------
Total Assets............................................ 13,698,220
------------
Liabilities:
Investment management fee payable........................... 9,649
Accrued expenses and other payables......................... 43,850
------------
Total Liabilities....................................... 53,499
------------
Net Assets.............................................. $13,644,721
============
Composition of Net Assets:
Paid-in-capital............................................. $107,969,002
Net unrealized depreciation................................. (45,729,847)
Dividends in excess of net investment income................ (577,944)
Accumulated net realized loss............................... (48,016,490)
------------
Net Assets.............................................. $13,644,721
============
Net Asset Value Per Share,
12,792,179 shares outstanding
(unlimited shares authorized of $.01 par value)........... $1.07
============
See Notes to Financial Statements
18
Morgan Stanley High Income Advantage Trust III
FINANCIAL STATEMENTS continued
Statement of Operations
For the six months ended July 31, 2002 (unaudited)
Net Investment Income:
Income
Interest.................................................... $ 999,763
Dividends................................................... 11,338
-----------
Total Income............................................ 1,011,101
-----------
Expenses
Investment management fee................................... 57,271
Professional fees........................................... 46,099
Registration fees........................................... 17,935
Transfer agent fees and expenses............................ 17,641
Shareholder reports and notices............................. 14,208
Custodian fees.............................................. 8,254
Trustees' fees and expenses................................. 5,779
Other....................................................... 5,176
-----------
Total Expenses.......................................... 172,363
-----------
Net Investment Income................................... 838,738
-----------
Net Realized and Unrealized Loss:
Net realized loss........................................... (6,169,982)
Net change in unrealized depreciation....................... 3,843,223
-----------
Net Loss................................................ (2,326,759)
-----------
Net Decrease................................................ $(1,488,021)
===========
See Notes to Financial Statements
19
Morgan Stanley High Income Advantage Trust III
FINANCIAL STATEMENTS continued
Statement of Changes in Net Assets
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
JULY 31, JANUARY 31, 2002
2002
----------- ----------------
(unaudited)
Increase (Decrease) in Net Assets:
Operations:
Net investment income....................................... $ 838,738 $ 3,054,593
Net realized loss........................................... (6,169,982) (6,633,349)
Net change in unrealized depreciation....................... 3,843,223 (6,609,909)
----------- ------------
Net Decrease............................................ (1,488,021) (10,188,665)
Dividends to shareholders from net investment income........ (923,408) (3,734,923)
Decrease from transactions in shares of beneficial
interest.................................................. (36,261) (16,018)
----------- ------------
Net Decrease............................................ (2,447,690) (13,939,606)
Net Assets:
Beginning of period......................................... 16,092,411 30,032,017
----------- ------------
End of Period
(Including dividends in excess of net investment income of
$577,944 and $493,274, respectively)........................ $13,644,721 $ 16,092,411
=========== ============
See Notes to Financial Statements
20
Morgan Stanley High Income Advantage Trust III
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2002 (UNAUDITED)
1. Organization and Accounting Policies
Morgan Stanley High Income Advantage Trust III (the "Trust") is registered under
the Investment Company Act of 1940, as amended, as a diversified, closed-end
management investment company. The Trust's primary investment objective is to
earn a high level of current income and, as a secondary objective, capital
appreciation, but only when consistent with its primary objective. The Trust
seeks to achieve its objective by investing primarily in lower-rated fixed
income securities. The Trust was organized as a Massachusetts business trust on
November 23, 1988 and commenced operations on February 28, 1989.
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) an equity 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
securities are traded on more than one exchange; the securities are valued on
the exchange designated as the primary market pursuant to procedures adopted by
the Trustees); (2) all other portfolio securities for which over-the-counter
market quotations are readily available are valued at the latest available bid
price; (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 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; (4) certain of the Trust's 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 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.
21
Morgan Stanley High Income Advantage Trust III
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2002 (UNAUDITED) continued
B. Accounting for Investments -- Security transactions are accounted for on the
trade date (date the order to buy or sell is executed). Realized gains and
losses on security transactions are determined by the identified cost method.
Discounts are accreted and premiums are amortized over the life of the
respective securities. Interest income is accrued daily except where collection
is not expected.
C. Joint Repurchase Agreement Account -- Pursuant to an Exemptive Order issued
by the Securities and Exchange Commission, the Trust, 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 and are
collateralized by cash, or U.S. Treasury or federal agency obligations.
D. Federal Income Tax Status -- It is the Trust'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.
E. Dividends and Distributions to Shareholders -- The Trust 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 Agreement
Pursuant to an Investment Management Agreement, the Trust pays the Investment
Manager a management fee, calculated weekly and payable monthly, by applying the
following annual rates to the Trust's weekly net assets: 0.75% to the portion of
weekly net assets not exceeding $250 million; 0.60% to the portion of weekly net
assets exceeding $250 million but not exceeding $500 million; 0.50% to the
portion of weekly net assets exceeding $500 million but
22
Morgan Stanley High Income Advantage Trust III
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2002 (UNAUDITED) continued
not exceeding $750 million; 0.40% to the portion of weekly net assets exceeding
$750 million but not exceeding $1 billion; and 0.30% to the portion of weekly
net assets exceeding $1 billion.
3. Security Transactions and Transactions with Affiliates
The cost of purchases and proceeds from sales of portfolio securities, excluding
short-term investments, for the six months ended July 31, 2002 aggregated
$3,495,926 and $3,779,459, respectively.
Morgan Stanley Trust, an affiliate of the Investment Manager, is the Trust's
transfer agent. At July 31, 2002, the Trust had transfer agent fees and expenses
payable of approximately $5,000.
4. Shares of Beneficial Interest
CAPITAL
PAID IN
EXCESS OF
SHARES PAR VALUE PAR VALUE
---------- --------- ------------
Balance, January 31, 2001................................... 12,837,779 $128,378 $111,148,908
Treasury shares purchased and retired (weighted average
discount 2.38%)*.......................................... (11,600) (116) (15,902)
Reclassification due to permanent book/tax differences...... -- -- (3,256,005)
---------- -------- ------------
Balance, January 31, 2002................................... 12,826,179 128,262 107,877,001
Treasury shares purchased and retired (weighted average
discount 3.30%)*.......................................... (34,000) (340) (35,921)
---------- -------- ------------
Balance, July 31, 2002...................................... 12,792,179 $127,922 $107,841,080
========== ======== ============
- ---------------------
* The Trustees have voted to retire the shares purchased.
5. Dividends
The Trust declared the following dividends from net investment income:
DECLARATION AMOUNT RECORD PAYABLE
DATE PER SHARE DATE DATE
- --------------------- --------- ----------------- ------------------
July 30, 2002 $0.012 August 9, 2002 August 23, 2002
August 27, 2002 $0.012 September 6, 2002 September 20, 2002
23
Morgan Stanley High Income Advantage Trust III
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2002 (UNAUDITED) continued
6. Federal Income Tax Status
At January 31, 2002, the Trust had a net capital loss carryover of approximately
$40,649,000, which may be used to offset future capital gains to the extent
provided by regulations which is available through January 31 of the following
years:
AMOUNT IN THOUSANDS
-----------------------------------------------------------------------
2003 2004 2005 2006 2007 2008 2009 2010
------- ------ ------ ------ ------ ------ ------ -------
$10,665 $4,258 $3,007 $5,910 $1,633 $1,867 $2,195 $11,114
======= ====== ====== ====== ====== ====== ====== =======
Capital losses incurred after October 31 ("post-October losses") within the
taxable year are deemed to arise on the first business day of the Trust's next
taxable year. The Trust incurred and will elect to defer net capital losses of
approximately $1,198,000 during fiscal 2002.
As of January 31, 2002, the Trust had temporary book/tax differences primarily
attributable to post-October losses and book amortization of discount on debt
securities and interest on bonds in default.
7. Litigation
On August 29, 2001, a purported class action complaint was filed in the United
States District Court for the Southern District of New York on behalf of
investors in Morgan Stanley High Income Advantage Trust III alleging that the
Trust, its investment advisor and certain of its officers violated the
Investment Company Act of 1940 by deviating from a fundamental investment
restriction by purportedly investing over 25% of its assets in a single
industry. On September 24, 2002, the Court dismissed the complaint with
prejudice.
8. Subsequent Event -- Merger
On July 25, 2002, the Board of Trustees of the Trust and Morgan Stanley High
Yield Securities Inc. ("High Yield") approved a plan of reorganization whereby
the Trust would be merged into High Yield. The Plan of reorganization is subject
to the consent of the Trust's shareholders at a meeting to be held on December
10, 2002. If approved, the assets of the Trust would be combined with the assets
of High Yield and shareholders of the Trust would become Class D shareholders of
High Yield, receiving Class D shares of High Yield equal to the value of their
holdings in the Trust.
24
Morgan Stanley High Income Advantage Trust III
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 JANUARY 31,
MONTHS ENDED -----------------------------------------------
JULY 31, 2002 2002 2001 2000 1999 1998
------------- ------- ------- ------- ------- -------
(unaudited)
Selected Per Share Data:
Net asset value, beginning of period................ $1.25 $2.34 $4.04 $ 5.02 $ 6.18 $ 6.11
----- ----- ----- ------ ------ ------
Income (loss) from investment operations:
Net investment income........................... 0.07 0.24 0.59 0.66 0.72 0.78
Net realized and unrealized gain (loss)......... (0.18) (1.04) (1.65) (0.94) (1.16) 0.05
----- ----- ----- ------ ------ ------
Total income (loss) from investment operations...... (0.11) (0.80) (1.06) (0.28) (0.44) 0.83
----- ----- ----- ------ ------ ------
Less dividends from net investment income........... (0.07) (0.29) (0.64) (0.70) (0.72) (0.76)
----- ----- ----- ------ ------ ------
Net asset value, end of period...................... $1.07 $1.25 $2.34 $ 4.04 $ 5.02 $ 6.18
===== ===== ===== ====== ====== ======
Market value, end of period......................... $1.01 $1.27 $3.97 $4.188 $5.938 $7.375
===== ===== ===== ====== ====== ======
Total Return+....................................... (15.62)%(1) (63.16)% 11.05% (19.47)% (10.59)% 16.86%
Ratios to Average Net Assets:
Expenses............................................ 2.26 %(2) 1.79% 1.18% 1.08% 1.05% 0.96%
Net investment income............................... 10.98 %(2) 14.51% 17.89% 14.78% 12.61% 12.70%
Supplemental Data:
Net assets, end of period, in thousands............. $13,645 $16,092 $30,032 $51,869 $64,696 $79,572
Portfolio turnover rate............................. 24 %(1) 76% 21% 40% 81% 113%
- ---------------------
+ Total return is based upon the current market value on the
last day of each period reported. Dividends are assumed to
be reinvested at the prices obtained under the Trust's
dividend reinvestment plan. Total return does not reflect
brokerage commissions.
(1) Not annualized.
(2) Annualized.
See Notes to Financial Statements
25
(This Page Intentionally Left Blank)
(This Page Intentionally Left Blank)
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
OFFICERS
Charles A. Fiumefreddo
Chairman
Mitchell M. Merin
President and Chief Executive Officer
Barry Fink
Vice President, Secretary and General Counsel
Joseph J. McAlinden
Vice President
Ronald E. Robison
Vice President
Thomas F. Caloia
Treasurer
Francis Smith
Vice President and Chief Financial Officer
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, NY 10020
The financial statements included herein have been taken from the
records of the Trust without examination by the independent auditors
and accordingly they do not express an opinion thereon.
Investments and services offered through Morgan Stanley DW Inc.,
member SIPC.
[GRAPHIC OMITTED]
Morgan Stanley [LOGO]
Morgan Stanley
High Income
Advantage Trust III
Semiannual Report
July 31, 2002
38587RPT-7981I02-ANS-9/02
Morgan Stanley [LOGO]
Morgan Stanley High Income Advantage Trust III
LETTER TO THE SHAREHOLDERS - JANUARY 31, 2002
Dear Shareholder:
The 12-month period ended January 31, 2002, was a highly volatile one for the
high-yield market, especially after the terrorist attacks of September 11. These
events and the subsequent war on terrorism had a profound effect on the outlook
for the economy and the financial markets. Despite a 50-basis-point reduction in
the federal funds rate, a flight to quality pushed high-yield security prices
sharply lower. Airlines, the lodging and insurance industries, and the
telecommunications and cable industries experienced some of the sharpest price
declines in the marketplace. Even industries that held up relatively well, such
as food, drugs, utilities and energy, experienced price declines. The high-yield
market recovered somewhat in October and November but softened again in
December.
Credit spreads in the high-yield market relative to U.S. Treasury securities
remain at historically wide levels and came very close to reaching an all-time
peak in September. The spreads remained particularly wide within the lower-rated
portion of the market as investors continued to prefer the relatively higher
quality end of the market.
Performance and Portfolio Strategy
For the 12-month period ended January 31, 2002, Morgan Stanley High Income
Advantage Trust III produced a total return of -38.48 percent, based on a change
in net asset value (NAV) and reinvestment of dividends totaling $0.291 per
share. For the same period, the Trust's total return was -63.16 percent, based
on a change in its market price on the New York Stock Exchange (NYSE) and
reinvestment of dividends.
During the fiscal year, the Trust instituted several important changes to its
dividend policy. First, in May, the Trust lowered its income dividend from
$0.035 per share to $0.017 per share. The Trust's January 2002, income dividend
was lowered to $0.012 per share. In addition, beginning with that dividend, the
Trust moved from paying a fixed dividend rate to one that fluctuates with the
amount of income earned by the Trust. We believe that adopting a fluctuating
dividend policy will provide the Trust with greater flexibility. Should the
Trust experience additional defaults, the dividend amount will be lower.
Conversely, should the economy improve, defaults stabilize and income levels
increase, the Trust's dividend rate could rise.
As stated in previous communications, the past three years have been one of the
most difficult periods for the high-yield market, with such events as the
September economic shock and recent accounting scandals only exacerbating the
problem. As a result of the substantial weakness in the market, we have seen
high-yield bond prices decline sharply and yields rise over much of this period.
The past 12 months remained particularly difficult for many companies in the
Morgan Stanley High Income Advantage Trust III
LETTER TO THE SHAREHOLDERS - JANUARY 31, 2002 continued
telecommunications sector and the many industries within that sector as poor
earnings and lower revenues pushed the sector lower.
The telecommunications sector experienced many rating downgrades and an elevated
default rate during this period, which resulted in security price declines for
most of the sector's bonds. Fixed-line telecommunications was the
worst-performing sector during the past 12 months, down more than 40 percent.
Consequently, allocations in the fixed-line communications and wireless
communications industries accounted for much of the Trust's disappointing
performance. The Trust's positions in lower-rated credits also adversely
affected overall performance.
Over the past year, the Trust's portfolio management team continued to
reposition the portfolio for the current market environment. The team reduced
positions in telecommunications and related industries but increased the average
credit rating for securities in the Trust's portfolio. The Trust continues to
maintain constructive positions in the wireline and wireless communications,
cable and media industries. The Trust initiated positions in more than 60 new
companies, including Collins and Aikman, Stone Energy, Allied Waste, Chesapeake
Energy, Schuler Homes, Salem Communications, Healthnet, PRIMEDIA, Quebecor,
Nextmedia and Beazer Homes. The Trust eliminated positions in many companies
such as Brill Media, Envirodyne, Neff, Friendly's, Windemere, Sabreliner, and
James Cable.
Looking Ahead
The events of September 11 had a negative impact on the economy over the past
six months. We feel, however, that the current spread of the high-yield market
appears to be pricing in a more prolonged downturn with an extended period of
higher default rates than would be consistent with historical experience. We
consider that the monetary and fiscal policy moves that have already been
implemented are likely to bring the economy back to more normal growth levels,
which could lead to a recovery in the high-yield market. The Trust's portfolio
is positioned to participate in any potential recovery.
We appreciate your ongoing support of Morgan Stanley High Income Advantage Trust
III 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
2
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JANUARY 31, 2002
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------------
Corporate Bonds (86.0%)
Advertising/Marketing Services (0.7%)
$ 180 Interep National Radio Sales Inc. ............................ 10.00 % 07/01/08 $ 120,600
-------------
Aerospace & Defense (1.2%)
300 Loral Space & Communications Ltd. ............................ 9.50 01/15/06 189,000
-------------
Airlines (0.9%)
215 Air Canada Corp. (Canada) .................................... 10.25 03/15/11 147,275
-------------
Alternative Power Generation (0.8%)
145 Calpine Corp. ................................................ 8.50 02/15/11 120,707
-------------
Auto Parts: O.E.M. (1.6%)
20 Collins & Aikman Products Co. ................................ 11.50 04/15/06 19,100
70 Collins & Aikman Products Co.- 144A* ......................... 10.75 12/31/11 70,700
165 Dana Corp.- 144A* ............................................ 9.00 08/15/11 150,721
220 Hayes Lemmerz International, Inc. (Series B) (a)(b) .......... 8.25 12/15/08 9,900
60 Hayes Lemmerz International, Inc. (Series B) (a)(b) .......... 9.125 07/15/07 2,700
-------------
253,121
-------------
Broadcast/Media (1.2%)
270 Tri-State Outdoor Mediagroup, Inc. (b) ....................... 11.00 05/15/08 197,100
-------------
Broadcasting (2.2%)
70 Radio One, Inc. .............................................. 8.875 07/01/11 73,150
125 Salem Communications Holding Corp. ........................... 9.00 07/01/11 129,688
60 XM Satellite Radio Inc. ...................................... 14.00 03/15/10 45,000
115 Young Broadcasting Inc. ...................................... 10.00 03/01/11 108,100
-------------
355,938
-------------
See Notes to Financial Statements
3
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JANUARY 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------------
Cable/Satellite TV (10.1%)
$ 240 Adelphia Communications Corp. ................................ 10.50 % 07/15/04 $ 246,599
3,750 Australis Holdings Property Ltd. (Australia) (a)(b) .......... 15.00 11/01/02 --
60 British Sky Broadcasting Group PLC (United Kingdom) .......... 6.875 02/23/09 57,239
175 British Sky Broadcasting Group PLC (United Kingdom) .......... 8.20 07/15/09 179,547
225 Callahan Nordhein Westfalen (Germany) ........................ 14.00 07/15/10 105,750
350 Charter Communications Holdings Corp. ........................ 11.75++ 05/15/11 216,125
210 CSC Holdings Inc. (Series B) ................................. 7.625 04/01/11 207,476
140 Echostar DBS Corp.- 144A* .................................... 9.125 01/15/09 143,500
375 Knology Holdings, Inc. ....................................... 11.875++ 10/15/07 153,750
155 Ono Finance PLC (United Kingdom) ............................. 14.00 02/15/11 110,050
25 Pegasus Communications Corp. ................................. 9.75 12/01/06 21,250
220 Telewest Communications PLC (United Kingdom) ................. 9.875 02/01/10 145,750
355 United Pan Europe Communications N.V. (Netherlands) .......... 10.875 08/01/09 38,163
-------------
1,625,199
-------------
Casino/Gaming (1.7%)
950 Aladdin Gaming Capital Corp. (Series B) ...................... 13.50++ 03/01/10 29,688
55 Harrahs Operating Co. Inc. ................................... 8.00 02/01/11 57,608
600 Resort at Summerlin LP (Series B) (a)(b) ..................... 13.00 12/15/07 --
185 Station Casinos, Inc. ........................................ 9.875 07/01/10 194,250
-------------
281,546
-------------
Cellular Telephone (1.1%)
50 Dobson/Sygnet Communications ................................. 12.25 12/15/08 51,500
700 Dolphin Telecom PLC (Series B) (United Kingdom) (a) .......... 14.00++ 05/15/09 70
3,200 Dolphin Telecom PLC (United Kingdom) (a) ..................... 11.50++ 06/01/08 320
150 Tritel PCS Inc. .............................................. 12.75++ 05/15/09 129,000
-------------
180,890
-------------
Chemicals: Major Diversified (1.2%)
71 Equistar Chemical/Funding .................................... 10.125 09/01/08 69,935
130 Huntsman ICI Chemicals ....................................... 10.125 07/01/09 119,600
-------------
189,535
-------------
Chemicals: Specialty (1.7%)
60 Acetex Corp. (Canada) ........................................ 10.875 08/01/09 60,600
15 ISP Chemco-- 144A* ........................................... 10.25 07/01/11 15,600
125 ISP Holdings Inc.-- 144A* .................................... 10.625 12/15/09 123,750
40 Millennium America, Inc. ..................................... 9.25 06/15/08 40,400
40 OM Group Inc.-- 144A* ........................................ 9.25 12/15/11 41,200
-------------
281,550
-------------
See Notes to Financial Statements
4
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JANUARY 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------------
Commercial Printing/Forms (1.2%)
$ 500 Premier Graphics Inc. (b) .................................... 11.50 % 12/01/05 $ 15,625
155 Quebecor Media Inc. (Canada) ................................. 11.125 07/15/11 167,788
20 Quebecor Media Inc. (Canada) ................................. 13.75++ 07/15/11 12,650
-------------
196,063
-------------
Consumer/Business Services (3.2%)
541 Comforce Corp. (Series B) .................................... 15.00+ 12/01/09 162,156
145 Comforce Operating, Inc. ..................................... 12.00 12/01/07 106,575
160 MDC Communications Corp. (Canada) ............................ 10.50 12/01/06 120,000
145 Muzak LLC/Muzak Finance ...................................... 9.875 03/15/09 124,700
-------------
513,431
-------------
Containers/Packaging (1.9%)
315 Owens-Illinois, Inc. ......................................... 7.80 05/15/18 258,300
45 Riverwood International Corp. ................................ 10.875 04/01/08 46,350
-------------
304,650
-------------
Diversified-- Manufacturing (2.2%)
315 Eagle-Picher Industries, Inc. ................................ 9.375 03/01/08 187,425
1,000 Jordan Industries, Inc. (Series B) ........................... 11.75++ 04/01/09 170,000
-------------
357,425
-------------
Electric Utilities (1.1%)
100 Mirant Americas General Inc. ................................. 8.30 05/01/11 84,692
85 PG&E National Energy Group ................................... 10.375 05/16/11 88,682
-------------
173,374
-------------
Electronic Components (0.1%)
20 Flextronics International Ltd. ............................... 9.875 07/01/10 21,600
-------------
Electronic Distributors (0.8%)
125 BRL Universal Equipment ...................................... 8.875 02/15/08 126,250
1,000 CHS Electronics, Inc. (a)(b) ................................. 9.875 04/15/05 8,750
-------------
135,000
-------------
Electronic Equipment/Instruments (0.5%)
190 High Voltage Engineering, Inc. ............................... 10.75 08/15/04 74,100
-------------
Electronics/Appliances (0.0%)
5,000 International Semi-Tech Microelectronics, Inc.
(Canada)(a)(b) ............................................. 11.50 08/15/03 2,500
-------------
See Notes to Financial Statements
5
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JANUARY 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------------
Engineering & Construction (1.1%)
$ 115 Encompas Services Corp. ...................................... 10.50 % 05/01/09 $ 71,300
300 Metromedia Fiber Network, Inc. ............................... 10.00 12/15/09 99,000
-------------
170,300
-------------
Environmental Services (2.3%)
150 Allied Waste North America Inc. (Series B) ................... 10.00 08/01/09 152,062
100 Waste Management, Inc. ....................................... 7.375 08/01/10 103,456
110 WMX Technologies, Inc. ....................................... 7.00 10/15/06 113,313
-------------
368,831
-------------
Finance/Rental/Leasing (0.2%)
35 Ford Motor Credit Co. ........................................ 7.25 10/25/11 34,379
-------------
Financial Conglomerates (0.3%)
45 Case Credit Corp. ............................................ 6.125 02/15/03 42,856
-------------
Food Distributors (2.1%)
350 Volume Services America, Inc. ................................ 11.25 03/01/09 339,500
-------------
Food: Meat/Poultry/Fish (1.6%)
105 Michael Foods, Inc. .......................................... 11.75 04/01/11 113,925
115 Smithfield Foods Inc. ........................................ 7.625 02/15/08 112,700
30 Smithfield Foods Inc. (Series B) ............................. 8.00 10/15/09 31,275
-------------
257,900
-------------
Forest Products (2.4%)
110 Louisiana Pacific Corp. ...................................... 10.875 11/15/08 108,900
40 Louisiana Pacific Corp. ...................................... 8.875 08/15/10 39,446
225 Tembec Industries, Inc. (Canada) ............................. 8.50 02/01/11 232,875
-------------
381,221
-------------
Home Building (3.4%)
160 Beazer Homes USA, Inc. ....................................... 8.625 05/15/11 164,799
130 Centex Corp. ................................................. 7.875 02/01/11 132,701
140 Schuler Homes, Inc. .......................................... 9.375 07/15/09 146,650
110 Toll Brothers, Inc. .......................................... 8.25 02/01/11 111,100
-------------
555,250
-------------
Hospital/Nursing Management (1.0%)
145 HCA-- The Healthcare Co. ..................................... 8.75 09/01/10 159,500
-------------
See Notes to Financial Statements
6
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JANUARY 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------------
Hotels/Resorts/Cruiselines (1.4%)
$ 500 Epic Resorts LLC (Series B) (a)(b) ........................... 13.00 % 06/15/05 $ 70,000
45 Hilton Hotels Corp. .......................................... 7.95 04/15/07 45,239
120 HMH Properties (Series B) .................................... 7.875 08/01/08 116,100
-------------
231,339
-------------
Internet Software/Services (1.3%)
230 Exodus Communications, Inc. (a)(b) ........................... 11.625 07/15/10 50,600
500 Globix Corp. ................................................. 12.50 02/01/10 87,500
250 PSINet, Inc. (a)(b) .......................................... 10.50 12/01/06 20,000
600 PSINet, Inc. (a)(b) .......................................... 11.00 08/01/09 48,000
-------------
206,100
-------------
Managed Health Care (2.4%)
225 Aetna Inc. ................................................... 7.875 03/01/11 225,196
160 Healthnet, Inc. .............................................. 8.375 04/15/11 163,282
-------------
388,478
-------------
Media Conglomerates (0.7%)
100 Nextmedia Operating, Inc. - 144A* ............................ 10.75 07/01/11 105,500
-------------
Medical Distributors (0.3%)
45 AmerisourceBergen Corp. ...................................... 8.125 09/01/08 47,025
-------------
Medical Specialties (0.1%)
900 Mediq/PRN Life Support Services, Inc. (b) .................... 11.00 06/01/08 9,000
-------------
Medical/Nursing Services (1.1%)
175 Fresenius Med Cap Trust ...................................... 7.875 06/15/11 172,813
-------------
Miscellaneous Commercial Services (0.2%)
40 Coinmach Corp. - 144A* ....................................... 9.00 02/01/10 40,700
-------------
Movies/Entertainment (1.6%)
160 Alliance Atlantis Communications, Inc. (Canada) .............. 13.00 12/15/09 176,000
80 Six Flags, Inc. - 144A* ...................................... 8.875 02/01/10 79,900
-------------
255,900
-------------
Office Equipment/Supplies (0.0%)
1,300 Mosler, Inc. (a)(b) 11.00 04/15/03 --
-------------
See Notes to Financial Statements
7
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JANUARY 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------------
Oil & Gas Pipelines (0.4%)
$ 75 Williams Companies Inc. (Series A) .............................. 7.50 % 01/15/31 $ 67,752
---------
Oil & Gas Production (2.2%)
235 Chesapeake Energy Corp. ......................................... 8.125 04/01/11 224,425
55 Stone Energy Corp. -- 144A* ..................................... 8.25 12/15/11 55,688
80 Vintage Petroleum, Inc. ......................................... 7.875 05/15/11 73,600
---------
353,713
---------
Oilfield Services/Equipment (0.5%)
60 Hanover Equipment Trust -- 144A* ................................ 8.50 09/01/08 59,700
25 Hanover Equipment Trust -- 144A* ................................ 8.75 09/01/11 24,875
---------
84,575
---------
Other Consumer Specialties (0.7%)
165 Samsonite Corp. ................................................. 10.75 06/15/08 106,425
---------
Other Metals/Minerals (1.0%)
80 Murrin Murrin Holdings Property Ltd. (Australia) ................ 9.375 08/31/07 55,200
110 Phelps Dodge Corp. .............................................. 8.75 06/01/11 107,969
---------
163,169
---------
Publishing: Books/Magazines (1.0%)
175 PRIMEDIA, Inc. .................................................. 8.875 05/15/11 157,938
---------
Publishing: Newspapers (0.8%)
45 Belo Corp. ...................................................... 8.00 11/01/08 45,962
90 Hollinger Participation -- 144A* (Canada) ....................... 12.125+ 11/15/10 81,000
---------
126,962
---------
Pulp & Paper (0.9%)
35 Longview Fibre Co. 144A* ........................................ 10.00 01/15/09 35,875
110 Norske Skog Canada Ltd. (Canada) -- 144A* ....................... 8.625 06/15/11 111,650
---------
147,525
---------
Real Estate Development (0.7%)
120 CB Richard Ellis Services Inc. .................................. 11.25 06/15/11 110,400
---------
Real Estate Investment Trust (0.4%)
65 Istar Financial Inc. ............................................ 8.75 08/15/08 64,804
---------
See Notes to Financial Statements
8
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JANUARY 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------------
Recreational Products (1.0%)
$ 150 International Game Technology .................................. 8.375 % 05/15/09 $ 159,750
----------
Restaurants (1.2%)
6,251 American Restaurant Group Holdings, Inc. -- 144A* (c) .......... 0.00 12/15/05 191,271
1,500 FRD Acquisition Corp. (Series B) (a)(b) ........................ 12.50 07/15/04 7,500
----------
198,771
----------
Retail -- Specialty (1.1%)
185 Pantry, Inc. ................................................... 10.25 10/15/07 171,125
----------
Savings Banks (0.1%)
25 Golden State Holdings .......................................... 7.125 08/01/05 24,666
----------
Semiconductors (0.3%)
45 Fairchild Semiconductor Corp. .................................. 10.50 02/01/09 48,488
----------
Services to the Health Industry (1.2%)
75 Anthem Insurance -- 144A* ...................................... 9.125 04/01/10 81,466
110 Omnicare, Inc. ................................................. 8.125 03/15/11 115,225
----------
196,691
----------
Specialty Stores (0.5%)
75 Autonation, Inc. ............................................... 9.00 08/01/08 78,000
----------
Specialty Telecommunications (3.3%)
1,000 Birch Telecom Inc. (b) ......................................... 14.00 06/15/08 10,000
300 DTI Holdings, Inc. (Series B) (a) .............................. 12.50++ 03/01/08 4,500
950 Esprit Telecom Group PLC (United Kingdom) (b) .................. 11.50 12/15/07 2,375
500 Esprit Telecom Group PLC (United Kingdom) (b) .................. 10.875 06/15/08 1,250
1,800 Firstworld Communications, Inc. ................................ 13.00++ 04/15/08 107,999
225 Global Crossing Holdings, Ltd. (Bermuda) (a)(b) ................ 8.70 08/01/07 15,750
110 Global Crossing Holdings, Ltd. (Bermuda) (a)(b) ................ 9.50 11/15/09 5,775
510 GT Group Telecom Inc. (Canada) ................................. 13.25++ 02/01/10 66,300
60 McLeodUSA, Inc. (a)(b) ......................................... 11.375 01/01/09 15,000
250 McLeodUSA, Inc. (a)(b) ......................................... 11.50 05/01/09 58,750
205 Pac-West Telecomm, Inc. ........................................ 13.50 02/01/09 61,500
425 Primus Telecommunications Group, Inc. (Series B) ............... 9.875 05/15/08 89,249
250 Versatel Telecom International N.V. (Netherlands) .............. 13.25 05/15/08 80,000
700 Viatel Inc. (a)(b) ............................................. 11.25 04/15/08 875
200 Viatel Inc. (a) ................................................ 12.50++ 04/15/08 250
See Notes to Financial Statements
9
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JANUARY 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------------
$ 250 Viatel Inc. (issued 03/19/99) (a)(b) ........................... 11.50 % 03/15/09 $ 313
300 Viatel Inc. (issued 12/08/99) (a)(b) ........................... 11.50 03/15/09 375
735 World Access, Inc. (a)(b)(c) ................................... 13.25 01/15/08 7,350
250 Worldwide Fiber Inc. (Canada) (a)(b) ........................... 12.00 08/01/09 313
----------
527,924
Telecommunications (5.3%)
1,300 e. Spire Communications, Inc. (a)(b) ........................... 13.75 07/15/07 168,999
390 Focal Communications Corp. (Series B) .......................... 12.125++ 02/15/08 117,000
250 Hyperion Telecommunications, Inc. (Series B) ................... 12.25 09/01/04 31,250
250 MGC Communications, Inc. ....................................... 13.00 04/01/10 35,000
500 NEXTLINK Communications LLC .................................... 12.50 04/15/06 75,000
390 NTL Communications Corp. ....................................... 11.875 10/01/10 142,350
900 Rhythms Netconnections, Inc. (a)(b) ............................ 12.75 04/15/09 108,000
1,500 Rhythms Netconnections, Inc. (a)(b) ............................ 14.00 02/15/10 97,500
250 Startec Global Communications Corp. (a)(b) ..................... 12.00 05/15/08 2,500
115 Talton Holdings, Inc. (Series B) ............................... 11.00 06/30/07 73,600
----------
851,199
----------
Trucks/Construction/Farm Machinery (1.8%)
45 Case Corp. (Series B)........................................... 6.25 12/01/03 42,430
305 J.B. Poindexter & Co., Inc. .................................... 12.50 05/15/04 247,050
----------
289,480
----------
Wholesale Distributors (0.6%)
90 Buhrmann US, Inc. .............................................. 12.25 11/01/09 91,800
----------
Wireless Telecommunications (2.1%)
150 American Cellular Corp. ........................................ 9.50 10/15/09 141,000
285 AMSC Aquisition Co., Inc. (Series B) (a)(b) .................... 12.25 04/01/08 109,725
4,000 CellNet Data Systems, Inc. (a)(b) .............................. 14.00++ 10/01/07 5,000
500 Globalstar LP/Capital Corp. (b) ................................ 10.75 11/01/04 45,000
600 Orbcomm Global LP/Capital Corp. (Series B) (a)(b) .............. 14.00 08/15/04 18,000
1,000 USA Mobile Communications Holdings, Inc. (a)(b) ................ 14.00 11/01/04 20,000
500 WinStar Communications, Inc. (a)(b) ............................ 12.75 04/15/10 50
----------
338,775
----------
Total Corporate Bonds (Cost $47,908,753) 13,847,128
----------
Convertible Bonds (0.7%)
Telecommunication Equipment (0.7%)
215 Corning Inc. (Cost $118,190) ................................... 0.00 11/08/15 116,100
----------
See Notes to Financial Statements
10
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JANUARY 31, 2002 continued
NUMBER OF
SHARES VALUE
- ---------------------------------------------------------------------------------------------------
Preferred Stocks (5.6%)
Broadcasting (0.9%)
17 Paxson Communications Corp.+ .......................... $ 145,010
------------
Cellular Telephone (0.8%)
56 Dobson Communications+ ................................ 51,380
154 Nextel Communications, Inc. (Series D)+ ............... 73,934
------------
125,314
------------
Electric Utilities (1.2%)
172 TNP Enterprises, Inc.+ ................................ 188,340
------------
Publishing: Books/Magazines (0.1%)
130 PRIMEDIA, Inc. ........................................ 8,320
------------
Specialty Telecommunications (1.2%)
171 Broadwing Communications, Inc. (Series B) ............. 100,890
15 Crown Castle International Corp.+ ..................... 9,000
83 Intermedia Communication Inc. (Series B)+ ............. 85,595
4,102 XO Communications, Inc.+ .............................. 41
------------
195,526
------------
Telecommunication Equipment (1.4%)
470,213 FWT, Inc. (Class A)+(c) ............................... 235,106
------------
Total Preferred Stocks (Cost $2,618,356) .............. 897,616
------------
Common Stocks (d) (1.7%)
Apparel/Footwear Retail (0.0%)
551,830 County Seat Stores, Inc. (c) --
------------
Consumer/Business Services (1.1%)
9,750 Anacomp Inc. (Class A) (c) ............................ 170,624
------------
See Notes to Financial Statements
11
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JANUARY 31, 2002 continued
NUMBER OF
SHARES VALUE
- ---------------------------------------------------------------------------------------------------
Foods: Specialty/Candy (0.0%)
453 SFAC New Holdings Inc. (c) ............................ $ --
83 SFFB Holdings, Inc. (c) ............................... --
------------
90,000 Specialty Foods Acquisition Corp. -- 144A* --
------------
Medical/Nursing Services (0.0%)
104,665 Raintree Healthcare Corp. (c) ......................... --
------------
Restaurants (0.0%)
4,750 American Restaurant Group Holdings, Inc. -- 144A* ..... --
------------
Specialty Telecommunications (0.0%) ...................
6,667 Versatel Telecom International N.V.(ADR)(Netherlands) . 5,203
3,142 World Access, Inc. (c) ................................ 3
------------
5,206
------------
Telecommunication Equipment (0.0%)
41,066 FWT, Inc. (Class A) (c) ............................... 411
------------
Telecommunications (0.6%)
24,260 Covad Communications Group, Inc. (c) .................. 54,585
76,904 Focal Communications Corp. (c) ........................ 31,531
------------
86,116
------------
Textiles (0.0%)
112,296 United States Leather, Inc. (c) ....................... --
------------
Wireless Telecommunications (0.0%)
176,739 Arch Wireless, Inc. (c) ............................... 1,944
8,393 Vast Solutions, Inc. (Class B1) (c) ................... --
8,393 Vast Solutions, Inc. (Class B2) (c) ................... --
8,393 Vast Solutions, Inc. (Class B3) (c) ................... --
------------
1,944
------------
Total Common Stocks (Cost $13,940,919) 264,301
------------
See Notes to Financial Statements
12
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENTS - JANUARY 31, 2002 continued
NUMBER OF EXPIRATION
WARRANTS DATE VALUE
- -----------------------------------------------------------------------------------------------------------------
Warrants (d) (0.1%)
Aerospace & Defense (0.0%)
2,500 Sabreliner Corp.-- 144A* ................................... 04/15/03 $ --
-------------
Broadcasting (0.0%)
130 XM Satellite Radio Holdings Inc.-- 144A* ................... 03/15/10 2,600
-------------
Cable/Satellite TV (0.0%)
155 Ono Finance PLC-- 144A* (United Kingdom) ................... 02/15/11 1,163
-------------
Casino/Gaming (0.0%)
17,750 Aladdin Gaming Enterprises, Inc.-- 144A* ................... 03/01/10 --
500 Resort at Summerlin LP-- 144A* ............................. 12/15/07 --
-------------
--
-------------
Electric Utilities (0.1%)
150 TNP Enterprises, Inc.-- 144A* .............................. 04/01/11 4,500
-------------
Hotels/Resorts/Cruiselines (0.0%)
500 Epic Resorts LLC-- 144A* ................................... 06/15/05 --
-------------
Internet Software/Services (0.0%)
1,800 Verado Holdings, Inc.-- 144A* .............................. 04/15/08 --
-------------
Specialty Telecommunications (0.0%)
1,000 Birch Telecom Inc.-- 144A* ................................. 06/15/08 --
510 GT Group Telecom Inc. (Canada)-- 144A* ..................... 02/01/10 2,550
-------------
2,550
-------------
Telecommunications (0.0%)
250 Startec Global Communications Corp.-- 144A* ................ 05/15/08 --
-------------
Wireless Telecommunications (0.0%)
300 Motient Corp.-- 144A* ...................................... 04/01/08 3
-------------
Total Warrants (Cost $122,813) ............................. 10,816
-------------
See Notes to Financial Statements
13
Morgan Stanley High Income Advantage Trust III
PORTFOLIO OF INVESTMENT - JANUARY 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ------------------------------------------------------------------------------------------------------------------------
Short-Term Investment (1.8%)
Repurchase Agreement
$ 296 Joint repurchase agreement account (dated 01/31/02;
proceeds $296,016) (e) (Cost $296,000) ...................... 1.91% 02/01/02 $ 296,000
-------------
Total Investments (Cost $65,005,031) (f) .................................... 95.9% 15,431,961
Other Assets in Excess of Liabilities 4.1 660,450
----- -------------
Net Assets .................................................................. 100.0% $ 16,092,411
===== =============
- ---------------
ADR American Depository Receipt
* Resale is restricted to qualified institutional investors.
+ Payment-in-kind security.
++ Currently a zero coupon bond and will pay interest at the rate shown at a future specified date.
(a) Issuer in bankruptcy.
(b) Non-income producing security; bond in default.
(c) Acquired through exchange offer.
(d) Non-income producing securities.
(e) Collateralized by federal agency and U.S. Treasury obligations.
(f) The aggregate cost for federal income tax purposes approximates the aggregate cost for book purposes.
The aggregate gross unrealized appreciation is $279,967 and the aggregate gross unrealized depreciation
is $49,853,037, resulting in net unrealized depreciation of $49,573,070.
See Notes to Financial Statements
14
Morgan Stanley High Income Advantage Trust III
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
January 31, 2002
Assets:
Investments in securities, at value
(cost $65,005,031)............................. $ 15,431,961
Cash............................................. 17,436
Receivable for:
Investments sold............................. 580,894
Interest..................................... 447,816
Prepaid expenses and other assets................ 2,489
----------------
Total Assets................................. 16,480,596
----------------
Liabilities:
Payable for:
Investments purchased........................ 322,858
Investment management fee.................... 11,517
Accrued expenses and other payables.............. 53,810
----------------
Total Liabilities............................ 388,185
----------------
Net Assets................................... $ 16,092,411
================
Composition of Net Assets:
Paid-in-capital.................................. $ 108,005,263
Net unrealized depreciation...................... (49,573,070)
Dividends in excess of net investment income..... (493,274)
Accumulated net realized loss.................... (41,846,508)
----------------
Net Assets................................... $ 16,092,411
================
Net Asset Value Per Share,
12,826,179 shares outstanding
(unlimited shares authorized of $.01 par value) $1.25
=====
See Notes to Financial Statements
15
Morgan Stanley High Income Advantage Trust III
FINANCIAL STATEMENTS continued
Statement of Operations
For the year ended January 31, 2002
Net Investment Income:
Income
Interest............................... $ 3,418,773
Dividends.............................. 12,244
--------------
Total Income....................... 3,431,017
--------------
Expenses
Investment management fee.............. 158,273
Professional fees...................... 79,061
Transfer agent fees and expenses....... 42,906
Registration fees...................... 31,853
Shareholder reports and notices........ 27,429
Custodian fees......................... 16,713
Trustees' fees and expenses............ 11,644
Other.................................. 8,545
--------------
Total Expenses..................... 376,424
--------------
Net Investment Income.............. 3,054,593
--------------
Net Realized and Unrealized Loss:
Net realized loss...................... (6,633,349)
Net change in unrealized depreciation.. (6,609,909)
--------------
Net Loss........................... (13,243,258)
--------------
Net Decrease........................... $ (10,188,665)
==============
See Notes to Financial Statements
16
Morgan Stanley High Income Advantage Trust III
FINANCIAL STATEMENTS continued
Statement of Changes in Net Assets
FOR THE YEAR FOR THE YEAR
ENDED ENDED
JANUARY 31, 2002 JANUARY 31, 2001
---------------- ----------------
Increase (Decrease) in Net Assets:
Operations:
Net investment income................................... $ 3,054,593 $ 7,606,829
Net realized loss....................................... (6,633,349) (6,833,509)
Net change in unrealized depreciation................... (6,609,909) (14,394,604)
--------------- ---------------
Net Decrease........................................ (10,188,665) (13,621,284)
Dividends to shareholders from net investment income.... (3,734,923) (8,216,085)
Decrease from transactions in shares of beneficial
interest.............................................. (16,018) --
--------------- ---------------
Net Decrease........................................ (13,939,606) (21,837,369)
Net Assets:
Beginning of period..................................... 30,032,017 51,869,386
--------------- ---------------
End of Period
(Including dividends in excess of net investment income
of $493,274 and $67,712, respectively).................. $ 16,092,411 $ 30,032,017
=============== ==============
See Notes to Financial Statements
17
Morgan Stanley High Income Advantage Trust III
NOTES TO FINANCIAL STATEMENTS - JANUARY 31, 2002
1. Organization and Accounting Policies
Morgan Stanley High Income Advantage Trust III (the "Trust"), formerly Morgan
Stanley Dean Witter High Income Advantage Trust III, is registered under the
Investment Company Act of 1940, as amended, as a diversified, closed-end
management investment company. The Trust's primary investment objective is to
earn a high level of current income and, as a secondary objective, capital
appreciation, but only when consistent with its primary objective. The Trust
seeks to achieve its objective by investing primarily in lower-rated fixed
income securities. The Trust was organized as a Massachusetts business trust on
November 23, 1988 and commenced operations on February 28, 1989.
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) an equity 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
securities are traded on more than one exchange; the securities are valued on
the exchange designated as the primary market pursuant to procedures adopted by
the Trustees); (2) all other portfolio securities for which over-the-counter
market quotations are readily available are valued at the latest available bid
price; (3) 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., 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; (4) certain of the Trust's 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 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.
18
Morgan Stanley High Income Advantage Trust III
NOTES TO FINANCIAL STATEMENTS - JANUARY 31, 2002 continued
B. Accounting for Investments -- Security transactions are accounted for on the
trade date (date the order to buy or sell is executed). Realized gains and
losses on security transactions are determined by the identified cost method.
Discounts are accreted and premiums are amortized over the life of the
respective securities. Interest income is accrued daily except where collection
is not expected.
C. Joint Repurchase Agreement Account -- Pursuant to an Exemptive Order issued
by the Securities and Exchange Commission, the Trust, 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. Federal Income Tax Status -- It is the Trust'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.
E. Dividends and Distributions to Shareholders -- The Trust 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 Agreement
Pursuant to an Investment Management Agreement, the Trust pays the Investment
Manager a management fee, calculated weekly and payable monthly, by applying the
following annual rates to the Trust's weekly net assets: 0.75% to the portion of
weekly net assets not exceeding $250 million; 0.60% to the portion of weekly net
assets exceeding $250 million but not exceeding $500 million; 0.50% to the
portion of weekly net assets exceeding $500 million but not exceeding $750
million; 0.40% to the portion of weekly net assets exceeding $750 million but
19
Morgan Stanley High Income Advantage Trust III
NOTES TO FINANCIAL STATEMENTS - JANUARY 31, 2002 continued
not exceeding $1 billion; and 0.30% to the portion of weekly net assets
exceeding $1 billion.
3. Security Transactions and Transactions with Affiliates
The cost of purchases and proceeds from sales of portfolio securities, excluding
short-term investments, for the year ended January 31, 2002 aggregated
$15,252,699 and $15,047,073, respectively.
Morgan Stanley Trust, an affiliate of the Investment Manager, is the Trust's
transfer agent. At January 31, 2002, the Trust had transfer agent fees and
expenses payable of approximately $3,200.
4. Shares of Beneficial Interest
CAPITAL
PAID IN
EXCESS OF
SHARES PAR VALUE PAR VALUE
-------------- -------------- ------------------
Balance, January 31, 2000 and January 31, 2001........... 12,837,779 $ 128,378 $ 111,148,908
Treasury shares purchased and retired (weighted average
discount 2.38%)*....................................... (11,600) (116) (15,902)
Reclassification due to permanent book/tax differences... -- -- (3,256,005)
-------------- -------------- ------------------
Balance, January 31, 2002,............................... 12,826,179 $ 128,262 $ 107,877,001
============== ============== ==================
- ----------
* The Trustees have voted to retire the shares purchased.
5. Dividends
The Trust declared the following dividends from net investment income:
DECLARATION AMOUNT RECORD PAYABLE
DATE PER SHARE DATE DATE
- ---------------------- ----------- ------------------ --------------------
January 29, 2002 $ 0.012 February 8, 2002 February 22, 2002
February 26, 2002 $ 0.012 March 8, 2002 March 22, 2002
6. Federal Income Tax Status
At January 31, 2002, the Trust had a net capital loss carryover of approximately
$40,649,000, which may be used to offset future capital gains to the extent
provided by regulations, which is available through January 31 of the following
years:
AMOUNT IN THOUSANDS
- ---------------------------------------------------------------------------------------------------------
2003 2004 2005 2006 2007 2008 2009 2010
- --------- -------- ---------- --------- -------- ---------- ---------- ------------
$ 10,665 $ 4,258 $ 3,007 $ 5,910 $ 1,633 $ 1,867 $ 2,195 $ 11,114
========= ======== ========== ========= ======== ========== ========== ==========
20
Capital losses incurred after October 31 ("post-October" losses) within the
taxable year are deemed to arise on the first business day of the Trust's next
taxable year. The Trust incurred and will elect to defer net capital losses of
approximately $1,198,000 during fiscal 2002.
As of January 31, 2002, the Trust had temporary book/tax differences
attributable to post-October losses, and book amortization of discounts on debt
securities and interest on bonds in default and permanent book/tax differences
attributable to an expired capital loss carryover and tax adjustments on debt
securities sold by the Trust. To reflect reclassifications arising from the
permanent differences, paid-in-capital was charged $3,256,005, dividends in
excess of net investment income was charged $84,916 and accumulated net realized
loss was credited $3,340,921.
7. Change in Accounting Policy
Effective February 1, 2001, the Trust 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 Trust, but resulted in
a $339,684 increase in the cost of securities and a corresponding increase to
undistributed net investment income based on securities held as of January 31,
2001.
The effect of this change for the year ended January 31, 2002 was to increase
net investment income by $64,494; decrease unrealized depreciation by $20,422;
and increase net realized losses by $84,916. The statement of changes in net
assets and the financial highlights for prior periods have not been restated to
reflect this change.
8. Litigation
On August 29, 2001, a purported class action was filed on behalf of investors in
Morgan Stanley High Income Advantage Trust III alleging that the Trust, its
investment advisor and certain of its officers violated the Investment Company
Act of 1940 by deviating from a fundamental investment restriction by
purportedly investing over 25% of its assets in a single industry. The Trust,
its investment advisor and officers believe the suit to be without merit and
intend to vigorously contest the action.
21
Morgan Stanley High Income Advantage Trust III
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of beneficial interest
outstanding throughout each period:
FOR THE YEAR ENDED JANUARY 31
--------------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------ -------------- ----------- ----------- ---------
Selected Per Share Data:
Net asset value, beginning of period............ $ 2.34 $ 4.04 $ 5.02 $ 6.18 $ 6.11
------------ -------------- ----------- ----------- ---------
Income (loss) from investment operations:
Net investment income....................... 0.24(1) 0.59 0.66 0.72 0.78
Net realized and unrealized gain (loss)..... (1.04)(1) (1.65) (0.94) (1.16) 0.05
------------ -------------- ----------- ----------- ---------
Total income (loss) from investment operations.. (0.80) (1.06) (0.28) (0.44) 0.83
------------ -------------- ----------- ----------- ---------
Less dividends from net investment income....... (0.29) (0.64) (0.70) (0.72) (0.76)
------------ -------------- ----------- ----------- ---------
Net asset value, end of period.................. $ 1.25 $ 2.34 $ 4.04 $ 5.02 $ 6.18
============ ============== =========== =========== =========
Market value, end of period..................... $ 1.27 $ 3.97 $ 4.188 $ 5.938 $ 7.375
============ ============== =========== =========== =========
Total Return+................................... (63.16)% 11.05% (19.47)% (10.59)% 16.86%
Ratios to Average Net Assets:
Expenses........................................ 1.79% 1.18% 1.08% 1.05% 0.96%
Net investment income........................... 14.51%(1) 17.89% 14.78% 12.61% 12.70%
Supplemental Data:
Net assets, end of period, in thousands......... $ 16,092 $ 30,032 $ 51,869 $ 64,696 $ 79,572
Portfolio turnover rate......................... 76% 21% 40% 81% 113%
- ----------
+ Total return is based upon the current market value on the last day of
each period reported. Dividends are assumed to be reinvested at the
prices obtained under the Trust's dividend reinvestment plan. Total
return does not reflect brokerage commissions.
(1) Effective February 1, 2001, the Trust 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 January 31, 2002 was to
increase net investment income per share and increase net realized and
unrealized loss per share by $0.01 and to increase the ratio of net
investment income to average net assets by 0.31%. The Financial
Highlights data presented in this table for prior periods has not been
restated to reflect this change.
See Notes to Financial Statements
22
Morgan Stanley High Income Advantage Trust III
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Trustees of Morgan Stanley High Income
Advantage Trust III:
We have audited the accompanying statement of assets and liabilities of Morgan
Stanley High Income Advantage Trust III (the "Trust"), formerly Morgan Stanley
Dean Witter High Income Advantage Trust III, including the portfolio of
investments, as of January 31, 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 Trust'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 January 31, 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 High Income Advantage Trust III as of January 31, 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
March 12, 2002
2002 Federal Tax Notice (unaudited)
Of the Trust's ordinary income dividends paid during the fiscal year ended
January 31, 2002, 0.03% 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.
23
Morgan Stanley High Income Advantage Trust III
TRUSTEE AND OFFICER INFORMATION
Independent Trustees:
Number of
Term of Portfolios in
Position(s) Office and Fund Complex
Name, Age and Address of Held with Length of Overseen by
Independent Trustee Registrant Time Served* Principal Occupation(s) During Past 5 Years Trustee**
- ------------------------------------ -------------- ---------------- ------------------------------------------- -------------
Michael Bozic (61) Trustee Trustee since Retired; Director or Trustee of the 129
c/o Mayer, Brown, Rowe & Maw April 1994 Morgan Stanley Funds and the TCW/DW
Counsel to the Independent Trustees Term Trusts; formerly Vice Chairman
1675 Broadway of Kmart Corporation (December
New York, NY 1998- October 2000), Chairman and
Chief Executive Officer of Levitz
Furniture 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 since Director or Trustee of the Morgan 129
c/o Summit Ventures LLC January 1993 Stanley Funds and the TCW/DW Term
1 Utah Center Trusts; formerly United States
201 S. Main Street Senator (R-Utah) (1974-1992) and
Salt Lake City, UT Chairman, 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.
Wayne E. Hedien (68) Trustee Trustee since Retired; Director or Trustee of the 129
c/o Mayer, Brown, Rowe & Maw September 1997 Morgan Stanley Funds and the TCW/DW
Counsel to the Independent Trustees Term Trusts; formerly associated
1675 Broadway with the Allstate Companies
New York, NY (1966-1994), 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).
Other Directorships Held by Trustee
- ------------------------------------
Director of Weirton Steel
Corporation.
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 board of various civic and
charitable organizations.
Director of The PMI Group Inc.
(private mortgage insurance);
Trustee and Vice Chairman of The
Field Museum of Natural History;
director of various other business
and charitable organizations.
24
Morgan Stanley High Income Advantage Trust III
TRUSTEE AND OFFICER INFORMATION continued
Number of
Term of Portfolios in
Position(s) Office and Fund Complex
Name, Age and Address of Held with Length of Overseen by
Independent Trustee Registrant Time Served* Principal Occupation(s) During Past 5 Years Trustee**
- ------------------------------------ -------------- ---------------- ------------------------------------------- -------------
Dr. Manuel H. Johnson (53) Trustee Trustee since Chairman of the Audit Committee and 129
c/o Johnson Smick International, Inc. July 1991 Director or Trustee of the Morgan
1133 Connecticut Avenue, N.W. Stanley Funds and the TCW/DW Term
Washington, D.C. Trusts; Senior Partner, Johnson
Smick International, Inc., a
consulting 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 (65) Trustee Trustee since Chairman of the Insurance Committee 207
c/o Triumph Capital, L.P. July 1991 and Director or Trustee of the
237 Park Avenue Morgan Stanley Funds and the TCW/DW
New York, NY Term 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 since Retired; Chairman of the 129
c/o Mayer, Brown, Rowe & Maw April 1994 Derivatives Committee and Director
Counsel to the Independent Trustees or Trustee of the Morgan Stanley
1675 Broadway Funds and the TCW/DW Term Trusts;
New York, NY formerly Executive Vice President
and Chief Investment Officer of the
Home Insurance Company (August
1991-September 1995).
Other Directorships Held by Trustee
- ------------------------------------
Director of NVR, Inc. (home
construction); Chairman and Trustee
of the Financial Accounting
Foundation (oversight organization
of the Financial Accounting
Standards Board).
Director of various business
organizations.
Director of Citizens Communications
Company (telecommunications
company).
25
Morgan Stanley High Income Advantage Trust III
TRUSTEE AND OFFICER INFORMATION continued
Interested Trustees:
Position(s) Term of Office
Name, Age and Address of Held with and Length of
Interested Trustee Registrant Time Served* Principal Occupation(s) During Past 5 Years
- -------------------------------------- ---------------------- --------------- -----------------------------------------------
Charles A. Fiumefreddo (68) Chairman, Director or Trustee since Chairman, Director or Trustee and Chief
c/o Morgan Stanley Trust Trustee and Chief July 1991 Executive Officer of the Morgan Stanley
Harborside Financial Center, Executive Officer Funds and the TCW/DW Term Trusts; formerly
Plaza Two, Chairman, Chief Executive Officer and
Jersey City, NJ Director of the 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 since Senior Advisor of Morgan Stanley (since
c/o Morgan Stanley Trust June 2000 August 2000); Director of the Distributor
Harborside Financial Center, and Dean Witter Realty Inc.; Director or
Plaza Two, Trustee of the Morgan Stanley Funds and the
Jersey City, NJ TCW/DW Term Trusts (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).
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
Overseen by
Trustee** Other Directorships Held by Trustee
------------- ------------------------------------
129 None
129 None
129 Director of American Airlines,
Inc. and its parent company, AMR
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.).
26
Morgan Stanley High Income Advantage Trust III
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 Principal Occupation(s) During Past 5 Years
- --------------------------------- --------------- ----------------- -----------------------------------------------------------
Mitchell M. Merin (48) President President President and Chief Operating Officer of Morgan
1221 Avenue of the Americas since May 1999 Stanley Investment Management (since December
New York, NY 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) Vice President, Vice President General Counsel (since May 2000) and Managing
1221 Avenue of the Americas Secretary and Secretary and Director (since December 2000) of Morgan Stanley
New York, NY General Counsel General Counsel Investment Management; Managing Director (since
since February December 2000), and Secretary and General
1997 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 Treasurer First Vice President and Assistant Treasurer of the
c/o Morgan Stanley Trust since April Investment Manager, the Distributor and Morgan Stanley
Harborside Financial Center, 1989 Services; Treasurer of the Morgan Stanley Funds.
Plaza Two
Jersey City, NJ
Stephen F. Esser (37) Vice President Since January Managing Director and Portfolio Manager of the Investment
One Tower Bridge 2001 Manager and/or its investment management affiliates for over
West Conshohocken, 5 years.
Pennsylvania
Gordon W. Loery (41) Vice President Since January Executive Director and Portfolio Manager of the Investment
One Tower Bridge 2001 Manager and/or its investment management affiliates for over
West Conshohocken, 5 years.
Pennsylvania
Deanna L. Loughnane (35) Vice President Since January Executive Director and Portfolio Manager of the Investment
One Tower Bridge 2001 Manager and/or its investment management affiliates since
West Conshohocken, 1997; previously Vice President and Corporate Bond Analyst
Pennsylvania for Putnam Investments (1993-1997).
27
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
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 [GRAPHIC OMITTED]
Stephen F. Esser
Vice President Morgan Stanley
High Income
Gordon W. Loery Advantage Trust III
Vice President
Deanna L. Loughnane
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
Annual Report
January 31, 2002
-------------------------------
38587
MORGAN STANLEY HIGH YIELD SECURITIES INC.
PART B
STATEMENT OF ADDITIONAL INFORMATION
This Statement of Additional Information relates to the shares of Morgan
Stanley High Yield Securities Inc. ("High Yield") to be issued pursuant to an
Agreement and Plan of Reorganization, dated July 25, 2002, between High Yield
and Morgan Stanley High Income Advantage Trust III ("HIAT III") in connection
with the acquisition by High Yield of substantially all of the assets, subject
to stated liabilities, of HIAT III . 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 October 3, 2002. A copy of the Proxy Statement and Prospectus may be
obtained without charge by mailing a written request to High Yield Securities
Inc., 1221 Avenue of the Americas, New York, New York 10020 or by calling (800)
869-NEWS (TOLL FREE). Please retain this document for future reference.
The date of this Statement of Additional Information is October 3, 2002.
B-1
TABLE OF CONTENTS
PAGE
-----
INTRODUCTION ..................................... B-3
ADDITIONAL INFORMATION ABOUT HIGH YIELD .......... 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 October 3,
2002 (the "Proxy Statement and Prospectus"). The Proxy Statement and Prospectus
has been sent to HIAT III shareholders in connection with the solicitation of
proxies by the Board of Trustees of HIAT III to be voted at the Special Meeting
of shareholders of HIAT III to be held on December 10, 2002. This Statement of
Additional Information incorporates by reference the Statement of Additional
Information of High Yield dated September 30, 2002.
ADDITIONAL INFORMATION ABOUT HIGH YIELD
FUND HISTORY, INVESTMENT OBJECTIVES AND POLICIES
For additional information about High Yield's history, investment
objectives and policies, see "Fund History" and "Description of the Fund and
Its Investments and Risks" in High Yield's Statement of Additional Information.
MANAGEMENT
For additional information about the Board of Directors, officers and
management personnel of High Yield, see "Management of the Fund" and
"Investment Management and Other Services" in High Yield's Statement of
Additional Information.
INVESTMENT ADVISORY AND OTHER SERVICES
For additional information about High Yield's investment manager, see
"Investment Management and Other Services" in High Yield's Statement of
Additional Information. For additional information about High Yield's
independent auditors, see "Investment Management and Other Services" in High
Yield's Statement of Additional Information. For additional information about
other services provided to High Yield, see "Investment Management and Other
Services" in High Yield's Statement of Additional Information.
PORTFOLIO TRANSACTIONS AND BROKERAGE
For additional information about brokerage allocation practices, see
"Brokerage Allocation and Other Practices" in High Yield's Statement of
Additional Information.
DESCRIPTION OF FUND SHARES AND PRINCIPAL HOLDERS OF FUND SHARES
For additional information about the voting rights and other
characteristics of the shares of High Yield, and the principal owners of the
shares of High Yield, see "Capital Stock and Other Securities" and "Control
Persons and Principal Holders of Securities" in High Yield's Statement of
Additional Information.
PURCHASE, REDEMPTION AND PRICING OF SHARES
For additional information about the purchase and redemption of High
Yield's shares and the determination of net asset value, see "Purchase,
Redemption and Pricing of Shares" in High Yield's Statement of Additional
Information.
DIVIDENDS, DISTRIBUTIONS AND TAX STATUS
For additional information about High Yield's policies regarding dividends
and distributions and tax matters affecting High Yield and its shareholders,
see "Taxation of the Fund and Shareholders" in High Yield's Statement of
Additional Information.
B-3
DISTRIBUTION OF SHARES
For additional information about High Yield's distributor and the
distribution agreement between High Yield and its distributor, see "Investment
Management and Other Services" and "Underwriters" in High Yield's Statement of
Additional Information.
PERFORMANCE DATA
For additional information about High Yield's performance, see
"Calculation of Performance Data" in High Yield's Statement of Additional
Information.
FINANCIAL STATEMENTS
High Yield's most recent audited financial statements are set forth in
High Yield's Annual Report for the fiscal year ended August 31, 2002. A copy of
the Annual Report accompanies, and is incorporated by reference in, the Proxy
Statement and Prospectus. HIAT III's most recent audited financial statements
are set forth in HIAT III's Annual Report for the fiscal year ended January 31,
2002. HIAT III's most recent semi-annual financial statements (unaudited) are
set forth in HIAT III's Semi-Annual Report for the six-month period ended July
31, 2002. Copies of the Annual Report and Semi-Annual Report accompany, and are
incorporated by reference in, the Proxy Statement and Prospectus.
B-4
STATEMENT OF ADDITIONAL INFORMATION MORGAN STANLEY
SEPTEMBER 30, 2002 HIGH YIELD SECURITIES INC.
- --------------------------------------------------------------------------------
This Statement of Additional Information is not a prospectus. The
Prospectus (dated September 30, 2002) for Morgan Stanley High Yield Securities
Inc. (the "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 High Yield Securities Inc.
1221 Avenue of the Americas
New York, NY 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.............................10
III. Management of the Fund..................................................12
A. Board of Directors................................................12
B. Management Information............................................12
C. Compensation......................................................17
IV. Control Persons and Principal Holders of Securities.....................19
V. Investment Management and Other Services................................19
A. Investment Manager................................................19
B. Principal Underwriter.............................................20
C. Services Provided by the Investment Manager.......................20
D. Dealer Reallowances...............................................21
E. Rule 12b-1 Plan...................................................22
F. Other Service Providers...........................................26
G. Codes of Ethics...................................................26
VI. Brokerage Allocation and Other Practices................................26
A. Brokerage Transactions............................................26
B. Commissions.......................................................26
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..............................28
A. Purchase/Redemption of Shares.....................................28
B. Offering Price....................................................29
IX. Taxation of the Fund and Shareholders...................................30
X. Underwriters............................................................32
XI. Calculation of Performance Data.........................................32
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.
"Directors"--The Board of Directors of the Fund.
"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 High Yield Securities Inc., a registered open-end
investment company.
"Independent Directors"--Directors 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 & 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.
3
I. FUND HISTORY
- --------------------------------------------------------------------------------
The Fund was incorporated in the state of Maryland on June 14, 1979 under
the name InterCapital High Yield Securities Inc. On March 21, 1983, the Fund's
name was changed to Dean Witter High Yield Securities Inc. On June 22, 1998, the
name of the Fund was changed to Morgan Stanley Dean Witter High Yield Securities
Inc. Effective June 18, 2001 the Fund's name was changed to Morgan Stanley High
Yield Securities Inc.
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 earn a high level of current income. As a secondary
objective, the Fund seeks capital appreciation but only to the extent consistent
with its primary objective.
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."
FUTURES TRANSACTIONS. The Fund may purchase and sell interest rate
contracts that are traded on U.S. and foreign commodity exchanges.
The Fund may sell a futures contract or a call option thereon or purchase a
put option on such futures contract, if the Investment Manager anticipates
interest rates to rise, as a hedge against a decrease in the value of the Fund's
portfolio securities. If the Investment Manager anticipates that interest rates
will decline, the Fund may purchase a futures contract or a call option thereon
or sell a put option on such futures contract to protect against an increase in
the price of the securities the Fund intends to purchase. These futures
contracts and related options thereon will be used only as a hedge against
anticipated interest rate changes.
Although the terms of future contracts specify actual delivery or receipt of
securities, in most instances the contracts are closed out before the settlement
date without the making or taking of delivery of the securities. Closing out of
a futures contract is usually effected by entering into an offsetting
transaction. An offsetting transaction for a futures contract sale is effected
by the Fund entering into a futures contract purchase for the same aggregate
amount of the specific type of financial instrument and same delivery date. If
the price in the sale exceeds the price in the offsetting purchase, the Fund is
immediately paid the difference and thus realizes a gain. If the offsetting
purchase price exceeds the sale price, the Fund pays the difference and realizes
a loss. Similarly, the closing out of the futures contract purchase is effected
by the Fund entering into a futures contract sale. If the offsetting sale price
exceeds the purchase price, the Fund realizes a gain, and if the offsetting sale
price is less than the purchase price, the Fund realizes a loss.
Margin. If the Fund enters into a futures contract, it is initially
required to deposit an "initial margin" of cash or 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 or U.S. government
securities or other liquid portfolio securities, called "variation margin,"
which are reflective of price fluctuations in the futures contract.
4
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%.
Risks of Transactions in Futures Contracts and Related Options. A risk in
employing futures contracts to protect against the price volatility of portfolio
securities is that the prices of securities subject to futures contracts may
correlate imperfectly with the behavior of the cash prices of the Fund's
portfolio securities. The correlation may be distorted by the fact that the
futures market is dominated by short-term traders seeking to profit from the
difference between a contract or security price objective and their cost of
borrowed funds. This would reduce their value for hedging purposes over a short
time period. Such distortions are generally minor and would diminish as the
contract approached maturity. Another risk is that the Fund's manager could be
incorrect in its expectations as to the direction or extent of various interest
rate movements or the time span within which the movements take place. For
example, if the Fund sold futures contracts for the sale of securities in
anticipation of an increase in interest rates, and then interest rates went down
instead, causing bond prices to rise, the Fund would lose money on the sale.
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 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 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
hedges its portfolio.
5
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, 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.
OPTIONS. The Fund may purchase or sell (write) options on debt securities
as a means of achieving additional return or hedging the value of the Fund's
portfolio. The Fund may only buy options listed on national securities
exchanges. The Fund will not purchase options if, as a result, the aggregate
cost of all outstanding options exceeds 10% of the Fund's total assets.
A call option is a contract that gives the holder of the option the right to
buy from the writer of the call option, in return for a premium, the security
underlying the option at a specified exercise price at any time during the term
of the option. The writer of the call option has the obligation, upon exercise
of the option, to deliver the underlying security upon payment of the exercise
price during the option period. A put option is a contract that gives the holder
of the option the right to sell to the writer, in return for a premium, the
underlying security at a specified price during the term of the option. The
writer of the put has the obligation to buy the underlying security upon
exercise, at the exercise price during the option period.
The Fund may only write covered call or covered put options listed on
national exchanges. The Fund may not write covered options in an amount
exceeding 20% of the value of the total assets of the Fund. A call option is
"covered" if the Fund owns the underlying security covered by the call or has an
absolute and immediate right to acquire that security or futures contract
without additional cash consideration (or for additional cash consideration held
in a segregated account by its custodian) 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 or futures contract 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 with its custodian. 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 with its custodian, or else holds a put on the same security
or futures contract 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.
6
If the Fund has written an option, it may terminate its obligation by
effecting a closing purchase transaction. This 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. Similarly, if the Fund is the holder of an option,
it may liquidate its position by effecting a closing sale transaction. This is
accomplished by selling an option of the same fund as the option previously
purchased. There can be no assurance that either a closing purchase or sale
transaction on behalf of the Fund can be effected when the Fund so desires.
The Fund will realize a profit from a closing transaction if the price of
the transaction is less than the premium received from writing the option or is
more than the premium paid to purchase the option; the Fund will realize a loss
from a closing transaction if the price of the transaction is more than the
premium received from writing the option or is less than the premium paid to
purchase the option. Since call option prices generally reflect increases in the
price of the underlying security, any loss resulting from the purchase of a call
option may also be wholly or partially offset by unrealized appreciation of the
underlying security. If a put option written by the Fund is exercised, the Fund
may incur a loss equal to the difference between the exercise price of the
option and the sum of the sale price of the underlying security plus the
premiums received from the sale of the option. Other principal factors affecting
the market value of a put or a call option include supply and demand, interest
rates, the current market price and price volatility of the underlying security
and the time remaining until the expiration date.
An option position may be closed out only on an exchange which provides a
secondary market for an option of the same series. Although the Fund will
generally purchase or write only those options for which there appears to be an
active secondary market, there is no assurance that a liquid secondary market on
an exchange will exist for any particular option. In such event, it might not be
possible to effect closing transactions in particular options, so that the Fund
would have to exercise its options in order to realize any profit and would
incur brokerage commission upon the exercise of call options and upon covered
call option writer is unable to effect a closing purchase transaction in a
secondary market, it will not be able to sell the underlying security until the
option expires or it delivers the underlying security upon exercise.
MONEY MARKET SECURITIES. In addition to the money market 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:
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, 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 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
7
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
Directors 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.
MUNICIPAL OBLIGATIONS. The Fund may invest up to 10% of its total assets in
municipal obligations that pay interest exempt from federal income tax.
Municipal obligations are securities issued by state and local governments and
regional government authorities. These securities typically are "general
obligation" or "revenue" bonds, notes or commercial paper. General obligation
securities are secured by the issuer's faith and credit, as well as its taxing
power, for payment of principal and interest. Revenue bonds, however, are
generally payable from a specific revenue source. They are issued to fund a wide
variety of public and private projects in sectors such as transportation,
education and industrial development. Included within the revenue bonds category
are participations in lease obligations and installment contracts of
municipalities.
PUBLIC UTILITIES. The Fund's investments in the utilities industry are
impacted by risks particular to that industry. Changing regulation constitutes
one of the key industry-specific risks for the Fund, especially with respect to
its investments in traditionally regulated public utilities and partially
regulated utility companies. State and other regulators monitor and control
utility revenues and costs, and therefore may limit utility profits. Regulatory
authorities also may restrict a company's access to new markets, thereby
diminishing the company's long-term prospects.
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
8
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.
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.
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 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
9
(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, pursuant to
procedures adopted by the Directors, 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 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. As a primary objective, seek to earn a high level of current income.
2. As a secondary objective, seek capital appreciation but only to the
extent consistent with its primary objective.
The Fund may not:
1. Acquire common stocks in excess of 20% of its total assets.
2. Invest more than 5% of its total assets in the securities of any one
issuer (other than obligations of, or guaranteed by, the United States
government, its agencies or instrumentalities).
3. Purchase more than 10% of the voting securities, or more than 10% of
any class of securities, of any issuer. For purposes of this restriction,
all outstanding debt securities of an issuer are considered as one class and
all preferred stocks of an issuer are considered as one class.
10
4. Invest more than 25% of its total assets in securities of issuers in
any one industry. For purposes of this restriction, gas, electric, water and
telephone utilities will each be treated as being a separate industry. This
restriction does not apply to obligations issued or guaranteed by the United
States government or its agencies or instrumentalities.
5. Invest more than 5% of its total assets in securities of companies
having a record, together with predecessors, of less than three years of
continuous operation. This restriction shall not apply to any obligation of
the United States government, its agencies or instrumentalities.
6. Make short sales of securities.
7. Purchase securities on margin, except for such short-term loans as
are necessary for the clearance of purchases of portfolio securities.
8. Pledge its assets or assign or otherwise encumber them in excess of
4.5% of its net assets (taken at market value at the time of pledging) and
then only 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 margin for futures are
not deemed to be pledges of assets.
9. 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.
10. Purchase or sell real estate or interests therein, although it may
purchase securities of issuers which engage in real estate operations and
securities which are secured by real estate or interests therein.
11. Purchase or sell commodities except that the Fund may purchase
financial futures contracts and related options.
12. Make loans of money or securities, except: (a) the purchase of debt
obligations; (b) investment in repurchase agreements; or (c) by lending its
portfolio securities.
13. 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 invest in or sponsor such
programs.
14. Purchase securities of other investment companies, except in
connection with a merger, consolidation, reorganization or acquisition of
assets.
15. Invest for the purpose of exercising control or management of
another company.
16. Invest in securities of any company if, to the knowledge of the
Fund, any officer or director of the Fund or of the Investment Manager owns
more than 1/2 of 1% of the outstanding securities of such company, and such
officers and directors who own more than 1/2 of 1% own in the aggregate more
than 5% of the outstanding securities of such company.
17. Write, purchase or sell puts, calls, or combinations thereof except
options on futures contracts or options on debt securities.
18. Borrow money, except that the Fund may borrow for temporary
purposes in amounts not exceeding 5% (taken at the lower of cost or current
value) of its total assets (not including the amount borrowed).
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.
11
III. MANAGEMENT OF THE FUND
- --------------------------------------------------------------------------------
A. BOARD OF DIRECTORS
The Board of Directors of the Fund oversees the management of the Fund but
does not itself manage the Fund. The Directors 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 Directors
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 Directors are generally characterized as
a duty of loyalty and a duty of care. The duty of loyalty requires a Director to
exercise his or her powers in the interest of the Fund and not the Director's
own interest or the interest of another person or organization. A Director
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 Director reasonably believes to be
in the best interest of the Fund and its shareholders.
B. MANAGEMENT INFORMATION
DIRECTORS AND OFFICERS. The Board of the Fund consists of eight (8)
Directors. These same individuals also serve as directors or trustees for all of
the Morgan Stanley Funds. Five Directors 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"
Directors. The other three Directors (the "Management Directors") are affiliated
with the Investment Manager.
The Independent Directors 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 Director (as of December 31, 2001) and other directorships, if any,
held by the Director, 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
COMPLEX
POSITION(S) LENGTH OF OVERSEEN
NAME, AGE AND ADDRESS OF HELD WITH TIME PRINCIPAL OCCUPATION(S) DURING BY
INDEPENDENT DIRECTOR REGISTRANT SERVED* PAST 5 YEARS DIRECTOR
- --------------------------- ----------- ----------- -------------------------------------- -----------
Michael Bozic (61) Director Director 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
Directors 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.
NAME, AGE AND ADDRESS OF OTHER DIRECTORSHIPS HELD
INDEPENDENT DIRECTOR BY DIRECTOR
- --------------------------- -------------------------
Michael Bozic (61) Director of Weirton Steel
c/o Mayer, Brown, Rowe & Corporation.
Maw
Counsel to the Independent
Directors
1675 Broadway
New York, NY
12
NUMBER OF
PORTFOLIOS
IN FUND
COMPLEX
POSITION(S) LENGTH OF OVERSEEN
NAME, AGE AND ADDRESS OF HELD WITH TIME PRINCIPAL OCCUPATION(S) DURING BY
INDEPENDENT DIRECTOR REGISTRANT SERVED* PAST 5 YEARS DIRECTOR
- --------------------------- ----------- ----------- -------------------------------------- -----------
Edwin J. Garn (69) Director Director 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.
Wayne E. Hedien (68) Director Director 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),
Directors 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) Director Director 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) Director Director 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).
NAME, AGE AND ADDRESS OF OTHER DIRECTORSHIPS HELD
INDEPENDENT DIRECTOR BY DIRECTOR
- --------------------------- -------------------------
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.
Wayne E. Hedien (68) Director of The PMI Group
c/o Mayer, Brown, Rowe & Inc. (private mortgage
Maw insurance); Director and
Counsel to the Independent Vice Chairman of The
Directors 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 Director 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
- ----------------------------------
* This is the date the Director began serving the Morgan Stanley Funds.
The Directors who are affiliated with the Investment Manager or affiliates
of the Investment Manager (as set forth below) and executive officers of the
Fund, their term of office and length of time served, their
13
principal business occupations during the past five years, the number of
portfolios in the Fund Complex overseen by each management Director and the
other directorships, if any, held by the Director, are shown below.
NUMBER OF
PORTFOLIOS
IN FUND
COMPLEX
POSITION(S) LENGTH OF OVERSEEN
NAME, AGE AND ADDRESS OF HELD WITH TIME PRINCIPAL OCCUPATION(S) DURING BY
MANAGEMENT DIRECTOR REGISTRANT SERVED* PAST 5 YEARS DIRECTOR
- --------------------------- ----------- ----------- -------------------------------------- -----------
Charles A. Fiumefreddo (69) Chairman Director Chairman and Director or Trustee of 129
c/o Morgan Stanley Trust and since the Morgan Stanley Funds and the
Harborside Financial Director or July 1991 TCW/DW Term Trusts; formerly Chairman,
Center, Trustee Chief Executive Officer and Director
Plaza Two, of the Investment Manager, the
Jersey City, NJ 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) and Chief Executive
Officer of the Morgan Stanley Funds
and the TCW/DW Term Trusts (until
September 2002).
James F. Higgins (54) Director Director Director or Director 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) Director Director Director or Director 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 DIRECTOR BY DIRECTOR
- --------------------------- -------------------------
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 Director began serving the Morgan Stanley Funds.
14
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 and President since May President and Chief Operating Officer of Morgan Stanley
1221 Avenue of the Americas Chief Executive 1999 and Chief Investment Management (since December 1998); President,
New York, NY Officer Executive Officer Director (since April 1997) and Chief Executive Officer
since September 2002 (since June 1998) of the Investment Manager and Morgan
Stanley Services; Chairman, Chief Executive Officer and
Director of the Distributor (since June 1998); Chairman
(since June 1998) and Director (since January 1998) of
the Transfer Agent; Director of various Morgan Stanley
subsidiaries; President (since May 1999) and Chief
Executive Officer (since September 2002) of the Morgan
Stanley Funds and TCW/DW Term Trusts; Director 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
Ronald E. Robison (63) Vice President Since October 1998 Managing Director, Chief Administrative Officer and
1221 Avenue of the Americas Director since February 1999) of the Investment Manager
New York, NY and Morgan Stanley Services and Chief Executive Officer
and Director of the Transfer Agent; previously Managing
Director of the TCW Group Inc.
Joseph J. McAlinden (59) Vice President Since July 1995 Managing Director and Chief Investment Officer of the
1221 Avenue of the Americas Investment Manager, Morgan Stanley Investment
New York, NY Management Inc. and Morgan Stanley Investments LP; and
Director of the Transfer Agent. Chief Investment
Officer of the Van Kampen Funds.
Francis Smith (37) Vice President Since September 2002 Vice President and Chief Financial Officer of the
c/o Morgan Stanley Trust and Chief Morgan Stanley Funds and the TCW/DW Term Trusts (since
Harborside Financial Center Financial September 2002); Executive Director of the Investment
Plaza Two, Officer Manager and Morgan Stanley Services (since December
Jersey City, NJ 2001). Formerly, Vice President of the Investment
Manager and Morgan Stanley Services (August
2000-November 2001), Senior Manager at
PricewaterhouseCoopers LLP (January 1998-August 2000)
and Associate-Fund Administration at BlackRock
Financial Management (July 1996-December 1997).
15
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 Funds, and Sara Badler, Stefanie Chang-Yu, 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 Joanne Doldo, Natasha
Kassian and Sheldon Winicour, Vice Presidents and Assistant General Counsels of
the Investment Manager and Morgan Stanley Services, are Assistant Secretaries of
the Funds.
For each Director, the dollar range of equity securities beneficially owned
by the Director is shown below.
AGGREGATE DOLLAR RANGE OF EQUITY SECURITIES IN
ALL REGISTERED INVESTMENT COMPANIES OVERSEEN
DOLLAR RANGE OF EQUITY SECURITIES IN THE FUNDS BY DIRECTOR IN FAMILY OF INVESTMENT COMPANIES
NAME OF DIRECTOR (AS OF DECEMBER 31, 2001) (AS OF DECEMBER 31, 2001)
- ------------------------- -------------------------------------------------- -------------------------------------------------
INDEPENDENT:
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 $10,001-$50,000 over $100,000
INTERESTED:
Charles A. Fiumefreddo $10,001-$50,000 over $100,000
James F. Higgins None over $100,000
Philip J. Purcell None over $100,000
As to each independent Director 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.
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, six of the directors/trustees, including all of the
independent directors/trustees, serve as members of the Derivatives Committee
and three directors/trustees including two independent directors/trustees serve
as members of 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
16
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 and Nugent. During
the Fund's fiscal year ended August 31, 2002, the Audit Committee held 10
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 Mr.
Fiumefreddo and all of the Independent Directors of the Fund. During the Fund's
fiscal year ended August 31, 2002, the Derivatives Committee held three
meetings.
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 August 31, 2002, the Insurance Committee held one
meeting.
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.
DIRECTOR AND OFFICER INDEMNIFICATION. The Fund's By-Laws provides that no
Director, officer, employee or agent of the Fund is liable to the Fund or to a
shareholder, nor is any Director, 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 By-Laws provides that a Director, 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 Director an annual fee of $800 plus a per
meeting fee of $50 for meetings of the Board of Directors, the Independent
Directors or Committees of the Board of Directors attended by the Director (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 Directors or
a Committee meeting (except an Audit Committee meeting), or a meeting of the
Independent Directors and/or more than one Committee meeting (except an Audit
Committee meeting), take place on a single day, the Directors are paid a single
meeting fee by the Fund. The Fund also reimburses such Directors for travel and
other out-of-pocket expenses incurred by them in connection with attending such
meetings. Directors 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 Director. The Fund
pays Mr. Fiumefreddo an annual fee for his service as Chairman of the Board and
for administrative services provided to the Board of Directors.
17
The following table illustrates the compensation that the Fund paid to its
Directors for the fiscal year ended August 31, 2002.
FUND COMPENSATION
AGGREGATE
COMPENSATION
NAME OF DIRECTOR 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
Charles A. Fiumefreddo...................................... 3,063
The following table illustrates the compensation paid to the Fund's
Directors 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 Directors received
compensation from any other funds in the Fund Complex, except 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 DIRECTOR FUND COMPLEX
- ---------------------------- ---------------
Michael Bozic............................................... $150,150
Edwin J. Garn............................................... 150,150
Wayne E. Hedien............................................. 150,100
Dr. Manuel H. Johnson....................................... 219,900
Michael E. Nugent........................................... 228,362
Charles A. Fiumefreddo...................................... 360,000
As of the date of this Statement of Additional Information, 51 of the Morgan
Stanley Funds, 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 referred to as an "Eligible Director") 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 Director 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 Director for service to the Adopting Fund
in the five
- ------------------------
(1) An Eligible Director may elect alternative payments of his or her retirement
benefits based upon the combined life expectancy of the Eligible Director
and his or her spouse on the date of such Eligible Director's retirement. In
addition, the Eligible Director 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 Director and spouse, will be the actuarial equivalent of the
Regular Benefit.
18
year period prior to the date of the Eligible Director'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 Directors by the Fund for the fiscal year ended August 31,
2002 and by the 52 Morgan Stanley Funds (including the Fund) for the calendar
year ended December 31, 2001, and the estimated retirement benefits for the
Independent Directors, to commence upon their retirement, from the Fund as of
August 31, 2002 and from the 52 Morgan Stanley Funds as of calendar year ended
December 31, 2001. For the calendar year ended December 31, 2001, no retirement
benefits were accrued to the Independent Trustees from any other funds in the
Fund Complex.
RETIREMENT BENEFITS FROM THE FUND AND ALL MORGAN STANLEY FUNDS
FOR ALL ADOPTING FUNDS
----------------------------- ESTIMATED ANNUAL
ESTIMATED RETIREMENT BENEFITS BENEFITS
CREDITED ACCRUED AS EXPENSES UPON RETIREMENT(2)
YEARS ESTIMATED ------------------------- -------------------------
OF SERVICE AT PERCENTAGE OF BY ALL FROM FROM ALL
RETIREMENT ELIGIBLE BY THE ADOPTING THE ADOPTING
NAME OF INDEPENDENT DIRECTOR (MAXIMUM 10) COMPENSATION FUND FUNDS FUND FUNDS
- ---------------------------- ------------- ------------- -------- -------------- -------- --------------
Michael Bozic.............. 10 60.44% $ 360 $21,395 $ 907 $48,443
Edwin J. Garn.............. 10 60.44 520 33,443 927 49,121
Wayne E. Hedien............ 9 51.37 691 44,952 779 41,437
Dr. Manuel H. Johnson...... 10 60.44 376 22,022 1,360 72,014
Michael E. Nugent.......... 10 60.44 625 38,472 1,209 64,157
- ------------------------
(2) Based on current levels of compensation. Amount of annual benefits also
varies depending on the Director's elections described in Footnote (1) on
page 18.
IV. CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
- --------------------------------------------------------------------------------
The following person owned 5% or more of the outstanding shares of Class A
of the Fund as of September 6, 2002: Robert M. Sullivan Jr., 1428 Longmeadow
St., Longmeadow, MA 01106-2239--5.38%.
As of the date of this Statement of Additional Information, the aggregate
number of shares of common stock of the Fund owned by the Fund's officers and
Directors as a group was less than 1% of the Fund's shares of common stock
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 following annual rates to the net assets of the Fund
determined as of the close of each business day: 0.50% to the portion of daily
net assets not exceeding $500 million; 0.425% to the portion of daily net assets
exceeding $500 million but not exceeding $750 million; 0.375% to the portion of
daily net assets exceeding $750 million but not exceeding $1 billion; 0.35% to
the portion of daily net
19
assets exceeding $1 billion but not exceeding $2 billion; 0.325% to the portion
of daily net assets exceeding $2 billion but not exceeding $3 billion; and 0.30%
to the portion of daily net assets exceeding $3 billion. The management fee is
allocated among the Classes pro rata based on the net assets of the Fund
attributable to each Class. For the fiscal years ended August 31, 2000, 2001 and
2002, the Investment Manager accrued total compensation under the Management
Agreement in the amounts of $8,439,728, $5,350,108 and $3,258,237, respectively.
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 Directors, including the
Independent Directors, 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 Directors 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 Directors 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 Directors 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 Directors, including all of the Independent Directors,
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
20
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
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.
Expenses not expressly assumed by the Investment Manager under the
Management Agreement or by the Distributor, will be paid by the Fund. These
expenses will be allocated among the four Classes of shares pro rata based on
the net assets of the Fund attributable to each Class, except as described
below. 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 Directors' meetings and of preparing, printing and mailing of proxy
statements and reports to shareholders; fees and travel expenses of Directors 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 Directors 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 Directors) 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 12b-1 fees
relating to a particular Class will be allocated directly to that Class. In
addition, other expenses associated with a particular Class (except advisory or
custodial fees) may be allocated directly to that Class, provided that such
expenses are reasonably identified as specifically attributable to that Class
and the direct allocation to that Class is approved by the Directors.
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 Directors, including a majority of
the Independent Directors; provided that in either event such continuance is
approved annually by the vote of a majority of the Directors, including a
majority of the Independent Directors.
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.
21
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 each Class, other than
Class D, pays the Distributor compensation accrued daily and payable monthly at
the following maximum annual rates: 0.25%, 0.75% and 0.85% of the average daily
net assets of Class A, Class B and Class C, respectively.
The Distributor also receives the proceeds of front-end sales charges
("FSCs") and of contingent deferred sales charges ("CDSCs") imposed on certain
redemptions of shares, which are separate and apart from payments made pursuant
to the Plan. The Distributor has informed the Fund that it and/or Morgan Stanley
DW received the proceeds of CDSCs and FSCs, for the last three fiscal years
ended August 31, in approximate amounts as provided in the table below (the
Distributor did not retain any of these amounts).
2002 2001 2000
-------------------- -------------------- --------------------
Class A................ FSCs:(1) $ 135,390 FSCs:(1) $ 217,448 FSCs:(1) $ 187,035
CDSCs: $ 26,842 CDSCs: $ 12,759 CDSCs: $ 26,734
Class B................ CDSCs: $1,519,542 CDSCs: $3,170,758 CDSCs: $4,887,041
Class C................ CDSCs: $ 29,347 CDSCs: $ 61,850 CDSCs: $ 86,304
- ------------------------
(1) FSCs apply to Class A only.
The Distributor has informed the Fund that the entire fee payable by
Class A and a portion of the fees payable by each of Class B and Class C each
year pursuant to the Plan equal to 0.20% of the average daily net assets of
Class B and 0.25% of the average daily net assets of Class C are currently each
characterized as a "service fee" under the Rules of the National Association of
Securities Dealers, Inc. (of which the Distributor is a member). The "service
fee" is a payment made for personal service and/or the maintenance of
shareholder accounts. The remaining portion of the Plan fees payable by a Class,
if any, is characterized as an "asset-based sales charge" as such is defined by
the Rules of the Association.
Under the Plan and as required by Rule 12b-1, the Directors receive and
review promptly after the end of each calendar quarter a written report provided
by the Distributor of the amounts expended under the Plan and the purpose for
which such expenditures were made. During the fiscal year ended August 31, 2002,
Class A, Class B and Class C shares of the Fund accrued amounts payable to the
Distributor under the Plan of $48,012, $3,747,816 and $349,455, respectively,
which amounts are equal to 0.18%, 0.75% and 0.85% of the average daily net
assets of Class A, Class B and Class C, respectively.
The Plan was adopted in order to permit the implementation of the Fund's
method of distribution. Under this distribution method the Fund offers four
Classes, each with a different distribution arrangement.
With respect to Class A shares, Morgan Stanley DW compensates its Financial
Advisors by paying them, from proceeds of the FSC, commissions for the sale of
Class A shares, currently a gross sales credit of up to 4.0% of the amount sold
(except as provided in the following sentence) and an annual residual
commission, currently a residual of up to 0.20% of the current value of the
respective accounts for which they are the Financial Advisors or dealers of
record in all cases. On orders of $1 million or more (for which no sales charge
was paid) or net asset value purchases by employer-sponsored employee benefit
plans, whether or not qualified under the Internal Revenue Code, for which
(i) the Transfer Agent serves as Trustee, (ii) Morgan Stanley's Retirement Plan
Services serves as recordkeeper pursuant to a written Recordkeeping Services
Agreement or (iii) an entity independent from Morgan Stanley serves as
recordkeeper under an alliance or similar agreement with Morgan Stanley's
Retirement Plan Services ("Morgan Stanley Eligible Plans"), the Investment
Manager compensates Financial Advisors by paying them, from its own funds, a
gross sales credit of 1.0% of the amount sold.
With respect to Class B shares, Morgan Stanley DW compensates its Financial
Advisors by paying them, from its own funds, commissions for the sale of
Class B shares, currently a gross sales credit of up
22
to 4.0% of the amount sold (except as provided in the following sentence) and an
annual residual commission, currently a residual of up to 0.20% of the current
value (not including reinvested dividends or distributions) of the amount sold
in all cases. In the case of Class B shares purchased by Morgan Stanley Eligible
Plans, Morgan Stanley DW compensates its Financial Advisors by paying them, from
its own funds, a gross sales credit of 3.0% of the amount sold.
With respect to Class C shares, Morgan Stanley DW compensates its Financial
Advisors by paying them, from its own funds, commissions for the sale of
Class C shares, currently a gross sales credit of up to 1.0% of the amount sold
and an annual residual commission, currently up to 0.85% of the current value of
the respective accounts for which they are the Financial Advisors of record.
With respect to Class D shares other than shares held by participants in the
Investment Manager's mutual fund asset allocation program and in the Morgan
Stanley Choice Program, the Investment Manager compensates Morgan Stanley DW's
Financial Advisors by paying them, from its own funds, commissions for the sale
of Class D shares, currently a gross sales credit of up to 1.0% of the amount
sold. There is a chargeback of 100% of the amount paid if the Class D shares are
redeemed in the first year and a chargeback of 50% of the amount paid if the
Class D shares are redeemed in the second year after purchase. The Investment
Manager also compensates Morgan Stanley DW's Financial Advisors by paying them,
from its own funds, an annual residual commission, currently up to 0.10% of the
current value of the respective accounts for which they are the Financial
Advisors of record (not including accounts of participants in the Investment
Manager's mutual fund asset allocation program and the Morgan Stanley Choice
Program).
The gross sales credit is a charge which reflects commissions paid by Morgan
Stanley DW to its Financial Advisors and Morgan Stanley DW's Fund-associated
distribution-related expenses, including sales compensation, and overhead and
other branch office distribution-related expenses including (a) the expenses of
operating Morgan Stanley DW's branch offices in connection with the sale of Fund
shares, including lease costs, the salaries and employee benefits of operations
and sales support personnel, utility costs, communications costs and the costs
of stationery and supplies, (b) the costs of client sales seminars, (c) travel
expenses of mutual fund sales coordinators to promote the sale of Fund shares
and (d) other expenses relating to branch promotion of Fund sales.
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 distribution fee that the Distributor receives from the Fund under the
Plan, in effect, offsets distribution expenses incurred under the Plan on behalf
of the Fund and, in the case of Class B shares, opportunity costs, such as the
gross sales credit and an assumed interest charge thereon ("carrying charge").
These expenses may include the cost of Fund-related educational and/or
business-related trips or payment of Fund-related educational and/or promotional
expenses of Financial Advisors. 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. In the Distributor's reporting of the distribution expenses to
the Fund, in the case of Class B shares, such assumed interest (computed at the
"broker's call rate") has been calculated on the gross credit as it is reduced
by amounts received by the Distributor under the Plan and any contingent
deferred sales charges received
23
by the Distributor upon redemption of shares of the Fund. No other interest
charge is included as a distribution expense in the Distributor's calculation of
its distribution costs for this purpose. The broker's call rate is the interest
rate charged to securities brokers on loans secured by exchange-listed
securities.
The Fund is authorized to reimburse expenses incurred or to be incurred in
promoting the distribution of the Fund's Class A and Class C shares and in
servicing shareholder accounts. Reimbursement will be 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 0.25%, in the case of
Class A, and 0.85%, in the case of Class C, of the average net assets of the
respective Class during the month. No interest or other financing charges, if
any, incurred on any distribution expenses on behalf of Class A and Class C will
be reimbursable under the Plan. With respect to Class A, in the case of all
expenses other than expenses representing the service fee, and, with respect to
Class C, in the case of all expenses other than expenses representing a gross
sales credit or a residual to Financial Advisors and other authorized financial
representatives, such amounts shall be determined at the beginning of each
calendar quarter by the Directors, including, a majority of the Independent
Directors. Expenses representing the service fee (for Class A) or a gross sales
credit or a residual to Financial Advisors and other authorized financial
representatives (for Class C) 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 reimbursed by the Fund, the Distributor will provide and the
Directors will review a quarterly budget of projected 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 Directors will
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 Class A and
Class C shares.
Each Class paid 100% of the amounts accrued under the Plan with respect to
that Class for the fiscal year ended August 31, 2002 to the Distributor. The
Distributor and Morgan Stanley DW estimate that they have spent, pursuant to the
Plan, $124,910,663 on behalf of Class B since the inception of the Plan. It is
estimated that this amount was spent in approximately the following ways:
(i) 4.08% ($5,098,452)--advertising and promotional expenses; (ii) 0.05%
($58,266)--printing of prospectuses for distribution to other than current
shareholders; and (iii) 95.87% ($119,753,945)--other expenses, including the
gross sales credit and the carrying charge, of which 9.99% ($11,958,129)
represents carrying charges, 24.55% ($29,394,898) represents commission credits
to Morgan Stanley DW branch offices and other selected broker-dealers for
payments of commissions to Financial Advisors and other authorized financial
representatives, 34.74% ($41,607,270) represents overhead and other branch
office distribution-related expenses, and 30.72% ($36,793,648) represents excess
distribution expenses of Dean Witter High Income Securities, the net assets of
which were combined with those of the Fund on November 10, 1997 pursuant to an
Agreement and Plan of Reorganization. The amount accrued by Class A and a
portion of the amounts accrued by Class C under the Plan during the fiscal year
ended August 31, 2002 were service fees. The remainder of the amounts accrued by
Class C were for expenses which relate to compensation of sales personnel and
associated overhead expenses.
In the case of Class B shares, at any given time, the expenses of
distributing shares of the Fund may be more or less than the total of (i) the
payments made by the Fund pursuant to the Plan; and (ii) the proceeds of CDSCs
paid by investors upon redemption of shares. For example, if $1 million in
expenses in distributing Class B shares of the Fund had been incurred and
$750,000 had been received as described in (i) and (ii) above, the excess
expense would amount to $250,000. The Distributor has advised the Fund that in
the case of Class B shares the excess distribution expenses, including the
carrying charge designed to approximate the opportunity costs incurred by Morgan
Stanley DW which arise from it having advanced monies without having received
the amount of any sales charges imposed at the time of sale of the Fund's
Class B shares, totaled $60,068,745 as of August 31, 2002, which was equal to
16.17% of the net assets of Class B on such date. Because there is no
requirement under the Plan that the Distributor be reimbursed for all
distribution expenses with respect to Class B shares or any requirement that the
Plan be continued from year to year, this excess amount does not constitute a
24
liability of the Fund. Although there is no legal obligation for the Fund to pay
expenses incurred in excess of payments made to the Distributor under the Plan
and the proceeds of CDSCs paid by investors upon redemption of shares, if for
any reason the Plan is terminated, the Directors will consider at that time the
manner in which to treat such expenses. Any cumulative expenses incurred, but
not yet recovered through distribution fees or CDSCs, may or may not be
recovered through future distribution fees or CDSCs.
In the case of Class A and Class C shares, expenses incurred pursuant to the
Plan in any calendar year in excess of 0.25% or 0.85% of the average daily net
assets of Class A or Class C, respectively, will not be reimbursed by the Fund
through payments in any subsequent year, except that expenses representing a
gross sales commission credited to Morgan Stanley Financial Advisors and other
authorized financial representatives at the time of sale may be reimbursed in
the subsequent calendar year. The Distributor has advised the Fund that
unreimbursed expenses representing a gross sales commission credited to Morgan
Stanley Financial Advisors and other authorized financial representatives at the
time of sale totaled $74,429 in the case of Class C at December 31, 2001 (end of
the calendar year), which was equal to 0.17% of the net assets of Class C on
such date, and that there were no such expenses that may be reimbursed in the
subsequent year in the case of Class A on such date. No interest or other
financing charges will be incurred on any Class A or Class C distribution
expenses incurred by the Distributor under the Plan or on any unreimbursed
expenses due to the Distributor pursuant to the Plan.
No interested person of the Fund nor any Independent Director 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 Directors, including a majority of the Independent
Directors, consider whether the Plan should be continued. Prior to approving the
last continuation of the Plan, the Directors 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 Directors 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: (a) the Plan is essential in order to
give Fund investors a choice of alternatives for payment of distribution and
service charges and to enable the Fund to continue to grow and avoid a pattern
of net redemptions which, in turn, are essential for effective investment
management; and (b) 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 Directors, including each of the
Independent Directors, 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 Directors' 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
affected Class or Classes of the Fund, and all material amendments to the Plan
must also be approved by the Directors in the manner described above. The Plan
may be terminated at any time, without payment of any penalty, by vote of a
majority of the Independent Directors 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 Directors shall be committed to the discretion of the Independent
Directors.
25
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
- --------------------------------------------------------------------------------
A. BROKERAGE TRANSACTIONS
Subject to the general supervision of the Directors, 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. Purchases and sales of securities on a stock
exchange are effected through brokers who charge a commission for their
services. 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.
The Fund did not pay any brokerage commissions during the fiscal years ended
August 31, 2000, 2001 and 2002.
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
26
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 August 31, 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 Directors, including the Independent
Directors, 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.
The Fund did not pay any brokerage commissions to any affiliated brokers or
dealers during the fiscal years ended August 31, 2000, 2001 and 2002.
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 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 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 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 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 their other clients and may not in all
cases benefit the Fund directly.
The Investment Manager and certain of its affiliates currently serves 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
27
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 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 August 31, 2002, the Fund did not pay any
brokerage commissions to brokers because of research services provided.
E. REGULAR BROKER-DEALERS
During the fiscal year ended August 31, 2002, 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 August 31, 2002, the Fund did not own any
securities issued by any of such issuers.
VII. CAPITAL STOCK AND OTHER SECURITIES
- --------------------------------------------------------------------------------
The Fund is authorized to issue 2 billion shares of common stock of $0.01
par value for each Class. Shares of the Fund, when issued, are fully paid,
non-assessable, fully transferrable and redeemable at the option of the holder.
Except for agreements entered into by the Fund in its ordinary course of
business within the limitations of the Fund's fundamental investment policies
(which may be modified only by shareholder vote), the Fund will not issue any
securities other than common stock.
All shares of common stock are equal as to earnings, assets and voting
privileges except that each Class will have exclusive voting privileges with
respect to matters relating to distribution expenses borne solely by such Class
or any other matter in which the interests of one Class differ from the
interests of any other Class. In addition, Class B shareholders will have the
right to vote on any proposed material increase in Class A's expenses, if such
proposal is submitted separately to Class A shareholders. Also, as discussed
herein, Class A, Class B and Class C bear the expenses related to the
distribution of their respective shares.
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
Directors may call special meetings of shareholders for action by shareholder
vote as may be required by the Investment Company Act or the Fund's By-Laws.
Under certain circumstances, the Directors may be removed by action of the
Directors. In addition, under certain circumstances, the shareholders may call a
meeting to remove Directors 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 Directors being selected, while the
holders of the remaining shares would be unable to elect any Directors.
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
28
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.
TRANSFERS OF SHARES. In the event a shareholder requests a transfer of Fund
shares to a new registration, the shares will be transferred without sales
charge at the time of transfer. With regard to the status of shares which are
either subject to the CDSC or free of such charge (and with regard to the length
of time shares subject to the charge have been held), any transfer involving
less than all of the shares in an account will be made on a pro rata basis (that
is, by transferring shares in the same proportion that the transferred shares
bear to the total shares in the account immediately prior to the transfer). The
transferred shares will continue to be subject to any applicable CDSC as if they
had not been so transferred.
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 Fund's Class B, Class C and Class D shares are offered at net asset
value per share and the Class A shares are offered at net asset value per share
plus any applicable FSC which is distributed among the Fund's Distributor,
Morgan Stanley DW and other authorized dealers as described in Section "V.
Investment Management and Other Services -- E. Rule 12b-1 Plan." The price of
Fund shares, called "net asset value," is based on the value of the Fund's
portfolio securities. Net asset value per share of each Class is calculated by
dividing the value of the portion of the Fund's securities and other assets
attributable to that Class, less the liabilities attributable to that Class, by
the number of shares of that Class outstanding. The assets of each Class of
shares are invested in a single portfolio. The net asset value of each Class,
however, will differ because the Classes have different ongoing fees.
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 Directors, 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
Directors. 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 Directors
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
Directors.
29
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
closing bid and asked prices. Unlisted options on debt securities are valued at
the mean between their latest bid and asked price. Futures are valued at the
latest sale price on the commodities exchange on which they trade unless the
Directors determine that such price does not reflect their fair value, in which
case they will be value at their fair market value as determined by the
Directors. All other securities and other assets are valued at their fair value
as determined in good faith under procedures established by and under the
supervision of the Directors.
Certain of the Fund's portfolio securities may be valued by an outside
pricing service approved by the Fund's Directors. 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 well 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 Directors determine that 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 Directors.
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 Directors.
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 although it may not always do so in a particular year.
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.
30
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 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 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.
Subject to certain exceptions, a corporate shareholder may be eligible for a
70% dividends received deduction to the extent that the Fund earns and
distributes qualifying dividends from its investments. Distributions of net
capital gains by the Fund will not be eligible for the dividends received
deduction.
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, and the amount of any dividends eligible for the federal
dividends received deduction for corporations.
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
31
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 will 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.
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
- --------------------------------------------------------------------------------
Prior to July 28, 1997, the Fund offered only one Class of shares subject to
a maximum sales charge of 5.50% and no 12b-1 fee. Because the distribution
arrangement for Class A most closely resembles the distribution arrangement
applicable prior to the implementation of multiple classes (i.e., Class A is
sold with a front-end sales charge), historical performance information has been
restated to reflect (i) the actual maximum sales charge applicable to Class A
(i.e., 4.25%) and (ii) the ongoing 12b-1 fee applicable to Class A Shares.
Furthermore, because all shares of the Fund held prior to July 28, 1997 have
been designated Class D shares, the Fund's historical performance has also been
restated to reflect the absence of any sales charge in the case of Class D
shares. Also set forth below is the actual performance of Class B and Class C as
of their last fiscal year.
32
From time to time, the Fund may quote its "yield" and/or its "total return"
in advertisements and sales literature. These figures are computed separately
for Class A, Class B, Class C and Class D shares. 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" of each Class. 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 of the applicable Class 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. The yields for the 30-day
period ended August 31, 2002, calculated pursuant to this formula, were 25.68%
for Class A, 26.32% for Class B, 26.26% for Class C and 27.22% for Class D.
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. The ending redeemable value is reduced by any
contingent deferred sales charge ("CDSC") at the end of the one, five, ten year
or other period. 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 in the
case of Class A shares is reduced by the Class A 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 Class A for the one year, five year and ten year
period ended August 31, 2002 were -25.03%, -15.21% and -2.66%, respectively. The
average annual total returns for Class B for the one year and five year periods
ended August 31, 2002 and for the period July 28, 1997 (inception of the Class)
through August 31, 2002 were -25.34%, -15.07% and -14.63%, respectively. The
average annual total returns for Class C for the one year and five year periods
ended August 31, 2002 and for the period July 28, 1997 (inception of the Class)
through August 31, 2002 were -22.78%, -15.00% and -14.64%, respectively. The
average annual total returns for Class D for the one year, five year and ten
year period ended August 31, 2002 were -21.45%, -14.29% and -2.00%,
respectively.
In addition, the Fund may advertise its total return for each Class over
different periods of time by means of aggregate, average, year-by-year or other
types of total return figures. These calculations may or may not reflect the
imposition of the maximum front-end sales charge for Class A or the deduction of
the CDSC for each of Class B and Class C which, if reflected, would reduce the
performance quoted. For example, the average annual total return of the Fund may
be calculated in the manner described above, but without deduction for any
applicable sales charge. Based on the foregoing calculation, the Fund's average
annual total returns for Class A for the one year, five year and ten year period
ended August 31, 2002 were -21.70%, -14.48% and -2.23%, respectively. The
average annual total returns for Class B for the one year, five year and life of
the Class periods ended August 31, 2002 were -22.00%, -14.89% and -14.54%,
respectively. The average annual total returns for Class C for the one year,
five year and life of the Class periods ended August 31, 2002 were -22.11%,
- -15.00% and -14.64%, respectively. Because the Class D shares are not subject to
any sales charge, the Fund would only advertise average annual total returns as
calculated in the previous paragraph.
In addition, the Fund may compute its aggregate total return for each Class
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
aggregated total return involves a percentage obtained by dividing the ending
value (without reduction for any sales charge) by the initial $1,000 investment
and subtracting 1 from the result. Based on this calculation, the total returns
for Class A for the one year, five year and ten year period ended August 31,
2002 were -21.70%, -54.24 % and -20.21%, respectively. The total returns for
Class B for the one year, five year and life of the Class
33
periods ended August 31, 2002 were -22.00%, -55.35% and -55.08%, respectively.
The total returns for Class C for the one year, five year and life of the Class
periods ended August 31, 2002 were -22.11%, -55.62% and -55.35%, respectively.
The total returns for Class D for the one year, five year and ten year period
ended August 31, 2002 were -21.45%, -53.74% and -18.32%, respectively.
The Fund may also advertise the growth of hypothetical investments of
$10,000, $50,000 and $100,000 in each Class of shares of the Fund by adding 1 to
the Fund's aggregate total return to date (expressed as a decimal and without
taking into account the effect of any applicable CDSC) and multiplying by
$9,575, $48,250 and $97,250 in the case of Class A (investments of $10,000,
$50,000 and $100,000 adjusted for the initial sales charge) or by $10,000,
$50,000 and $100,000 in the case of each of Class B, Class C and Class D, as the
case may be. Investments of $10,000, $50,000 and $100,000 in each Class at
inception of the Class would have grown (or declined) to the following amounts
at August 31, 2002:
INVESTMENT AT INCEPTION OF:
INCEPTION --------------------------------
CLASS DATE: $10,000 $50,000 $100,000
- ----- --------- -------- --------- ---------
Class A............................... 09/26/79 $23,135 $116,583 $234,978
Class B............................... 07/28/97 4,492 22,462 44,924
Class C............................... 07/28/97 4,465 22,325 44,649
Class D............................... 09/26/79 25,540 127,699 255,398
For purposes of restating the performance of Class A, the inception date set
forth in the above table is the inception date of the Fund. However, Class A did
not actually commence operation until July 28, 1997.
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. Based on these calculations, the
average annual total returns (after taxes on distributions) for Class A for the
one year, five year and the ten year periods ended August 31, 2002 were -29.49%,
- -19.74% and -7.48%, respectively, and the average annual total returns (after
taxes on distributions and redemptions) for Class A for the one year, five year
and the ten year periods ended August 31, 2002 were -15.07%, -12.01% and -3.03%,
respectively. The average annual total returns (after taxes on distributions)
for Class D for the one year, five year and the ten year periods ended
August 31, 2002 were -26.21%, -18.93% and -6.94%, respectively and the average
annual total returns (after taxes on distributions and redemptions) for Class D
for the one year, five year and the ten year periods ended August 31, 2002 were
- -12.86%, -11.43% and -2.59%, 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
August 31, 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 High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------
Corporate Bonds (89.0%)
Advertising/Marketing Services (0.6%)
$ 3,340 Interep National Radio Sales, Inc. (Series B)..... 10.00% 07/01/08 $ 2,989,300
------------
Aerospace & Defense (0.5%)
9,385 Loral Space & Communications Ltd.................. 9.50 01/15/06 2,346,250
------------
Airlines (0.8%)
6,450 Air Canada Corp. (Canada)......................... 10.25 03/15/11 4,128,000
------------
Alternative Power Generation (0.4%)
3,735 Calpine Corp...................................... 8.50 02/15/11 1,960,875
------------
Auto Parts: O.E.M. (4.6%)
1,630 Arvinmeritor, Inc................................. 8.75 03/01/12 1,726,848
1,365 Collins & Aikman Products Co...................... 11.50 04/15/06 1,286,512
3,700 Collins & Aikman Products Co...................... 10.75 12/31/11 3,644,500
5,155 Dana Corp......................................... 9.00 08/15/11 4,923,025
2,300 Dura Operating Corp. (Series B)................... 8.625 04/15/12 2,334,500
3,385 Intermet Corp. - 144A*............................ 9.75 06/15/09 3,435,775
1,310 Lear Corp. (Series B)............................. 8.11 05/15/09 1,372,225
2,890 Metaldyne Corp. - 144A*........................... 11.00 06/15/12 2,535,975
2,260 Stoneridge, Inc................................... 11.50 05/01/12 2,327,800
------------
23,587,160
------------
Broadcast/Media (1.4%)
10,000 Tri-State Outdoor Media Group, Inc. (b)........... 11.00 05/15/08 7,200,000
------------
Broadcasting (1.6%)
3,785 Salem Communications Holdings Corp................ 9.00 07/01/11 3,889,087
1,795 XM Satellite Radio Inc............................ 14.00 03/15/10 614,787
4,245 Young Broadcasting Inc............................ 10.00 03/01/11 3,884,175
------------
8,388,049
------------
Cable/Satellite TV (5.3%)
50,687 Australis Holdings Property Ltd. (Australia) (a)
(b).............................................. 15.00 11/01/02 0
3,620 British Sky Broadcasting Group PLC (United
Kingdom)......................................... 6.875 02/23/09 3,462,856
2,950 British Sky Broadcasting Group PLC (United
Kingdom)......................................... 8.20 07/15/09 2,966,343
9,805 Callahan Nordrhein Westfalen (Germany) (a) (b).... 14.00 07/15/10 232,869
3,540 Charter Communications Holdings, Inc.............. 13.50++ 01/15/11 1,345,200
7,060 Charter Communications Holdings/Charter Capital... 11.75++ 05/15/11 2,647,500
19,000 Diva Systems Corp. (Series B) (a) (d)............. 12.625++ 03/01/08 2,351,250
6,145 Echostar DBS Corp. - 144A*........................ 9.125 01/15/09 5,991,375
16,510 Knology Holdings, Inc............................. 11.875++ 10/15/07 5,283,200
6,600 Ono Finance PLC (United Kingdom).................. 13.00 05/01/09 1,320,000
915 Pegasus Communications Corp. (Series B)........... 9.75 12/01/06 432,337
7,355 Telewest Communications PLC (United Kingdom)...... 9.875 02/01/10 1,103,250
See Notes to Financial Statements
35
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------
$ 11,525 United Pan Europe Communications N.V. (Series B)
(Netherlands) (b)................................ 10.875% 08/01/09 $ 403,375
------------
27,539,555
------------
Casino/Gaming (3.1%)
22,000 Aladdin Gaming Holdings/Capital Corp. (Series
B)............................................... 13.50++ 03/01/10 440,000
2,400 Harrah's Operating Co., Inc....................... 8.00 02/01/11 2,633,362
4,850 Park Place Entertainment Corp..................... 8.875 09/15/08 5,019,750
24,035 Resort At Summerlin LP (Series B) (a) (b)......... 13.00 12/15/07 0
4,725 Station Casinos, Inc.............................. 8.375 02/15/08 4,914,000
2,970 Venetian Casino/LV Sands - 144A*.................. 11.00 06/15/10 2,981,137
------------
15,988,249
------------
Cellular Telephone (1.9%)
2,230 Dobson/Sygnet Communications Co................... 12.25 12/15/08 1,404,900
29,800 Dolphin Telecom PLC (Series B) (United Kingdom)
(a) (d).......................................... 14.00++ 05/15/09 2,980
25,025 Dolphin Telecom PLC (United Kingdom) (a) (d)...... 11.50++ 06/01/08 2,502
11,050 Nextel Partners, Inc.............................. 14.00++ 02/01/09 4,751,500
4,258 Tritel PCS, Inc................................... 12.75++ 05/15/09 3,491,560
------------
9,653,442
------------
Chemicals: Major Diversified (1.8%)
3,665 Equistar Chemical/Funding......................... 10.125 09/01/08 3,518,400
6,705 Huntsman ICI Chemicals LLC........................ 10.125 07/01/09 5,967,450
------------
9,485,850
------------
Chemicals: Specialty (2.4%)
2,560 Acetex Corp. (Canada)............................. 10.875 08/01/09 2,662,400
850 ISP Chemco, Inc. (Series B)....................... 10.25 07/01/11 850,000
4,710 ISP Holdings, Inc. (Series B)..................... 10.625 12/15/09 4,050,600
2,930 Lyondell Chemical Co. (Series B).................. 9.875 05/01/07 2,900,700
1,725 Millennium America, Inc........................... 9.25 06/15/08 1,794,000
------------
12,257,700
------------
Commercial Printing/Forms (1.1%)
3,935 Mail-Well I Corp. - 144A*......................... 9.625 03/15/12 2,715,150
13,000 Premier Graphics, Inc. (b)........................ 11.50 12/01/05 406,250
2,490 Quebecor Media, Inc. (Canada)..................... 11.125 07/15/11 2,079,150
935 Quebecor Media, Inc. (Canada)..................... 13.75++ 07/15/11 444,125
------------
5,644,675
------------
Consumer/Business Services (3.1%)
13,000 Comforce Operating, Inc........................... 12.00 12/01/07 7,540,000
4,249 MDC Communications Corp. (Canada)................. 10.50 12/01/06 3,526,670
6,085 Muzak LLC/Muzak Finance Corp...................... 9.875 03/15/09 5,080,975
------------
16,147,645
------------
See Notes to Financial Statements
36
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------
Containers/Packaging (1.8%)
$ 10,000 LLS Corp. (b)..................................... 11.625% 08/01/09 $ 900,000
7,540 Owens-Illinois, Inc............................... 7.80 05/15/18 6,032,000
2,235 Pliant Corp....................................... 13.00 06/01/10 2,246,175
------------
9,178,175
------------
Diversified Manufacturing (2.3%)
9,755 Eagle-Picher Industries, Inc...................... 9.375 03/01/08 7,608,900
7,750 Jordan Industries, Inc. (Series B)................ 10.375 08/01/07 4,495,000
------------
12,103,900
------------
Drugstore Chains (0.7%)
2,000 Rite Aid Corp..................................... 6.875 08/15/13 1,160,000
2,025 Rite Aid Corp..................................... 7.70 02/15/27 1,113,750
2,000 Rite Aid Corp. - 144A*............................ 6.125 12/15/08 1,160,000
------------
3,433,750
------------
Electric Utilities (0.7%)
3,620 PG&E National Energy Group, Inc................... 10.375 05/16/11 1,339,400
3,050 PSEG Energy Holdings - 144A*...................... 8.625 02/15/08 2,287,500
------------
3,626,900
------------
Electronic Components (0.3%)
1,585 Flextronics International Ltd. (Singapore)........ 9.875 07/01/10 1,640,475
------------
Electronic Distributors (0.9%)
4,280 BRL Universal Equipment Corp...................... 8.875 02/15/08 4,333,500
20,000 CHS Electronics, Inc. (a) (b)..................... 9.875 04/15/05 175,000
------------
4,508,500
------------
Electronic Equipment/Instruments (0.6%)
8,280 High Voltage Engineering, Inc..................... 10.75 08/15/04 2,980,800
------------
Electronics/Appliances (0.0%)
84,930 International Semi-Tech Microelectronics, Inc.
(Canada) (a) (b)................................. 11.50 08/15/03 8,493
------------
Engineering & Construction (0.1%)
2,310 Encompass Services Corp........................... 10.50 05/01/09 231,000
6,575 Metromedia Fiber Network, Inc. (a) (b)............ 10.00 12/15/09 32,875
7,000 Metromedia Fiber Network, Inc. (Series B) (a)
(b).............................................. 10.00 11/15/08 35,000
------------
298,875
------------
Environmental Services (1.7%)
6,025 Allied Waste North America, Inc. (Series B)....... 10.00 08/01/09 5,934,625
3,025 Waste Management, Inc. (Series A)................. 7.375 08/01/10 3,079,598
------------
9,014,223
------------
Financial Conglomerates (0.4%)
2,100 Case Credit Corp.................................. 6.125 02/15/03 2,028,417
------------
See Notes to Financial Statements
37
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------
Food Distributors (0.9%)
$ 4,905 Volume Services America, Inc...................... 11.25% 03/01/09 $ 4,647,487
------------
Food: Meat/Fish/Dairy (1.9%)
4,455 Michael Foods, Inc. (Series B).................... 11.75 04/01/11 4,878,225
5,200 Smithfield Foods, Inc............................. 7.625 02/15/08 4,810,000
------------
9,688,225
------------
Forest Products (2.1%)
4,290 Louisiana Pacific Corp............................ 10.875 11/15/08 4,509,862
1,615 Louisiana Pacific Corp............................ 8.875 08/15/10 1,689,744
4,800 Tembec Industries, Inc. (Canada).................. 8.50 02/01/11 4,836,000
------------
11,035,606
------------
Gas Distributors (0.2%)
3,595 Dynegy Holdings, Inc.............................. 6.875 04/01/11 1,222,300
------------
Home Building (2.9%)
5,610 Schuler Homes, Inc................................ 9.375 07/15/09 5,652,075
405 Schuler Homes, Inc................................ 10.50 07/15/11 407,025
2,445 Tech Olympic USA, Inc. - 144A*.................... 9.00 07/01/10 2,304,412
2,305 Tech Olympic USA, Inc. - 144A*.................... 10.375 07/01/12 2,114,838
4,400 Toll Corp......................................... 8.25 02/01/11 4,356,000
------------
14,834,350
------------
Hospital/Nursing Management (0.8%)
3,600 HCA, Inc.......................................... 7.875 02/01/11 3,933,421
------------
Hotels/resorts/cruiselines (3.6%)
1,455 Hilton Hotels Corp................................ 7.95 04/15/07 1,482,773
4,800 HMH Properties, Inc. (Series B)................... 7.875 08/01/08 4,560,000
4,890 Horseshoe Gaming Holding Corp. (Series B)......... 8.625 05/15/09 5,073,375
3,990 Prime Hospitalty Corp. (Series B)................. 8.375 05/01/12 3,810,450
410 Starwood Hotels & Resorts Worldwide, Inc. -
144A*............................................ 7.375 05/01/07 400,775
3,480 Starwood Hotels & Resorts Worldwide, Inc. -
144A*............................................ 7.875 05/01/12 3,401,700
------------
18,729,073
------------
Industrial Conglomerates (0.4%)
2,250 Tyco International Group S.A. (Luxembourg)........ 6.75 02/15/11 1,856,250
------------
Industrial Specialties (3.7%)
4,935 Cabot Safety Corp................................. 12.50 07/15/05 5,033,700
1,430 Foamex LP/Capital Corp. - 144A*................... 10.75 04/01/09 1,315,600
7,163 International Wire Group, Inc..................... 11.75 06/01/05 5,927,383
1,660 Johnsondiversey, Inc. - 144A*..................... 9.625 05/15/12 1,643,400
840 Tekni-Plex, Inc. (Series B)....................... 12.75 06/15/10 835,800
See Notes to Financial Statements
38
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------
$ 1,125 Tekni-Plex, Inc. - 144A*.......................... 12.75% 06/15/10 $ 1,119,375
3,285 UCAR Finance, Inc................................. 10.25 02/15/12 3,301,425
------------
19,176,683
------------
Internet Software/Services (1.8%)
12,020 Exodus Communications, Inc. (a) (b)............... 11.625 07/15/10 721,200
33,200 Globix Corp. (a) (b).............................. 12.50 02/01/10 5,976,000
11,000 PSINet, Inc. (a) (b).............................. 10.50 12/01/06 1,072,500
14,500 PSINet, Inc. (a) (b).............................. 11.00 08/01/09 1,413,750
------------
9,183,450
------------
Managed Health Care (1.4%)
4,000 Aetna, Inc........................................ 7.875 03/01/11 4,240,784
2,690 Health Net, Inc................................... 8.375 04/15/11 3,048,687
------------
7,289,471
------------
Media Conglomerates (1.4%)
3,280 AOL Time Warner, Inc.............................. 6.875 05/01/12 2,955,070
4,260 Nextmedia Operating, Inc.......................... 10.75 07/01/11 4,110,900
------------
7,065,970
------------
Medical Distributors (0.9%)
4,320 Amerisource Bergen Corp........................... 8.125 09/01/08 4,492,800
------------
Medical/Nursing Services (0.8%)
4,865 Fresenius Medical Care Capital Trust.............. 7.875 06/15/11 4,013,625
------------
Metal Fabrications (0.5%)
2,800 Trimas Corp. - 144A*.............................. 9.875 06/15/12 2,772,000
------------
Movies/Entertainment (1.5%)
4,755 Alliance Atlantis Communications, Inc. (Canada)... 13.00 12/15/09 5,028,413
3,140 Six Flags, Inc.................................... 8.875 02/01/10 2,723,950
------------
7,752,363
------------
Office Equipment/Supplies (0.0%)
22,000 Mosler, Inc. (a) (b).............................. 11.00 04/15/03 0
------------
Oil & Gas Production (2.9%)
4,260 Chesapeake Energy Corp............................ 8.125 04/01/11 4,174,800
1,820 Magnum Hunter Resources, Inc. - 144A*............. 9.60 03/15/12 1,856,400
2,375 Stone Energy Corp................................. 8.25 12/15/11 2,404,688
7,080 Vintage Petroleum, Inc............................ 7.875 05/15/11 6,584,400
------------
15,020,288
------------
Oil Refining/Marketing (1.6%)
4,000 Husky Oil Ltd. (Canada)........................... 8.90 08/15/28 4,440,712
4,980 Tesoro Petroleum Corp. - 144A*.................... 9.625 04/01/12 3,660,300
------------
8,101,012
------------
See Notes to Financial Statements
39
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------
Oilfield Services/Equipment (0.9%)
$ 2,515 Hanover Equipment Trust - 144A*................... 8.50% 09/01/08 $ 2,338,950
2,410 Hanover Equipment Trust - 144A*................... 8.75 09/01/11 2,217,200
------------
4,556,150
------------
Other Metals/Minerals (0.8%)
3,310 Murrin Murrin Holdings Property Ltd.
(Australia)...................................... 9.375 08/31/07 997,138
3,100 Phelps Dodge Corp................................. 8.75 06/01/11 3,213,996
------------
4,211,134
------------
Publishing: Books/Magazines (0.7%)
4,720 PRIMEDIA, Inc..................................... 8.875 05/15/11 3,681,600
------------
Publishing: Newspapers (0.7%)
4,261 Hollinger Participation Trust (Canada) - 144A*.... 12.125+ 11/15/10 3,558,221
------------
Pulp & Paper (0.8%)
4,310 Norske Skog Canada Ltd. (Canada).................. 8.625 06/15/11 4,223,800
------------
Real Estate Development (0.8%)
4,890 CB Richard Ellis Services, Inc.................... 11.25 06/15/11 4,327,650
------------
Real Estate Investment Trusts (0.6%)
3,005 Istar Financial, Inc.............................. 8.75 08/15/08 3,076,594
------------
Recreational Products (0.9%)
4,430 International Game Technology..................... 8.375 05/15/09 4,762,250
------------
Restaurants (1.5%)
141,992 American Restaurant Group Holdings, Inc. - 144A*
(c).............................................. 0.00 12/15/05 4,344,955
34,207 FRD Acquisition Corp. (Series B) (a) (b).......... 12.50 07/15/04 3,249,665
------------
7,594,620
------------
Retail - Specialty (0.1%)
9,000 Mrs. Fields Holdings Co........................... 14.00++ 12/01/05 270,000
------------
Semiconductors (0.5%)
2,210 Fairchild Semiconductors Corp..................... 10.50 02/01/09 2,331,550
------------
Services to the Health Industry (2.1%)
3,045 Anthem Insurance - 144A*.......................... 9.125 04/01/10 3,521,826
3,465 Healthsouth Corp. - 144A*......................... 7.625 06/01/12 2,775,673
4,600 Omnicare, Inc. (Series B)......................... 8.125 03/15/11 4,784,000
------------
11,081,499
------------
Specialty Stores (0.6%)
2,975 AutoNation, Inc................................... 9.00 08/01/08 3,108,875
------------
Specialty Telecommunications (3.8%)
4,535 American Tower Corp............................... 9.375 02/01/09 2,811,700
11,500 Birch Telecom, Inc. (a) (b)....................... 14.00 06/15/08 115,000
14,370 DTI Holdings, Inc. (Series B) (a) (d)............. 12.50++ 03/01/08 1,437
See Notes to Financial Statements
40
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------
$ 17,085 Esprit Telecom Group PLC (United Kingdom) (b)..... 11.50% 12/15/07 $ 1,709
29,088 Esprit Telecom Group PLC (United Kingdom) (b)..... 10.875 06/15/08 2,909
47,000 Firstworld Communications, Inc. (a) (d)........... 13.00++ 04/15/08 4,582,500
10,000 Global Crossing Holdings, Ltd. (Bermuda) (a)
(b).............................................. 8.70 08/01/07 112,500
3,490 Global Crossing Holdings, Ltd. (Bermuda) (a)
(b).............................................. 9.50 11/15/09 39,263
23,050 GT Group Telecom, Inc. (Canada) (a) (d)........... 13.25++ 02/01/10 28,813
8,400 Primus Telecommunications Group, Inc.............. 12.75 10/15/09 4,032,000
2,000 RSL Communications PLC (United Kingdom) (a) (b)... 9.125 03/01/08 40,000
9,000 RSL Communications PLC (United Kingdom) (a) (b)... 10.50 11/15/08 180,000
3,000 RSL Communications PLC (United Kingdom) (a) (b)... 9.875 11/15/09 60,000
13,000 Tele1 Europe BV (Netherlands)..................... 13.00 05/15/09 1,430,000
12,000 Versatel Telecom BV (Netherlands)
(Issued 05/27/98) (a) (b)........................ 13.25 05/15/08 3,465,000
3,000 Versatel Telecom BV (Netherlands)
(Issued 12/03/98) (a) (b)........................ 13.25 05/15/08 866,250
31,445 Viatel Inc. (b)................................... 11.25 04/15/08 157,225
14,200 Viatel Inc. (Issued 03/19/99) (b)................. 11.50 03/15/09 71,000
29,393 Viatel Inc. (Issued 12/08/99) (b)................. 11.50 03/15/09 146,965
32,545 World Access, Inc. (a) (b) (c).................... 13.25 01/15/08 1,505,206
11,500 Worldwide Fiber, Inc. (Canada) (a) (b)............ 12.00 08/01/09 1,150
------------
19,650,627
------------
Steel (0.3%)
1,715 Oregon Steel Mills, Inc. - 144A*.................. 10.00 07/15/09 1,768,594
------------
Telecommunication Equipment (1.2%)
7,025 SBA Communications Corp........................... 12.00++ 03/01/08 3,863,750
10,500 Spectrasite Holdings, Inc......................... 12.00++ 07/15/08 1,890,000
3,500 Spectrasite Holdings, Inc......................... 11.25++ 04/15/09 595,000
------------
6,348,750
------------
Telecommunications (1.0%)
61,075 e. Spire Communications, Inc. (a) (b)............. 13.75 07/15/07 6,108
18,752 Focal Communications Corp. (Series B)............. 12.125++ 02/15/08 1,500,160
15,000 Hyperion Telecommunication, Inc. (Series B) (b)... 12.25 09/01/04 600,000
1,500 NEXTLINK Communications LLC (a) (b)............... 12.50 04/15/06 15,000
17,500 NEXTLINK Communications, Inc. (a) (b)............. 9.00 03/15/08 175,000
4,180 NEXTLINK Communications, Inc. (a) (b)............. 10.75 11/15/08 41,800
775 NEXTLINK Communications, Inc. (a) (b)............. 10.75 06/01/09 7,750
2,505 NTL Communications Corp. (Series B) (a) (b)....... 11.875 10/01/10 400,800
27,850 Rhythms Netconnections, Inc. (a) (b).............. 12.75 04/15/09 661,438
14,965 Rhythms Netconnections, Inc. (Series B) (a) (d)... 13.50++ 05/15/08 224,475
13,850 Startec Global Communications Corp. (a) (b)....... 12.00 05/15/08 1,385
2,100 WorldCom, Inc. (a) (b)............................ 7.50 05/15/11 288,750
See Notes to Financial Statements
41
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------
$ 1,725 WorldCom, Inc. (a) (b)............................ 6.95% 08/15/28 $ 237,188
6,100 WorldCom, Inc. (a) (b)............................ 8.25 05/15/31 838,750
------------
4,998,604
------------
Trucks/Construction/Farm Machinery (2.3%)
1,930 Case Corp. (Series B)............................. 6.25 12/01/03 1,852,790
7,215 J.B. Poindexter & Co., Inc........................ 12.50 05/15/04 6,484,481
2,180 Manitowoc Co., Inc. (The) - 144A*................. 10.50 08/01/12 2,250,850
1,370 NMHG Holding Co. - 144A*.......................... 10.00 05/15/09 1,383,700
------------
11,971,821
------------
Wholesale Distributors (1.4%)
4,000 Burhmann US, Inc.................................. 12.25 11/01/09 4,005,000
2,540 Fisher Scientific International, Inc.............. 7.125 12/15/05 2,546,350
560 Fisher Scientific International, Inc.............. 9.00 02/01/08 579,600
------------
7,130,950
------------
Wireless Telecommunications (0.6%)
3,675 American Cellular Corp............................ 9.50 10/15/09 496,125
2,919 Arch Wireless Holdings, Inc....................... 10.00 05/15/07 1,809,846
1,544 Arch Wireless Holdings, Inc....................... 12.00 05/15/09 185,280
65,300 CellNet Data Systems, Inc. (a) (d)................ 14.00++ 10/01/07 6,530
19,610 Globalstar LP/Capital Corp. (a) (b)............... 10.75 11/01/04 686,350
33,000 WinStar Communications, Inc. (a) (d).............. 14.75++ 04/15/10 3,300
11,400 WinStar Communications, Inc. (a) (b).............. 12.75 04/15/10 1,140
------------
3,188,571
------------
Total Corporate Bonds
(COST $1,486,695,632)....................................................... 458,795,492
------------
Convertible Bonds (1.5%)
Electronic Components (0.7%)
8,830 Solectron Corp.................................... 0.00 11/20/20 3,841,050
------------
Hotels/Resorts/Cruiselines (0.0%)
1,643 Premier Cruises Ltd. - 144A*...................... 10.00+ 08/15/05 0
------------
Telecommunication Equipment (0.8%)
9,420 Corning Inc....................................... 0.00 11/08/15 4,097,700
------------
Total Convertible Bonds
(Cost $11,229,282).......................................................... 7,938,750
------------
See Notes to Financial Statements
42
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
NUMBER OF
SHARES VALUE
- ------------------------------------------------------------------------------
Common Stocks (d) (2.3%)
Aerospace & Defense (0.1%)
85,242 Orbital Sciences Corp. (c)........................ $ 318,807
------------
Apparel/Footwear Retail (0.0%)
2,621,192 County Seat Stores, Inc. (c)...................... 0
------------
Casino/Gaming (0.0%)
207,312 Fitzgerald Gaming Corp............................ 0
------------
Consumer/Business Services (1.5%)
440,700 Anacomp, Inc. (Class A) (c)....................... 7,712,250
------------
Entertainment & Leisure (0.1%)
15,308 AMF Bowling Worldwide, Inc........................ 420,970
------------
Food: Specialty/Candy (0.0%)
10,908 SFAC New Holdings, Inc. (c)....................... 0
2,005 SFFB Holdings, Inc. (c)........................... 0
574,725 Specialty Foods Acquisition Corp. - 144A*......... 0
------------
0
------------
Hotels/Resorts/Cruiselines (0.0%)
981,277 Premier Holdings, Inc. (c)........................ 0
781,421 Vagabond Inns, Inc. (Class D)..................... 0
------------
0
------------
Medical Specialties (0.1%)
48,816 MEDIQ, Inc. (c)................................... 265,071
------------
Medical/Nursing Services (0.0%)
1,151,324 Raintree Healthcare Corp. (c)..................... 0
------------
Motor Vehicles (0.0%)
709 Northern Holdings Industrial Corp. (c)*........... 0
------------
Restaurants (0.0%)
38,057 American Restaurant Group Holdings, Inc. -
144A*............................................ 0
------------
Specialty Telecommunications (0.1%)
2,171,896 Mpower Holding Corp. (c).......................... 325,784
264,189 Song Networks Holding AB (ADR) (Sweden)........... 15,851
40,557 Versatel Telecom International N.V. (ADR)
(Netherlands).................................... 137,894
94,263 World Access, Inc. (c)............................ 141
------------
479,670
------------
Telecommunication Equipment (0.0%)
196,000 FWT, Inc. (Class A) (c)........................... 1,960
------------
See Notes to Financial Statements
43
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
NUMBER OF
SHARES VALUE
- ------------------------------------------------------------------------------
Telecommunications (0.1%)
520,697 Covad Communications Group, Inc. (c).............. $ 562,353
105,656 Focal Communications Corp. (c).................... 108,826
------------
671,179
------------
Textiles (0.0%)
1,754,730 United States Leather, Inc. (c)................... 0
------------
Wireless Telecommunications (0.3%)
224,719 Arch Wireless, Inc. (c)........................... 143,820
1,454,105 Motient Corp. (c)................................. 1,599,516
274,390 Vast Solutions, Inc. (Class B1) (c)............... 0
274,390 Vast Solutions, Inc. (Class B2) (c)............... 0
274,390 Vast Solutions, Inc. (Class B3) (c)............... 0
------------
1,743,336
------------
Total Common Stocks
(COST $290,861,374).............................. 11,613,243
------------
Preferred Stocks (3.3%)
Broadcasting (0.7%)
570 Paxson Communications Corp.+...................... 3,422,820
------------
Cellular Telephone (0.9%)
4,806 Dobson Communications Corp.+...................... 1,057,320
5,780 Nextel Communications, Inc. (Series D)+........... 3,583,705
------------
4,641,025
------------
Electric Utilities (0.9%)
5,076 TNP Enterprises, Inc. (Series D)+................. 4,568,400
------------
Publishing: Books/Magazines (0.0%)
6,625 PRIMEDIA, Inc..................................... 238,500
------------
Restaurants (0.4%)
6,007 American Restaurant Group Holdings, Inc. (Series
B)............................................... 1,045,288
1,071 FRD Acquisition Co. (Units)[+/+].................. 1,071,000
------------
2,116,288
------------
Specialty Telecommunications (0.2%)
7,333 Broadwing Communications, Inc. (Series B)......... 714,968
1 Crown Castle International Corp.+................. 357
1,691 Intermedia Communications, Inc. (Series B)+....... 67,624
47,064 McLeodUSA, Inc. (Series A) $0.44 (Conv.).......... 104,953
180,721 XO Communications, Inc............................ 1,807
------------
889,709
------------
See Notes to Financial Statements
44
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
NUMBER OF
SHARES VALUE
- -----------------------------------------------------------------------------------------
Telecommunication Equipment (0.2%)
2,244,200 FWT, Inc (Series A) (c)...................................... $ 1,009,890
------------
Total Preferred Stocks
(COST $52,459,703).......................................... 16,886,632
------------
NUMBER OF EXPIRATION
WARRANTS DATE
- --------- ----------
Warrants (d) (0.1%)
Aerospace & Defense (0.0%)
9,000 Sabreliner Corp. - 144A*.......................... 04/15/03 0
------------
Broadcasting (0.0%)
5,700 XM Satellite Radio, Inc. - 144A*.................. 03/15/10 3,420
------------
Cable/Satellite TV (0.0%)
57,000 Diva Systems Corp. - 144A*........................ 03/01/08 0
6,600 Ono Finance PLC (United Kingdom) - 144A*.......... 05/31/09 660
------------
660
------------
Casino/Gaming (0.0%)
220,000 Aladdin Gaming Holdings LLC - 144A*............... 03/01/10 0
20,000 Resort At Summerlin LP - 144A*.................... 12/15/07 0
------------
0
------------
Electric Utilities (0.0%)
1,040 TNP Enterprises, Inc. - 144A*..................... 04/01/11 26,000
------------
Entertainment & Leisure (0.1%)
36,019 AMF Bowling Worldwide, Inc. (Series A)............ 03/09/09 216,114
35,191 AMF Bowling Worldwide, Inc. (Series B)............ 03/09/09 175,955
------------
392,069
------------
Internet Software/Services (0.0%)
47,000 Verado Holdings, Inc. - 144A*..................... 04/15/08 0
------------
Restaurants (0.0%)
3,500 American Restaurant Group Holdings, Inc. -
144A*............................................ 08/15/08 0
------------
Retail - Specialty (0.0%)
9,000 Mrs. Fields Holding, Inc. - 144A*................. 12/01/05 0
------------
Specialty Telecommunications (0.0%)
11,500 Birch Telecom, Inc................................ 06/15/08 0
23,050 GT Group Telecom, Inc. (Canada) - 144A*........... 02/01/10 2,305
104,289 McLeodUSA, Inc.................................... 04/16/07 9,386
------------
11,691
------------
See Notes to Financial Statements
45
Morgan Stanley High Yield Securities Inc.
PORTFOLIO OF INVESTMENTS o AUGUST 31, 2002 continued
NUMBER OF EXPIRATION
WARRANTS DATE VALUE
- -----------------------------------------------------------------------------------------------------------------------
Telecommunications (0.0%)
11,850 Startec Global Communications Corp. - 144A*..................................... 05/15/08 $ 0
------------
Wireless Telecommunications (0.0%)
10,000 Metricom, Inc................................................................... 02/15/10 0
18,250 Motient Corp. - 144A*........................................................... 04/01/08 182
------------
182
------------
Total Warrants
(Cost $6,104,595).......................................................................... 434,022
------------
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE
- --------- ---- ----
Short-Term Investment (0.5%)
Repurchase Agreement
$ 2,850 Joint repurchase agreement account (dated
08/30/02; proceeds $2,850,594) (e)
(Cost $2,850,000)................................. 1.875% 09/03/02 2,850,000
----------------
Total Investments
(Cost $1,850,200,586) (f)........................................... 96.7% 498,518,139
Other Assets in Excess of Liabilities............................... 3.3 17,174,020
------------------ ----------------
Net Assets.......................................................... 100.0% $ 515,692,159
================== ================
- ---------------------
ADR American Depository Receipt.
* Resale is restricted to qualified institutional investors.
+ Payment-in-kind security.
++ Currently a zero coupon bond and is scheduled to pay interest at the
rate shown at a future specified date.
[+/+] Consists of one or more class of securities traded together as a unit;
preferred stocks with attached warrants.
(a) Issuer in bankruptcy.
(b) Non-income producing security; bond in default.
(c) Acquired through exchange offer.
(d) Non-income producing securities.
(e) Collateralized by federal agency and U.S. Treasury obligations.
(f) The aggregate cost for federal income tax purposes approximates the
aggregate cost for book purposes. The aggregate gross unrealized
appreciation is $7,620,178 and the aggregate gross unrealized
depreciation is $1,359,302,625, resulting in net unrealized depreciation
of $1,351,682,447.
See Notes to Financial Statements
46
Morgan Stanley High Yield Securities Inc.
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
August 31, 2002
Assets:
Investments in securities, at value (cost
$1,850,200,586).................................. $ 498,518,139
Receivable for:
Interest........................................ 12,441,151
Investments sold................................ 6,327,777
Capital stock sold.............................. 551,144
Prepaid expenses and other assets................. 54,789
--------------
Total Assets.................................. 517,893,000
--------------
Liabilities:
Payable for:
Investments purchased........................... 865,033
Capital stock redeemed.......................... 427,364
Distribution fee................................ 269,100
Investment management fee....................... 219,183
Payable to bank................................... 228,794
Accrued expenses and other payables............... 191,367
--------------
Total Liabilities............................. 2,200,841
--------------
Net Assets.................................... $ 515,692,159
==============
Composition of Net Assets:
Paid-in-capital................................... 2,780,173,995
Net unrealized depreciation....................... (1,351,682,447)
Dividends in excess of net investment income...... (17,405,768)
Accumulated net realized loss..................... (895,393,621)
--------------
Net Assets.................................... $ 515,692,159
==============
Class A Shares:
Net Assets........................................ $23,879,067
Shares Outstanding (500,000,000 authorized, $.01
par value)....................................... 15,369,470
Net Asset Value Per Share..................... $1.55
=====
Maximum Offering Price Per Share,
(net asset value plus 4.44% of net asset
value)....................................... $1.62
=====
Class B Shares:
Net Assets........................................ $371,398,868
Shares Outstanding (500,000,000 authorized, $.01
par value)....................................... 239,992,793
Net Asset Value Per Share..................... $1.55
=====
Class C Shares:
Net Assets........................................ $33,977,953
Shares Outstanding (500,000,000 authorized, $.01
par value)....................................... 21,913,543
Net Asset Value Per Share..................... $1.55
=====
Class D Shares:
Net Assets........................................ $86,436,271
Shares Outstanding (500,000,000 authorized, $.01
par value)....................................... 55,671,724
Net Asset Value Per Share..................... $1.55
=====
See Notes to Financial Statements
47
Morgan Stanley High Yield Securities Inc.
FINANCIAL STATEMENTS continued
Statement of Operations
For the year ended August 31, 2002
Net Investment Income:
Income
Interest.......................................... $ 99,363,134
Dividend.......................................... 753,719
-------------
100,116,853
-------------
Expenses
Distribution fee (Class A shares)................. 48,012
Distribution fee (Class B shares)................. 3,747,816
Distribution fee (Class C shares)................. 349,455
Investment management fee......................... 3,258,237
Transfer agent fees and expenses.................. 1,381,858
Professional fees................................. 251,733
Shareholder reports and notices................... 160,601
Registration fees................................. 97,084
Custodian fees.................................... 30,503
Directors' fees and expenses...................... 18,833
Other............................................. 321,757
-------------
Total Expenses................................ 9,665,889
-------------
Net Investment Income......................... 90,450,964
-------------
Net Realized and Unrealized Gain (Loss):
Net realized loss................................. (375,136,573)
Net change in unrealized depreciation............. 111,513,872
-------------
Net Loss...................................... (263,622,701)
-------------
Net Decrease...................................... $(173,171,737)
=============
See Notes to Financial Statements
48
Morgan Stanley High Yield Securities Inc.
FINANCIAL STATEMENTS continued
Statement of Changes in Net Assets
FOR THE YEAR FOR THE YEAR
ENDED ENDED
AUGUST 31, 2002 AUGUST 31, 2001
--------------- ---------------
Increase (Decrease) in Net Assets:
Operations:
Net investment income................... $ 90,450,964 $ 182,819,538
Net realized loss....................... (375,136,573) (282,975,609)
Net change in unrealized depreciation... 111,513,872 (513,181,124)
------------- --------------
Net Decrease........................ (173,171,737) (613,337,195)
------------- --------------
Dividends and Distributions to
Shareholders from:
Net Investment Income:
Class A shares........................ (3,878,089) (7,002,632)
Class B shares........................ (69,129,555) (150,569,611)
Class C shares........................ (5,647,596) (10,293,101)
Class D shares........................ (16,092,318) (29,754,002)
Paid-in-Capital
Class A shares........................ (425,216) --
Class B shares........................ (7,579,753) --
Class C shares........................ (619,234) --
Class D shares........................ (1,764,452) --
------------- --------------
Total Dividends and Distributions... (105,136,213) (197,619,346)
------------- --------------
Net decrease from capital stock
transactions........................... (94,605,170) (72,611,177)
------------- --------------
Net Decrease........................ (372,913,120) (883,567,718)
Net Assets:
Beginning of period..................... 888,605,279 1,772,172,997
------------- --------------
End of Period
(Including dividends in excess of net
investment income of $17,405,768 and
$17,487,233, respectively)............. $ 515,692,159 $ 888,605,279
============= ==============
See Notes to Financial Statements
49
Morgan Stanley High Yield Securities Inc.
NOTES TO FINANCIAL STATEMENTS o AUGUST 31, 2002
1. Organization and Accounting Policies
Morgan Stanley High Yield Securities Inc. (the "Fund") is registered under the
Investment Company Act of 1940, as amended, (the "Act") as a diversified,
open-end management investment company. The Fund's primary investment objective
is to earn a high level of current income and, as a secondary objective, capital
appreciation, but only when consistent with its primary objective. The Fund was
incorporated in Maryland on June 14, 1979 and commenced operations on
September 26, 1979. On July 28, 1997, the Fund converted to a multiple class
share structure.
The Fund offers Class A shares, Class B shares, Class C shares and Class D
shares. The four classes are substantially the same except that most Class A
shares are subject to a sales charge imposed at the time of purchase and some
Class A shares, and most Class B shares and Class C shares are subject to a
contingent deferred sales charge imposed on shares redeemed within one year, six
years and one year, respectively. Class D shares are not subject to a sales
charge. Additionally, Class A shares, Class B shares and Class C shares incur
distribution expenses.
The 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) 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 securities are traded on more than one exchange, the securities are valued
on the exchange designated as the primary market pursuant to procedures adopted
by the Directors); (2) all other portfolio securities for which over-the-counter
market quotations are readily available are valued at the latest available bid
price; (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 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 Directors (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); (4) certain portfolio securities may be
valued by an outside pricing service approved by the Directors. The pricing
service may utilize a matrix system incorporating security quality, maturity and
50
Morgan Stanley High Yield Securities Inc.
NOTES TO FINANCIAL STATEMENTS o AUGUST 31, 2002 continued
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 time of purchase
are valued on a mark-to-market basis until sixty days prior to maturity and
thereafter at amortized cost based on their value on the 61st day. Short-term
debt securities having a maturity date of sixty days or less at the time of
purchase are valued at amortized cost.
B. Accounting for Investments -- Security transactions are accounted for on the
trade date (date the order to buy or sell is executed). Realized gains and
losses on security transactions are determined by the identified cost method.
Dividend income and other distributions are recorded on the ex-dividend date.
Discounts are accreted and premiums are amortized over the respective life of
the securities. Interest income is accrued daily except where collection is not
expected.
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 and are collateralized by
cash, or U.S. Treasury or federal agency obligations.
D. Multiple Class Allocations -- Investment income, expenses (other than
distribution fees), and realized and unrealized gains and losses are allocated
to each class of shares based upon the relative net asset value on the date such
items are recognized. Distribution fees are charged directly to the respective
class.
E. 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
51
Morgan Stanley High Yield Securities Inc.
NOTES TO FINANCIAL STATEMENTS o AUGUST 31, 2002 continued
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 Agreement
Pursuant to an Investment Management Agreement, the Fund pays the Investment
Manager a management fee, calculated 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: 0.50% to the portion of daily net assets not exceeding
$500 million; 0.425% to the portion of daily net assets exceeding $500 million
but not exceeding $750 million; 0.375% to the portion of daily net assets
exceeding $750 million but not exceeding $1 billion; 0.35% to the portion of
daily net assets exceeding $1 billion but not exceeding $2 billion; 0.325% to
the portion of daily net assets exceeding $2 billion but not exceeding
$3 billion; and 0.30% to the portion of daily net assets exceeding $3 billion.
3. Plan of Distribution
Shares of the Fund are distributed by Morgan Stanley Distributors Inc. (the
"Distributor"), an affiliate of the Investment Manager. The Fund has adopted a
Plan of Distribution (the "Plan") pursuant to Rule 12b-1 under the Act. The Plan
provides that the Fund pay the Distributor a fee which is accrued daily and paid
monthly at the following annual rates: (i) Class A -- up to 0.25% of the average
daily net assets of Class A; (ii) Class B -- 0.75% of the average daily net
assets of Class B; and (iii) Class C -- up to 0.85% of the average daily net
assets of Class C.
In the case of Class B shares, provided that the Plan continues in effect, any
cumulative expenses incurred by the Distributor but not yet recovered may be
recovered through the payment of future distribution fees from the Fund pursuant
to the Plan and contingent deferred sales charges paid by investors upon
redemption of Class B shares. Although there is no legal obligation for the Fund
to pay expenses incurred in excess of payments made to the Distributor under the
Plan and the proceeds of contingent deferred sales charges paid by investors
upon redemption of shares, if for any reason the Plan is terminated, the
Directors will consider at that time the manner in which to treat such expenses.
The Distributor has advised the Fund that such excess amounts totaled
$60,068,745 at August 31, 2002.
In the case of Class A shares and Class C shares, expenses incurred pursuant to
the Plan in any calendar year in excess of 0.25% or 0.85% of the average daily
net assets of Class A or Class C, respectively, will not be reimbursed by the
Fund through payments in any subsequent year, except that expenses representing
a
52
Morgan Stanley High Yield Securities Inc.
NOTES TO FINANCIAL STATEMENTS o AUGUST 31, 2002 continued
gross sales credit to Morgan Stanley Financial Advisors or other selected
broker-dealer representatives may be reimbursed in the subsequent calendar year.
For the year ended August 31, 2002, the distribution fee was accrued for
Class A shares and Class C shares at the annual rate of 0.18% and 0.85%,
respectively.
The Distributor has informed the Fund that for the year ended August 31, 2002,
it received contingent deferred sales charges from certain redemptions of the
Fund's Class A Shares, Class B shares and Class C shares of $26,842, $1,519,542
and $29,347, respectively and received $135,390 in front-end sales charges from
sales of the Fund's Class A shares. The respective shareholders pay such charges
which are not an expense of the Fund.
4. Security Transactions and Transactions with Affiliates
The cost of purchases and proceeds from sales of portfolio securities, excluding
short-term investments, for the year ended August 31, 2002, aggregated
$252,783,370 and $375,196,197, respectively.
Morgan Stanley Trust, an affiliate of the Investment Manager and Distributor, is
the Fund's transfer agent. At August 31, 2002, the Fund had transfer agent fees
and expenses payable of approximately $24,000.
The Fund has an unfunded noncontributory defined benefit pension plan covering
all independent Directors of the Fund who will have served as independent
Directors for at least five years at the time of retirement. Benefits under this
plan are based on years of service and compensation during the last five years
of service. Aggregate pension costs for the year ended August 31, 2002 included
in Directors' fees and expenses in the Statement of Operations amounted to
$7,230. At August 31, 2002, the Fund had an accrued pension liability of $58,619
which is included in accrued expenses in the Statement of Assets and
Liabilities.
5. Federal Income Tax Status
At August 31, 2002, the Fund had a net capital loss carryover of approximately
$530,730,000, which may be used to offset future capital gains to the extent
provided by regulations, which is available through August 31 in the following
years:
AMOUNT IN THOUSANDS
- -----------------------------------------------------------------------
2003 2004 2005 2006 2007 2008 2009 2010
- ------- ------- ------- ------- ------- ------- ------- --------
$50,599 $23,296 $39,319 $12,603 $24,919 $69,857 $89,299 $220,838
======= ======= ======= ======= ======= ======= ======= ========
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 $363,679,000 during fiscal 2002.
53
Morgan Stanley High Yield Securities Inc.
NOTES TO FINANCIAL STATEMENTS o AUGUST 31, 2002 continued
As of August 31, 2002, the Fund had temporary book/tax differences primarily
attributable to post-October losses, capital loss deferrals on wash sales, book
amortization of discounts on debt securities and interest and amortization of
discounts on bonds in default. The Fund had permanent book/tax differences
primarily attributable to an expired capital loss carryover and tax adjustments
on debt securities sold by the Fund. To reflect reclassifications arising from
the permanent differences, paid-in-capital was charged $172,175,337, dividends
in excess of net investment income was charged $948,800 and accumulated net
realized loss was credited $173,124,137.
6. Capital Stock
Transactions in capital stock were as follows:
FOR THE YEAR FOR THE YEAR
ENDED ENDED
AUGUST 31, 2002 AUGUST 31, 2001
--------------------------- ---------------------------
SHARES AMOUNT SHARES AMOUNT
------------ ------------- ------------ -------------
CLASS A SHARES
Sold.......................... 10,201,614 $ 20,177,481 19,209,128 $ 63,780,578
Reinvestment of dividends..... 1,119,515 2,083,474 1,049,177 3,186,287
Redeemed...................... (11,782,958) (23,700,021) (17,600,601) (59,066,199)
------------ ------------- ------------ -------------
Net increase (decrease) --
Class A...................... (461,829) (1,439,066) 2,657,704 7,900,666
------------ ------------- ------------ -------------
CLASS B SHARES
Sold.......................... 39,306,397 74,811,260 87,486,847 281,384,559
Reinvestment of dividends..... 14,993,853 27,953,825 17,505,252 53,772,493
Redeemed...................... (101,220,067) (190,557,689) (136,458,377) (426,230,286)
------------ ------------- ------------ -------------
Net decrease -- Class B....... (46,919,817) (87,792,604) (31,466,278) (91,073,234)
------------ ------------- ------------ -------------
CLASS C SHARES
Sold.......................... 7,565,119 14,251,142 13,531,056 45,899,890
Reinvestment of dividends..... 1,601,530 2,981,218 1,676,677 5,136,460
Redeemed...................... (8,724,288) (16,164,050) (13,756,797) (45,459,076)
------------ ------------- ------------ -------------
Net increase -- Class C....... 442,361 1,068,310 1,450,936 5,577,274
------------ ------------- ------------ -------------
CLASS D SHARES
Sold.......................... 13,842,546 25,568,899 20,506,858 63,372,986
Reinvestment of dividends..... 6,026,961 11,290,465 5,852,214 17,880,440
Redeemed...................... (23,300,211) (43,301,174) (24,049,991) (76,269,309)
------------ ------------- ------------ -------------
Net increase (decrease) --
Class D...................... (3,430,704) (6,441,810) 2,309,081 4,984,117
------------ ------------- ------------ -------------
Net decrease in Fund.......... (50,369,989) $ (94,605,170) (25,048,557) $ (72,611,177)
============ ============= ============ =============
54
Morgan Stanley High Yield Securities Inc.
NOTES TO FINANCIAL STATEMENTS o AUGUST 31, 2002 continued
7. Change in Accounting Policy
Effective September 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
$5,326,859 increase in the cost of securities and a corresponding increase in
undistributed net investment income based on securities held as of August 31,
2001.
The effect of this change for the year ended August 31, 2002 was to increase net
investment income by $4,981,336; increase unrealized depreciation by $3,780,819;
and increase net realized losses by $1,200,517. The statement of changes in net
assets and the financial highlights for prior periods have not been restated to
reflect this change.
8. Merger
On July 25, 2002, the Trustees of Morgan Stanley High Income Advantage Trust
("HIAT"), Morgan Stanley High Income Advantage Trust II ("HIAT II") and Morgan
Stanley High Income Advantage Trust III ("HIAT III") approved plans of
reorganization whereby HIAT, HIAT II and HIAT III would be merged into the Fund.
The plans of reorganization are subject to the consent of HIAT's, HIAT II's and
HIAT III's shareholders at separate meetings to be held on December 10, 2002. If
approved, the assets of HIAT, HIAT II and HIAT III would be combined with the
assets of the Fund and shareholders of HIAT, HIAT II and HIAT III would become
Class D shareholders of the Fund, receiving Class D shares of the Fund equal to
the value of their holdings in HIAT, HIAT II and HIAT III, respectively.
55
Morgan Stanley High Yield Securities Inc.
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of capital stock outstanding
throughout each period:
FOR THE YEAR ENDED AUGUST 31,
---------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
Class A Shares
Selected Per Share Data:
Net asset value,
beginning of period..... $ 2.32 $ 4.35 $ 5.51 $ 6.16 $ 6.82
------ ------ ------ ------ ------
Income (loss) from
investment operations:
Net investment
income[+/+]........... 0.26 (2) 0.47 0.69 0.72 0.76
Net realized and
unrealized loss....... (0.73)(2) (1.99) (1.13) (0.63) (0.71)
------ ------ ------ ------ ------
Total income (loss) from
investment operations... (0.47) (1.52) (0.44) 0.09 0.05
------ ------ ------ ------ ------
Less dividends and
distributions from:
Net investment
income................ (0.27) (0.51) (0.72) (0.74) (0.71)
Paid-in-capital........ (0.03) - - - -
------ ------ ------ ------ ------
Total dividends and
distributions........... (0.30) (0.51) (0.72) (0.74) (0.71)
------ ------ ------ ------ ------
Net asset value, end of
period.................. $ 1.55 $ 2.32 $ 4.35 $ 5.51 $ 6.16
====== ====== ====== ====== ======
Total Return+............ (21.70)% (37.05)% (8.88)% 1.47% 0.40%
Ratios to Average Net
Assets(1):
Expenses................. 0.99 % 0.77 % 0.70 % 0.68% 0.75%
Net investment income.... 13.76 %(2) 15.17 % 13.62 % 12.42% 11.30%
Supplemental Data:
Net assets, end of
period, in thousands.... $23,879 $36,762 $57,273 $68,667 $30,678
Portfolio turnover
rate.................... 39 % 49 % 20 % 36% 66%
- ---------------------
[+/+] The per share amounts were computed using an average number of shares
outstanding during the period.
+ Does not reflect the deduction of sales charge. Calculated based on the
net asset value as of the last business day of the period.
(1) Reflects overall Fund ratios for investment income and non-class
specific expenses.
(2) Effective September 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 August 31, 2002 was to increase net investment
income per share and increase net realized and unrealized loss per share
by $0.01 and to increase the ratio of net investment income to average
net assets by 0.74%. The Financial Highlights data presented in this
table for prior periods has not been restated to reflect this change.
See Notes to Financial Statements
56
Morgan Stanley High Yield Securities Inc.
FINANCIAL HIGHLIGHTS continued
FOR THE YEAR ENDED AUGUST 31,
-------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------- ------------- ------------- ------------- -------------
Class B Shares
Selected Per Share Data:
Net asset value,
beginning of period..... $ 2.32 $ 4.34 $ 5.50 $ 6.15 $ 6.82
------ ------ ------ ------ ------
Income (loss) from
investment operations:
Net investment
income[+/+]........... 0.25 (2) 0.46 0.66 0.69 0.73
Net realized and
unrealized loss....... (0.73) (2) (1.99) (1.13) (0.64) (0.72)
------ ------ ------ ------ ------
Total income (loss) from
investment operations... (0.48) (1.53) (0.47) 0.05 0.01
------ ------ ------ ------ ------
Less dividends and
distributions from:
Net investment
income................ (0.26) (0.49) (0.69) (0.70) (0.68)
Paid-in-capital........ (0.03) - - - -
------ ------ ------ ------ ------
Total dividends and
distributions........... (0.29) (0.49) (0.69) (0.70) (0.68)
------ ------ ------ ------ ------
Net asset value, end of
period.................. $ 1.55 $ 2.32 $ 4.34 $ 5.50 $ 6.15
====== ====== ====== ====== ======
Total Return+............ (22.00)% (37.27)% (9.39)% 0.92% (0.23)%
Ratios to Average Net
Assets(1):
Expenses................. 1.56 % 1.37 % 1.25 % 1.24% 1.25 %
Net investment income.... 13.19 %(2) 14.57 % 13.07 % 11.86% 10.80 %
Supplemental Data:
Net assets, end of
period, in thousands.... $371,399 $664,706 $1,381,008 $1,927,186 $1,761,147
Portfolio turnover
rate.................... 39 % 49 % 20 % 36% 66 %
- ---------------------
[+/+] The per share amounts were computed using an average number of shares
outstanding during the period.
+ Does not reflect the deduction of sales charge. Calculated based on the
net asset value as of the last business day of the period.
(1) Reflects overall Fund ratios for investment income and non-class
specific expenses.
(2) Effective September 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 August 31, 2002 was to increase net investment
income per share and increase net realized and unrealized loss per share
by $0.01 and to increase the ratio of net investment income to average
net assets by 0.74%. The Financial Highlights data presented in this
table for prior periods has not been restated to reflect this change.
See Notes to Financial Statements
57
Morgan Stanley High Yield Securities Inc.
FINANCIAL HIGHLIGHTS continued
FOR THE YEAR ENDED AUGUST 31,
----------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ------------ ----------- ----------- -----------
Class C Shares
Selected Per Share Data:
Net asset value,
beginning of period..... $ 2.32 $ 4.34 $ 5.51 $ 6.15 $ 6.82
------ ------ ------ ------ ------
Income (loss) from
investment operations:
Net investment
income++.............. 0.25 (2) 0.45 0.66 0.68 0.72
Net realized and
unrealized loss....... (0.73)(2) (1.98) (1.14) (0.62) (0.72)
------ ------ ------ ------ ------
Total income (loss) from
investment operations... (0.48) (1.53) (0.48) 0.06 0.00
------ ------ ------ ------ ------
Less dividends and
distributions from:
Net investment
income................ (0.26) (0.49) (0.69) (0.70) (0.67)
Paid-in-capital........ (0.03) - - - -
------ ------ ------ ------ ------
Total dividends and
distributions........... (0.29) (0.49) (0.69) (0.70) (0.67)
------ ------ ------ ------ ------
Net asset value, end of
period.................. $ 1.55 $ 2.32 $ 4.34 $ 5.51 $ 6.15
====== ====== ====== ====== ======
Total Return+............ (22.11)% (37.24)% (9.66)% 0.99% (0.34)%
Ratios to Average Net
Assets(1):
Expenses................. 1.66 % 1.47 % 1.35 % 1.34% 1.36 %
Net investment income.... 13.09 %(2) 14.47 % 12.97 % 11.76% 10.69 %
Supplemental Data:
Net assets, end of
period, in thousands.... $33,978 $49,818 $86,951 $109,142 $56,626
Portfolio turnover
rate.................... 39 % 49 % 20 % 36% 66 %
- ---------------------
[+/+] The per share amounts were computed using an average number of shares
outstanding during the period.
+ Does not reflect the deduction of sales charge. Calculated based on the
net asset value as of the last business day of the period.
(1) Reflects overall Fund ratios for investment income and non-class
specific expenses.
(2) Effective September 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 August 31, 2002 was to increase net investment
income per share and increase net realized and unrealized loss per share
by $0.01 and to increase the ratio of net investment income to average
net assets by 0.74%. The Financial Highlights data presented in this
table for prior periods has not been restated to reflect this change.
See Notes to Financial Statements
58
Morgan Stanley High Yield Securities Inc.
FINANCIAL HIGHLIGHTS continued
FOR THE YEAR ENDED AUGUST 31,
------------------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------ ------------ ----------- -----------
Class D Shares
Selected Per Share Data:
Net asset value,
beginning of period..... $ 2.32 $ 4.35 $ 5.51 $ 6.16 $ 6.82
------ ------ ------ ------ ------
Income (loss) from
investment operations:
Net investment
income[+/+]........... 0.26 (2) 0.48 0.70 0.74 0.78
Net realized and
unrealized loss....... (0.73) (2) (1.99) (1.13) (0.64) (0.71)
------ ------ ------ ------ ------
Total income (loss) from
investment
operations.............. (0.47) (1.51) (0.43) 0.10 0.07
------ ------ ------ ------ ------
Less dividends and
distributions from:
Net investment
income................ (0.27) (0.52) (0.73) (0.75) (0.73)
Paid-in-capital........ (0.03) - - - -
------ ------ ------ ------ ------
Total dividends and
distributions........... (0.30) (0.52) (0.73) (0.75) (0.73)
------ ------ ------ ------ ------
Net asset value, end of
period.................. $ 1.55 $ 2.32 $ 4.35 $ 5.51 $ 6.16
====== ====== ====== ====== ======
Total Return+............ (21.45)% (36.95)% (8.69)% 1.67% 0.63%
Ratios to Average Net
Assets(1):
Expenses................. 0.81 % 0.62 % 0.50 % 0.49% 0.51%
Net investment income.... 13.94 %(2) 15.32 % 13.82 % 12.61% 11.54%
Supplemental Data:
Net assets, end of
period, in thousands.... $86,436 $137,319 $246,941 $333,714 $400,582
Portfolio turnover
rate.................... 39 % 49 % 20 % 36% 66%
- ---------------------
[+/+] The per share amounts were computed using an average number of shares
outstanding during the period.
+ Does not reflect the deduction of sales charge. Calculated based on the
net asset value as of the last business day of the period.
(1) Reflects overall Fund ratios for investment income and non-class
specific expenses.
(2) Effective September 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 August 31, 2002 was to increase net investment
income per share and increase net realized and unrealized loss per share
by $0.01 and to increase the ratio of net investment income to average
net assets by 0.74%. The Financial Highlights data presented in this
table for prior periods has not been restated to reflect this change.
See Notes to Financial Statements
59
Morgan Stanley High Yield Securities Inc.
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors of
Morgan Stanley High Yield Securities Inc.:
We have audited the accompanying statement of assets and liabilities of Morgan
Stanley High Yield Securities Inc. (the "Fund"), including the portfolio of
investments, as of August 31, 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 August 31, 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 High Yield Securities Inc. as of August 31, 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
September 23, 2002
60
MORGAN STANLEY HIGH YIELD SECURITIES INC.
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. 28 to the Registrant's Registration Statement on Form N-1A, dated
September 30, 2002, which was filed electronically pursuant to Regulation S-T
on September 30, 2002 as an amendment to Registrant's Registration Statement on
Form N-1A (File Nos. 811-2932 and 2-64782).
ITEM 16. EXHIBITS
(1) Articles of Incorporation dated June 12, 1979 (incorporated herein by
reference to Exhibit 1(a) of Post-Effective Amendment No. 19 to the
Registration Statement on Form N-1A, filed on October 25, 1995);
Articles of Amendments dated March 18, 1983, December 16, 1985 and
January 19, 1989 (incorporated herein by reference to Exhibits 1(b),
1(c) and 1(d), respectively, of Post-Effective Amendment No. 19 to the
Registration Statement on Form N-1A, filed on October 25, 1995; Articles
of Amendments, dated May 23, 1997 and July 28, 1997 and Articles
Supplementary dated July 28, 1997 (incorporated herein by reference to
Exhibits 1(a), 1(c) and 1(b), respectively, of Post-Effective Amendment
No. 21 to the Registration Statement on Form N-1A, filed on July 3,
1997; Articles of Amendment, dated June 22, 1998 (incorporated herein by
reference to Exhibit 1 of Post-Effective Amendment No. 23 to the
Registration Statement on Form N-1A, filed on October 29, 1998; and
Articles of Amendment dated June 18, 2001 (incorporated herein by
reference to Exhibit 1(d) of Post-Effective Amendment No. 27 to the
Registration Statement on Form N-1A, filed on October 30, 2001).
(2) Amended and Restated By-Laws of Registrant dated as of September 24, 2002
(incorporated herein by reference to Exhibit 2 of Post-Effective
Amendment No. 28 to the Registration Statement on Form N-1A, filed on
September 30, 2002).
(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. 23 to the Registration Statement on Form
N-1A filed on October 29, 1998).
(7) (a) Amended Distribution Agreement between Registrant and Morgan Stanley
Distributors Inc. (incorporated herein by reference to Exhibit 6 of
Post-Effective Amendment No. 23 to the Registration Statement on Form
N-1A, filed on October 29, 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 Post-Effective Amendment No. 17 to the Registration
Statement on Form N-1A, filed on October 23, 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. 24 to the Registration Statement) on Form N-1A, filed on
August 27, 1999).
C-1
(8) Not Applicable
(9) (a) Custody Agreement between the Registrant and The Bank of New York
dated September 20, 1991 (incorporated herein by reference to Exhibit
8 of Post-Effective Amendment No. 19 to the Registration Statement on
Form N-1A, filed on October 25, 1995); 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. 20 to
the Registration Statement on Form N-1A, filed on October 24, 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. 27 to the
Registration Statement on Form N-1A, filed on October 30, 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. 27 to the Registration
Statement on Form N-1A filed on October 30, 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. 26 to the Registration Statement on Form N-1A filed on
October 30, 2000).
(10) (a) Amended and Restated Plan of Distribution pursuant to Rule 12b-1
(incorporated herein by reference to Exhibit 15 of Post-Effective
Amendment No. 21 to the Registration Statement on Form N-1A, filed on
July 3, 1997).
(10) (b) Morgan Stanley Funds Multiple Class Plan pursuant to Rule 18f-3 dated
March 12, 2001 (incorporated herein by reference to Exhibit 14 of
Post-Effective Amendment No. 27 to the Registration Statement on Form
N-1A, filed on October 30, 2001.
(11) (a) Opinion and consent of Mayer, Brown, Rowe & Maw filed herein.
(b) Opinion and consent of Piper Rudnick LLP filed herein.
(12) Opinion and consent of Mayer, Brown, Rowe & Maw regarding tax matters
filed herein.
(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. 23 to the
Registration Statement on Form N-1A, filed on October 29, 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 August 30, 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 August 31,
2001 (incorporated herein by reference to Form 24f-2 filed with the
Securities and Exchange Commission on November 6, 2001).
(b) Form of Proxy (previously filed with Registrant's initial Registration
Statement on Form N-14 filed on August 30, 2002 and incorporated herein
by reference).
(c) Voting Information Card (previously filed with Registrant's initial
Registration Statement on Form N-14 filed on August 30, 2002 and
incorporated herein by reference).
C-2
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 orparty 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 registration statement has
been signed on behalf of the registrant, in the City of New York and State of
New York, on the 3rd day of October, 2002.
MORGAN STANLEY HIGH YIELD SECURITIES INC.
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/ Mitchell M. Merin Chief Executive Officer and President October 3, 2002
............................
2. Principal Financial Officer
/s/ Francis Smith Chief Financial Officer October 3, 2002
............................
3. Majority of Directors
/s/ Charles A. Fiumefreddo Chairman and Director October 3, 2002
............................
/s/ Michael Bozic Director October 3, 2002
............................
/s/ Edwin J. Garn Director October 3, 2002
............................
/s/ Wayne E. Hedien Director October 3, 2002
............................
/s/ James F. Higgins Director October 3, 2002
............................
/s/ Manuel H. Johnson Director October 3, 2002
............................
/s/ Michael E. Nugent Director October 3, 2002
............................
/s/ Philip J. Purcell Director October 3, 2002
............................
C-4
MORGAN STANLEY HIGH YIELD SECURITIES INC.
EXHIBIT INDEX
11(a) Opinion and consent of Mayer, Brown, Rowe & Maw
11(b) Opinion and consent of Piper Rudnick LLP
12 Opinion and consent of Mayer, Brown, Rowe & Maw regarding tax matters
14 Consent of Independent Auditors