<Page>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED
MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number: 811-07117
Morgan Stanley Limited Duration Fund
(Exact name of registrant as specified in charter)
1221 Avenue of the Americas, New York, New York 10020
(Address of principal executive offices) (Zip code)
Ronald E. Robison
1221 Avenue of the Americas, New York, New York 10020
(Name and address of agent for service)
Registrant's telephone number, including area code: 212-762-4000
Date of fiscal year end: April 30, 2004
Date of reporting period: April 30, 2004
Item 1 - Report to Shareholders
<Page>
WELCOME, SHAREHOLDER:
IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY LIMITED
DURATION FUND PERFORMED DURING THE ANNUAL PERIOD. WE WILL PROVIDE AN OVERVIEW OF
THE MARKET CONDITIONS, AND DISCUSS SOME OF THE FACTORS THAT AFFECTED PERFORMANCE
DURING THE REPORTING PERIOD. IN ADDITION, THIS REPORT INCLUDES THE FUND'S
FINANCIAL STATEMENTS AND A LIST OF FUND INVESTMENTS.
THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE FUND BEING
OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO
PASS. THERE IS NO ASSURANCE THAT THE FUND WILL ACHIEVE ITS INVESTMENT OBJECTIVE.
THE FUND IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES
OF SECURITIES OWNED BY THE FUND WILL DECLINE AND, THEREFORE, THE VALUE OF THE
FUND SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE
MONEY INVESTING IN THIS FUND.
<Page>
Fund Report
For the year ended April 30, 2004
TOTAL RETURN FOR THE 12 MONTHS ENDED APRIL 30, 2004
<Table>
<Caption>
LIPPER SHORT
LEHMAN BROTHERS INVESTMENT
1-5 YEAR GRADE BOND
LIMITED DURATION U.S. CREDIT INDEX(1) FUNDS INDEX(2)
0.99% 2.85% 1.51%
</Table>
THE FUND'S TOTAL RETURN FIGURE ASSUMES THE REINVESTMENT OF ALL DISTRIBUTIONS.
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. SEE PERFORMANCE SUMMARY FOR
STANDARDIZED PERFORMANCE INFORMATION.
MARKET CONDITIONS
The 12-month period ended April 30, 2004, was marked by significant volatility
in interest rates. After a relatively quiet May 2003, Treasury yields rose in
the summer as investors began to price in expectations for more rapid economic
growth. This pattern then reversed itself from last August through this March.
During these months, mounting signals of improvement in the economy were offset
by continued weakness in the job market as well as low inflationary pressures
and even some signs of deflation. This environment led the Federal Open Market
Committee (the "Fed") to keep rates at multidecade lows, which in turn led to a
sustained decrease in both interest rates and yields.
This pattern shifted in late March, when indicators of more-rapid growth began
to surface. In early April, the Bureau of Labor Statistics produced an
employment report showing that employment growth had exceeded the market's
expectations. Incoming price data also indicated an increasing bias toward
inflation. These shifts accelerated the market's expected date for the Fed to
move to a tightening mode and had a substantial effect on yields as investors
began to discount future Fed increases in advance.
Against this backdrop, the mortgage-backed securities (MBS) sector had a
somewhat mixed performance. Throughout much of the period, MBSs tended to
provide somewhat lower returns than equivalent-duration Treasury securities, as
declining interest rates resulted in expectations of more-rapid prepayment. MBSs
went on to outperform in April, however, as prepayment expectations slowed for
higher-coupon mortgages and their lower interest-rate sensitivity served to
ameliorate the effects of rising interest rates. MBSs outperformed government
securities over the year.
Corporate securities also performed strongly. The sector enjoyed declining yield
spreads (a measure of the risk premium demanded by investors, as measured by
additional yield over Treasuries) over the 12-month period as investors
responded to ongoing improvements in corporate balance sheets and credit
quality. The strongest performance came from industry sectors such as
industrials, whose financial condition is most closely linked to that of the
broader economy.
PERFORMANCE ANALYSIS
Morgan Stanley Limited Duration Fund underperformed its benchmark, the Lehman
Brothers 1-5 Year U.S. Credit Index and the Lipper Short Investment Grade Bond
Funds Index. The bulk of the Fund's underperformance is attributable to our
strategy of emphasizing government and mortgage securities. The Fund's
benchmark, by contrast, is comprised entirely of corporate bonds. These bonds
outperformed all other sectors of the investment-grade market, and the Fund's
roughly 30 percent exposure to corporate bonds was not sufficient to keep it in
harmony with the index.
2
<Page>
One of our primary strategies during the period was to maintain a relatively
defensive posture with regard to interest rates. Our analysis indicated that
economic recovery would lead to growing inflationary pressures and more rapid
jobs growth, which would in turn lead to rising interest rates. As a result, we
kept the Fund's duration (a measure of interest rate sensitivity) below that of
its benchmark. We also focused its MBS investments in higher-coupon securities,
whose structural characteristics have historically made them less sensitive to
adverse movements in interest rates. Both of these strategies bore fruit when
interest rates spiked in the later months of the period, though they also
hampered performance during the months when interest rates declined.
The portfolio's corporate holdings were also positioned to benefit from improved
economic growth. As was evident during much of the period, an expanding economy
generally benefits lower-rated securities the most. The Fund's holdings were
concentrated in securities rated BBB, the lowest credit tier of the
investment-grade market. These securities performed strongly and benefited from
the general decline in yield spreads.
PORTFOLIO COMPOSITION
<Table>
Corporate Debt - Non Convertible 33.1%
Mortgage Backed Securities 23.2
Asset-Backed Securities 18.9
U.S. Government Agencies 9.7
U.S. Treasuries 8.3
CMOs 3.7
Short-Term Investments 1.8
Foreign Government Bonds 1.3
</Table>
LONG-TERM CREDIT ANALYSIS
<Table>
Aaa/AAA 64.2%
Aa/AA 7.2
A/A 15.3
Baa/BBB 13.2
Ba/BB 0.1
</Table>
DATA AS OF APRIL 30, 2004. SUBJECT TO CHANGE DAILY. PORTFOLIO COMPOSITION IS A
PERCENTAGE OF TOTAL INVESTMENTS AND LONG-TERM CREDIT ANALYSIS IS A PERCENTAGE OF
LONG-TERM INVESTMENTS. PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND SHOULD NOT
BE DEEMED AS A RECOMMENDATION TO BUY OR SELL THE SECURITIES MENTIONED. MORGAN
STANLEY IS A FULL-SERVICE SECURITIES FIRM ENGAGED IN SECURITIES TRADING AND
BROKERAGE ACTIVITIES, INVESTMENT BANKING, RESEARCH AND ANALYSIS, FINANCING AND
FINANCIAL ADVISORY SERVICES.
3
<Page>
INVESTMENT STRATEGY
THE FUND WILL NORMALLY INVEST AT LEAST 65% OF ITS ASSETS IN SECURITIES ISSUED OR
GUARANTEED AS TO PRINCIPAL AND INTEREST BY THE U.S. GOVERNMENT, ITS AGENCIES OR
INSTRUMENTALITIES (INCLUDING ZERO COUPON SECURITIES), INVESTMENT GRADE
MORTGAGE-BACKED SECURITIES, INCLUDING COLLATERALIZED MORTGAGE OBLIGATIONS, AND
INVESTMENT GRADE CORPORATE AND OTHER TYPES OF BONDS. IN SELECTING PORTFOLIO
INVESTMENTS TO PURCHASE OR SELL, THE "INVESTMENT MANAGER," MORGAN STANLEY
INVESTMENT ADVISORS INC., CONSIDERS DOMESTIC AND INTERNATIONAL ECONOMIC
DEVELOPMENTS, INTEREST RATE LEVELS, THE STEEPNESS OF THE YIELD CURVE AND OTHER
FACTORS, AND SEEKS TO MAINTAIN AN OVERALL AVERAGE DURATION FOR THE FUND'S
PORTFOLIO OF THREE YEARS OR LESS.
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 WHO RESIDE AT THE SAME ADDRESS.
YOUR PARTICIPATION IN THIS PROGRAM WILL CONTINUE FOR AN UNLIMITED PERIOD OF TIME
UNLESS YOU INSTRUCT US OTHERWISE. YOU CAN REQUEST MULTIPLE COPIES OF THESE
DOCUMENTS BY CALLING (800) 350-6414, 8:00 A.M. TO 8:00 P.M., ET. ONCE OUR
CUSTOMER SERVICE CENTER HAS RECEIVED YOUR INSTRUCTIONS, WE WILL BEGIN SENDING
INDIVIDUAL COPIES FOR EACH ACCOUNT WITHIN 30 DAYS.
PROXY VOTING POLICIES AND PROCEDURES
A DESCRIPTION OF THE FUND'S POLICIES AND PROCEDURES WITH RESPECT TO THE VOTING
OF PROXIES RELATING TO THE FUND'S PORTFOLIO SECURITIES IS AVAILABLE WITHOUT
CHARGE, UPON REQUEST, BY CALLING (800) 869-NEWS (6397). THIS INFORMATION IS ALSO
AVAILABLE ON THE SECURITIES AND EXCHANGE COMMISSION'S WEB SITE AT
http://www.sec.gov.
4
<Page>
(This page has been left blank intentionally.)
<Page>
Performance Summary
[CHART]
PERFORMANCE OF A $10,000 INVESTMENT
<Table>
<Caption>
FUND LEHMAN(1) LIPPER(2)
April 30, 1994 $ 10,000 $ 10,000 $ 10,000
April 30, 1995 $ 10,476 $ 10,706 $ 10,461
April 30, 1996 $ 11,244 $ 11,586 $ 11,166
April 30, 1997 $ 11,905 $ 12,364 $ 11,869
April 30, 1998 $ 12,740 $ 13,375 $ 12,689
April 30, 1999 $ 13,505 $ 14,253 $ 13,342
April 30, 2000 $ 13,823 $ 14,553 $ 13,749
April 30, 2001 $ 15,042 $ 16,252 $ 15,039
April 30, 2002 $ 16,019 $ 17,389 $ 15,798
April 30, 2003 $ 16,650 $ 19,205 $ 16,555
April 30, 2004 $ 16,815++ $ 19,752 $ 16,804
</Table>
ENDING VALUE
<Table>
<Caption>
FUND LEHMAN(1) LIPPER(2)
$ 16,815++ $ 19,752 $ 16,804
</Table>
6
<Page>
AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED APRIL 30, 2004
<Table>
<Caption>
MSLDX
1 YEAR 0.99%(3)
5 YEARS 4.48(3)
10 YEARS 5.33(3)
SINCE INCEPTION (1/10/94) 4.97(3)
</Table>
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS AND CURRENT PERFORMANCE MAY
BE LOWER OR HIGHER THAN THE FIGURES SHOWN. FOR MORE UP-TO-DATE INFORMATION,
INCLUDING MONTH-END PERFORMANCE FIGURES, PLEASE VISIT morganstanley.com OR SPEAK
WITH YOUR FINANCIAL ADVISOR. INVESTMENT RETURNS AND PRINCIPAL VALUE WILL
FLUCTUATE AND FUND SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR
ORIGINAL COST. THE GRAPH AND TABLE DO NOT REFLECT THE DEDUCTION OF TAXES THAT A
SHAREHOLDER WOULD PAY ON FUND DISTRIBUTIONS OR THE REDEMPTION OF FUND SHARES.
- ----------
Notes on Performance
(1) THE LEHMAN BROTHERS U.S. CREDIT INDEX (1-5 YEAR) INCLUDES U.S. CORPORATE
AND SPECIFIED FOREIGN DEBENTURES AND SECURED NOTES WITH MATURITIES OF ONE
TO FIVE YEARS. INDEXES ARE UNMANAGED AND THEIR RETURNS DO NOT INCLUDE ANY
SALES CHARGES OR FEES. SUCH COSTS WOULD LOWER PERFORMANCE. IT IS NOT
POSSIBLE TO INVEST DIRECTLY IN AN INDEX.
(2) THE LIPPER SHORT INVESTMENT GRADE BOND FUNDS INDEX IS AN EQUALLY WEIGHTED
PERFORMANCE INDEX OF THE LARGEST QUALIFYING FUNDS (BASED ON NET ASSETS) IN
THE LIPPER SHORT INVESTMENT GRADE BOND FUNDS CLASSIFICATION. THE INDEX,
WHICH IS ADJUSTED FOR CAPITAL GAINS DISTRIBUTIONS AND INCOME DIVIDENDS, IS
UNMANAGED AND SHOULD NOT BE CONSIDERED AN INVESTMENT. THERE ARE CURRENTLY
30 FUNDS REPRESENTED IN THIS INDEX.
(3) FIGURE SHOWN ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS. THERE IS NO SALES
CHARGE.
++ ENDING VALUE ASSUMING A COMPLETE REDEMPTION ON APRIL 30, 2004.
7
<Page>
MORGAN STANLEY LIMITED DURATION FUND
PORTFOLIO OF INVESTMENTS - APRIL 30, 2004
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------
CORPORATE BONDS (35.3%)
AEROSPACE & DEFENSE (0.6%)
$ 435 Lockheed Martin Corp. 8.20% 12/01/09 $ 517,293
615 McDonnell Douglas Corp. 6.875 11/01/06 667,466
965 Raytheon Co. 4.85 01/15/11 962,122
180 Raytheon Co. 6.75 08/15/07 197,401
385 Raytheon Co. 8.30 03/01/10 454,909
----------------
2,799,191
----------------
AIR FREIGHT/COURIERS (0.1%)
770 Fedex Corp. - 144A* 2.65 04/01/07 753,558
----------------
AIRLINES (0.1%)
465 Southwest Airlines Co. 5.496 11/01/06 490,989
----------------
AUTO PARTS: O.E.M. (0.3%)
640 Delphi Automotive Systems Corp. 6.125 05/01/04 640,000
745 Johnson Controls, Inc. 5.00 11/15/06 782,955
----------------
1,422,955
----------------
BEVERAGES: ALCOHOLIC (0.2%)
880 Miller Brewing Co. - 144A* 4.25 08/15/08 883,883
----------------
BROADCASTING (0.3%)
1,275 Clear Channel Communications, Inc. 7.65 09/15/10 1,458,770
----------------
BUILDING PRODUCTS (0.1%)
275 Masco Corp. 4.625 08/15/07 284,369
----------------
CABLE/SATELLITE TV (0.6%)
1,120 Comcast Cable Communications 6.875 06/15/09 1,234,328
705 Comcast Corp. 5.85 01/15/10 741,195
350 Cox Communications Inc. 7.75 08/15/06 386,472
300 TCI Communications, Inc. 8.00 08/01/05 320,366
----------------
2,682,361
----------------
CHEMICALS: MAJOR DIVERSIFIED (0.1%)
390 ICI Wilmington Inc. 4.375 12/01/08 387,436
----------------
DEPARTMENT STORES (0.5%)
160 Federated Department Stores, Inc. 6.30 04/01/09 173,605
1,740 Federated Department Stores, Inc. 6.625 09/01/08 1,906,866
430 May Department Stores Co. 6.875 11/01/05 455,966
----------------
2,536,437
----------------
DISCOUNT STORES (0.1%)
310 Target Corp. 7.50 02/15/05 323,217
----------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
8
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------
DRUGSTORE CHAINS (0.3%)
$ 135 CVS Corp. 3.875% 11/01/07 $ 136,248
1,455 CVS Corp. 5.625 03/15/06 1,532,889
----------------
1,669,137
----------------
ELECTRIC UTILITIES (2.2%)
815 Appalachian Power Co. 3.60 05/15/08 800,330
1,400 Columbus Southern Power Co. 4.40 12/01/10 1,374,349
1,165 Constellation Energy Group 6.35 04/01/07 1,252,721
2,985 Consolidated Natural Gas Co. 5.375 11/01/06 3,137,005
735 Duke Energy Corp. 4.50 04/01/10 732,824
485 Entergy Gulf States, Inc. 3.60 06/01/08 469,994
690 Exelon Corp. 6.75 05/01/11 762,795
1,530 Pacific Gas & Electric 3.60 03/01/09 1,485,746
235 Panhandle Eastern Pipe Line Co. - 144A* 2.75 03/15/07 229,785
360 Wisconsin Electric Power Co. 4.50 05/15/13 346,387
----------------
10,591,936
----------------
ELECTRICAL PRODUCTS (0.1%)
565 Cooper Industries Inc. 5.25 07/01/07 595,904
----------------
ENVIRONMENTAL SERVICES (0.4%)
1,260 Waste Management, Inc. 6.875 05/15/09 1,396,022
510 WMX Technologies, Inc. 7.00 10/15/06 555,153
----------------
1,951,175
----------------
FINANCE/RENTAL/LEASING (3.0%)
905 American Honda Finance Corp. - 144A* 3.85 11/06/08 900,552
1,300 CIT Group Inc. 1.36 11/04/05 1,303,335
545 CIT Group Inc. 2.875 09/29/06 541,938
1,035 CIT Group Inc. 6.50 02/07/06 1,103,289
1,325 CIT Group Inc. 7.375 04/02/07 1,471,382
1,640 Countrywide Home Loans, Inc. 3.25 05/21/08 1,593,563
1,845 Ford Motor Credit Co. 6.875 02/01/06 1,953,691
1,730 Ford Motor Credit Co. 7.375 10/28/09 1,872,190
1,250 Ford Motor Credit Co. 6.50 01/25/07 1,326,384
210 Hertz Corp. 7.00 07/01/04 211,379
305 MBNA America Bank NA 7.75 09/15/05 326,456
1,535 MBNA Corp. 6.125 03/01/13 1,619,311
530 Prime Property Funding II - 144A* 7.00 08/15/04 538,664
----------------
14,762,134
----------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
9
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------
FINANCIAL CONGLOMERATES (4.7%)
$ 410 Chase Manhattan Corp. 6.00% 02/15/09 $ 440,318
145 Chase Manhattan Corp. 7.00 11/15/09 163,941
750 Citicorp 6.375 11/15/08 817,542
585 Citicorp 6.75 08/15/05 620,524
2,505 Citigroup Global Markets 1.22 12/12/06 2,505,556
835 Citigroup Inc. 5.50 08/09/06 886,033
1,205 Citigroup Inc. 5.75 05/10/06 1,278,040
2,215 General Electric Capital Corp. 4.25 12/01/10 2,169,958
2,550 General Electric Capital Corp. 5.375 03/15/07 2,703,581
2,225 General Motors Acceptance Corp. 4.50 07/15/06 2,274,386
2,870 General Motors Acceptance Corp. 6.125 08/28/07 3,035,022
1,150 ING Security Life Institutional - 144A* 2.70 02/15/07 1,140,393
820 JP Morgan Chase & Co. 5.25 05/30/07 864,541
1,475 Pricoa Global Funding I - 144A* 3.90 12/15/08 1,460,451
1,470 Prudential Funding LLC - 144A* 6.60 05/15/08 1,610,457
860 Prudential Insurance Co. - 144A* 6.375 07/23/06 926,625
----------------
22,897,368
----------------
FOOD RETAIL (1.1%)
900 Albertson's, Inc. 7.50 02/15/11 1,023,589
735 Kroger Co. 7.375 03/01/05 767,482
835 Kroger Co. 7.625 09/15/06 918,871
2,318 Safeway Inc. 6.15 03/01/06 2,454,945
----------------
5,164,887
----------------
FOOD: MAJOR DIVERSIFIED (0.5%)
325 General Mills Inc. 3.875 11/30/07 326,134
1,790 Kraft Foods Inc. 5.25 06/01/07 1,882,255
----------------
2,208,389
----------------
FOOD: MEAT/FISH/DAIRY (0.2%)
985 Conagra Foods, Inc. 6.00 09/15/06 1,049,203
----------------
FOREST PRODUCTS (0.7%)
460 Weyerhaeuser Co. 6.125 03/15/07 492,690
2,620 Weyerhaeuser Co. 6.75 03/15/12 2,876,613
----------------
3,369,303
----------------
GAS DISTRIBUTORS (0.1%)
220 Ras Laffan Liquid Natural
Gas Co. Ltd. - 144A* (Qatar) 7.628 09/15/06 232,828
----------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
10
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------
HOME BUILDING (0.1%)
$ 240 Centex Corp. 9.75% 06/15/05 $ 258,585
----------------
HOME FURNISHINGS (0.0%)
195 Mohawk Industries, Inc. (Class C) 6.50 04/15/07 210,744
----------------
HOME IMPROVEMENT CHAINS (0.1%)
565 Lowe's Companies, Inc. 7.50 12/15/05 610,016
----------------
HOTELS/RESORTS/CRUISELINES (0.4%)
795 Hyatt Equities LLC - 144A* 6.875 06/15/07 842,461
485 Marriott International, Inc. (Series D) 8.125 04/01/05 510,529
130 Marriott International, Inc. (Series E) 7.00 01/15/08 144,866
295 Starwood Hotels & Resorts Inc. 7.375 05/01/07 318,600
----------------
1,816,456
----------------
INDUSTRIAL CONGLOMERATES (0.4%)
1,940 Honeywell International, Inc. 5.125 11/01/06 2,042,093
----------------
INSURANCE BROKERS/SERVICES (0.5%)
2,235 Marsh & McLennan Companies Inc. 5.375 03/15/07 2,365,135
----------------
INTEGRATED OIL (0.8%)
1,210 Amerada Hess Corp. 6.65 08/15/11 1,291,650
358 Conoco Funding Co. (Canada) 5.45 10/15/06 381,007
2,070 Phillips Pete 8.50 05/25/05 2,210,317
----------------
3,882,974
----------------
INVESTMENT BANKS/BROKERS (1.3%)
2,370 Goldman Sachs Group Inc. 4.125 01/15/08 2,404,225
3,222 Lehman Brothers Holdings, Inc. 8.25 06/15/07 3,677,484
----------------
6,081,709
----------------
INVESTMENT MANAGERS (0.2%)
1,045 TIAA Global Markets - 144A* 5.00 03/01/07 1,097,589
----------------
LIFE/HEALTH INSURANCE (0.7%)
1,400 John Hancock Financial Services, Inc. 5.625 12/01/08 1,490,135
635 John Hancock Global Funding - 144A* 5.625 06/27/06 673,913
460 John Hancock Global Funding II - 144A* 7.90 07/02/10 538,054
630 Monumental Global Funding II - 144A* 6.05 01/19/06 669,650
----------------
3,371,752
----------------
MAJOR BANKS (3.3%)
2,640 Bank of America Corp. 3.375 02/17/09 2,559,520
485 Bank of America Corp. 3.875 01/15/08 489,227
765 Bank of America Corp. 4.75 10/15/06 797,934
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
11
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------
$ 355 Bank of New York (The) 5.20% 07/01/07 $ 377,242
440 Bank One Corp. 6.00 02/17/09 475,751
1,300 Bank One NA Illinois 1.23 05/05/06 1,302,291
1,390 Bank One NA Illinois 5.50 03/26/07 1,477,139
1,050 Fleetboston Financial Corp. 7.25 09/15/05 1,121,512
420 Household Finance Corp. 4.125 12/15/08 420,257
435 Household Finance Corp. 5.875 02/01/09 466,174
215 Household Finance Corp. 6.375 10/15/11 233,621
765 Household Finance Corp. 6.40 06/17/08 835,961
395 Household Finance Corp. 6.75 05/15/11 437,952
820 Huntington National Bank 2.75 10/16/06 816,218
1,260 Key Bank NA 7.125 08/15/06 1,380,883
520 Wachovia Corp. 3.625 02/17/09 510,336
1,240 Wachovia Corp. 4.95 11/01/06 1,298,545
1,165 Wells Fargo Co. 1.22 03/03/06 1,167,497
----------------
16,168,060
----------------
MAJOR TELECOMMUNICATIONS (1.7%)
670 AT&T Corp. 8.05 11/15/11 736,215
1,360 Deutsche Telekom International
Finance Corp. (Netherlands) 8.50 06/15/10 1,608,906
535 Telecom Italia Capital - 144A* (Italy) 4.00 11/15/08 530,863
1,925 Verizon Communications, Inc. 6.36 04/15/06 2,056,606
1,040 Verizon Global Funding Corp. 6.125 06/15/07 1,122,761
2,000 Verizon Global Funding Corp. 7.25 12/01/10 2,264,038
----------------
8,319,389
----------------
MANAGED HEALTH CARE (1.1%)
870 Aetna, Inc. 7.375 03/01/06 943,762
1,140 Aetna, Inc. 7.875 03/01/11 1,333,699
1,245 Anthem, Inc. 4.875 08/01/05 1,284,516
245 Anthem Insurance Companies, Inc. - 144A* 9.125 04/01/10 304,212
905 UnitedHealth Group Inc. 7.50 11/15/05 973,880
625 Wellpoint Health Network, Inc. 6.375 06/15/06 671,173
----------------
5,511,242
----------------
MEDIA CONGLOMERATES (0.9%)
945 News American Inc. 4.75 03/15/10 946,110
620 News American Inc. 6.625 01/09/08 677,171
480 Time Warner, Inc. 6.15 05/01/07 513,883
1,990 Time Warner, Inc. 6.125 04/15/06 2,111,416
----------------
4,248,580
----------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
12
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------
MOTOR VEHICLES (0.7%)
$ 750 DaimlerChrysler North American Holdings Co. 4.05% 06/04/08 $ 737,386
1,045 DaimlerChrysler North American Holdings Co. 6.40 05/15/06 1,112,367
1,525 DaimlerChrysler North American Holdings Co. 7.30 01/15/12 1,689,088
----------------
3,538,841
----------------
MULTI-LINE INSURANCE (1.4%)
465 AIG SunAmerica Global Finance - 144A* 5.20 05/10/04 465,265
825 American General Finance Corp. 4.625 09/01/10 826,356
1,780 American General Finance Corp. 5.875 07/14/06 1,897,834
250 Equitable Life Assurance - 144A* 6.95 12/01/05 267,633
500 Farmers Insurance Exchange - 144A* 8.50 08/01/04 505,999
1,420 Hartford Financial Services Group, Inc. (The) 7.75 06/15/05 1,505,947
455 Hartford Financial Services Group, Inc. (The) 2.375 06/01/06 449,865
345 Hartford Financial Services Group, Inc. (The) 7.90 06/15/10 403,406
500 International Lease Finance Corp. 3.75 08/01/07 502,005
----------------
6,824,310
----------------
OIL & GAS PRODUCTION (1.1%)
500 Kerr-McGee Corp. 5.875 09/15/06 529,188
985 Kerr-McGee Corp. 6.875 09/15/11 1,077,419
540 Nexen Inc. (Canada) 5.05 11/20/13 525,018
1,465 Pemex Project Funding Master Trust 7.875 02/01/09 1,622,488
700 Pemex Project Funding Master Trust 8.00 11/15/11 774,200
555 Pemex Project Funding Master Trust 9.125 10/13/10 652,125
----------------
5,180,438
----------------
OIL REFINING/MARKETING (0.4%)
400 Ashland Inc. 7.83 08/15/05 424,755
1,265 Marathon Oil Corp. 5.375 06/01/07 1,334,767
----------------
1,759,522
----------------
OTHER CONSUMER SERVICES (0.1%)
520 Cendant Corp. 6.25 01/15/08 562,093
----------------
OTHER METALS/MINERALS (0.2%)
995 Inco Ltd. (Canada) 7.75 05/15/12 1,155,166
----------------
PHARMACEUTICALS: MAJOR (0.1%)
505 Schering-Plough Corp. 5.30 12/01/13 505,128
----------------
PROPERTY - CASUALTY INSURERS (0.4%)
1,055 Allstate Finance Global Funding II - 144A* 2.625 10/22/06 1,049,647
1,100 Mantis Reef Ltd. - 144A* (Australia) 4.692 11/14/08 1,095,690
----------------
2,145,337
----------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
13
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------
PULP & PAPER (0.5%)
$ 820 International Paper Co. 3.80% 04/01/08 $ 812,156
805 MeadWestvaco Corp. 2.75 12/01/05 806,141
685 Sappi Papier Holding AG - 144A* (Austria) 6.75 06/15/12 741,489
----------------
2,359,786
----------------
RAILROADS (0.4%)
400 Union Pacific Corp. 3.625 06/01/10 376,728
615 Union Pacific Corp. 5.84 05/25/04 616,432
970 Union Pacific Corp. 6.79 11/09/07 1,073,011
----------------
2,066,171
----------------
REAL ESTATE DEVELOPMENT (0.7%)
2,813 World Financial Properties - 144A* 6.91 09/01/13 3,089,960
452 World Financial Properties - 144A* 6.95 09/01/13 497,695
----------------
3,587,655
----------------
REAL ESTATE INVESTMENT TRUSTS (0.7%)
2,495 EOP Operating L.P. 6.763 06/15/07 2,727,953
415 EOP Operating L.P. 8.375 03/15/06 455,984
465 Rouse Co. 3.625 03/15/09 446,120
----------------
3,630,057
----------------
REGIONAL BANKS (0.4%)
1,190 US Bancorp 5.10 07/15/07 1,251,890
740 US Bank NA 2.85 11/15/06 744,679
----------------
1,996,569
----------------
SAVINGS BANKS (0.2%)
1,015 Washington Mutual Inc. 8.25 04/01/10 1,194,637
----------------
TOBACCO (0.2%)
600 Altria Group Inc. 5.625 11/04/08 616,519
450 Philip Morris Companies, Inc. 7.65 07/01/08 497,122
----------------
1,113,641
----------------
TOTAL CORPORATE BONDS
(COST $171,763,041) 172,119,105
----------------
U.S. GOVERNMENT & AGENCIES (43.8%)
MORTGAGE PASS-THROUGH SECURITIES (24.7%)
5,575 Federal Home Loan Mortgage Corp.
PC Gold 6.50 03/01/26 - 02/01/33 5,808,398
2,326 Federal Home Loan Mortgage Corp. 7.50 10/01/26 - 08/01/32 2,499,352
2,800 Federal Home Loan Mortgage Corp. 7.50 *** 3,008,250
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
14
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------
$ 4,872 Federal Home Loan Mortgage Corp.
PC Gold 7.50% 01/01/30 - 12/01/32 $ 5,235,376
46,360 Federal National Mortgage Corp. 6.50 02/01/28 - 03/01/33 48,274,607
26,975 Federal National Mortgage Corp. 7.00 *** 28,526,063
1,093 Federal National Mortgage Corp. 7.00 02/01/30 - 05/01/34 1,155,477
17,856 Federal National Mortgage Corp. 7.50 09/01/29 - 05/01/33 19,105,875
2,485 Government National Mortgage Assoc. 3.50 08/20/29 2,517,080
1,054 Government National Mortgage Assoc. 4.00 09/20/29 1,062,434
2,660 Government National Mortgage Assoc. 4.375 06/20/22 - 05/20/23 2,689,091
630 Government National Mortgage Assoc. 4.625 10/20/24 - 12/20/24 646,156
----------------
120,528,159
----------------
U.S. GOVERNMENT & AGENCY OBLIGATIONS (19.1%)
50,160 Federal Home Loan Mortgage Corp. 2.75 08/15/06 50,280,434
42,000 U.S. Treasury Note 7.25 - 7.875 08/15/04 - 11/15/04 43,119,741
----------------
93,400,175
----------------
TOTAL U.S. GOVERNMENT & AGENCIES
(COST $214,011,107) 213,928,334
----------------
FOREIGN GOVERNMENT OBLIGATIONS (1.3%)
935 Quebec Province (Canada) 5.50 04/11/06 988,966
1,285 Quebec Province (Canada) 6.125 01/22/11 1,404,817
2,640 United Mexican States (Mexico) 8.375 01/14/11 3,042,600
945 United Mexican States (Mexico) 8.625 03/12/08 1,089,113
----------------
TOTAL FOREIGN GOVERNMENT OBLIGATIONS
(COST $6,553,782) 6,525,496
----------------
ASSET BACKED SECURITIES (20.1%)
FINANCE/RENTAL/LEASING
2,100 American Express Credit Account 5.53 10/15/08 2,219,021
2,600 American Express Credit Account
Master Trust 2003-4 A 1.69 01/15/09 2,547,506
2,000 Americredit Automobile Receivables
Trust 2004 - BM 2.07 08/06/08 1,975,961
2,200 Bank One Issuance Trust 2002-A4 2.94 06/16/08 2,223,986
1,150 BMW Vehicle Owner Trust 2002-2A4 4.46 05/25/07 1,178,586
1,200 Capital Auto Receivables Asset
Trust 2002-2A 4.50 10/15/07 1,231,514
1,500 Capital Auto Receivables Asset
Trust 2002-3A 3.58 10/16/06 1,529,126
2,700 Chase Credit Card Master Trust 5.50 11/17/08 2,864,694
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
15
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------
$ 1,400 Chase Manhattan Auto Owner Trust 2002A 4.21% 01/15/09 $ 1,437,791
1,100 Chase Manhattan Auto Owner Trust 2002A 4.24 09/15/08 1,128,644
4,000 Chase Manhattan Auto Owner
Trust 2003-C A4 2.94 06/15/10 3,972,960
3,600 Chase Manhattan Auto Owner
Trust 2003-C A4 2.83 09/15/10 3,538,707
2,275 Citibank Credit Card Issuance Trust 2002A 4.40 05/15/07 2,336,004
2,200 Citibank Credit Card Issuance
Trust 2000-A1 6.90 10/15/07 2,347,849
1,700 Citibank Credit Card Issuance
Trust 2003-A2 2.70 01/15/08 1,708,359
504 Connecticut RRB Special Purpose
Trust CL&P-1 5.36 03/30/07 514,997
1,200 Daimler Chrysler Auto Trust 2002-A A4 4.49 10/06/08 1,232,804
2,650 Daimler Chrysler Auto Trust 2002-C A4 3.09 01/08/08 2,676,085
2,600 Daimler Chrysler Auto Trust 2003-B A4 2.86 03/09/09 2,586,422
3,700 Daimler Chrysler Auto Trust 2004-A A4 2.58 04/08/09 3,639,024
2,500 Fleet Credit Card Master Trust II 2002-C 2.75 04/15/08 2,520,449
489 Ford Credit Auto Owner Trust 2002-B A3A 4.14 12/15/05 493,567
375 Ford Credit Auto Owner Trust 2002-B A4 4.75 08/15/06 386,626
2,250 Ford Credit Auto Owner Trust 2002-C A4 3.79 09/15/06 2,295,861
2,000 Ford Credit Auto Owner Trust 2002-D 3.13 11/15/06 2,027,681
1,400 Harley-Davidson Motorcycle Trust 2002-1 3.09 06/15/10 1,418,767
1,800 Harley-Davidson Motorcycle
Trust 2002-1 A2 4.50 01/15/10 1,859,305
3,300 Harley-Davidson Motorcycle Trust 2003 2.76 05/15/11 3,296,113
1,500 Harley-Davidson Motorcycle Trust 2003-1 2.63 11/15/10 1,505,671
319 Honda Auto Receivables Owner
Trust 2002-1 3.50 10/17/05 321,176
2,150 Honda Auto Receivables Owner
Trust 2002-2 A4 4.49 09/17/07 2,211,548
1,500 Honda Auto Receivables Owner
Trust 2002-4 2.70 03/17/08 1,504,437
2,000 Honda Auto Receivables Owner
Trust 2003-1 2.48 07/18/08 1,999,401
3,800 Honda Auto Receivables Owner
Trust 2001-3 A2 2.77 11/21/08 3,788,153
387 Household Automotive Trust 2001-3 A3 3.68 04/17/06 389,389
1,100 Hyundai Auto Receivables Trust 2003-A 2.33 11/15/07 1,098,074
1,000 MBNA Credit Card Master Trust 1997-JA 3.90 11/15/07 1,022,372
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
16
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------
$ 3,500 MBNA Credit Card Master
Trust 2004-A4 A4 2.70% 09/15/09 $ 3,449,565
1,450 MBNA Master Credit Card Trust 1997-J A 1.22 02/15/07 1,451,571
709 National City Auto Trust 2002-A 4.04 07/15/06 714,865
444 Nissan Auto Receivables Owner
Trust 2001-C 4.80 02/15/07 450,360
267 Nissan Auto Receivables Owner
Trust 2002-A A3 3.58 09/15/05 267,971
900 Nissan Auto Receivables Owner
Trust 2002 B 4.60 09/17/07 924,835
3,500 Nissan Auto Receivables Owner
Trust 2003-A A4 2.61 07/15/08 3,490,251
2,900 Nissan Auto Receivables Owner
Trust 2004-A A4 2.76 07/15/09 2,848,744
650 Nordstrom Private Label Credit Card
Master Trust 2001-1A A - 144A* 4.82 04/15/10 678,036
3,700 USAA Auto Owner Trust 2004-1 A4 2.67 10/15/10 3,639,459
2,437 Volkswagen Auto Lease Trust 2002-A 2.36 12/20/05 2,448,635
3,000 William Street Funding
Corp. 2003-1 A - 144A* 1.42 04/23/06 3,005,884
4,000 Whole Auto Loan Trust 2003-1 A4 2.58 03/15/10 3,960,218
----------------
ASSET BACKED SECURITIES
(COST $98,642,272) 98,359,024
----------------
COLLATERALIZED MORTGAGE OBLIGATIONS (4.0%)
U.S. GOVERNMENT AGENCIES
3,011 Federal Home Loan Mortgage Corp. 3.50 11/15/32 3,037,807
3,600 Federal Home Loan Mortgage Corp. 5.50 02/15/12 3,699,162
523 Federal Home Loan Mortgage Corp. 6.50 03/15/28 522,720
2,186 Federal National Mortgage Assoc. 5.00 09/25/12 2,193,999
9,779 Federal National Mortgage Assoc. 5.50 07/25/16 10,028,252
----------------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS
(COST $19,510,502) 19,481,940
----------------
SHORT-TERM INVESTMENTS (1.9%)
U.S. GOVERNMENT OBLIGATIONS (a) (0.3%)
1,450 U.S. Treasury Bill**
(COST $1,444,672) 0.945 - 0.98 07/15/04 - 09/23/04 1,444,735
----------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
17
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------------------
REPURCHASE AGREEMENT (1.6%)
$ 7,836 Joint repurchase agreement account
(dated 04/30/04; proceeds $7,836,669) (b)
(COST $7,836,000) 1.025% 05/03/04 $ 7,836,000
----------------
TOTAL SHORT-TERM INVESTMENTS
(COST $9,280,672) 9,280,735
----------------
TOTAL INVESTMENTS
(COST $519,761,376) (c) (d) 106.4% 519,694,634
LIABILITIES IN EXCESS OF OTHER ASSETS (6.4) (31,285,988)
----- ----------------
NET ASSETS 100.0% $ 488,408,646
===== ================
</Table>
- ----------
PC PARTICIPATION CERTIFICATE.
* RESALE IS RESTRICTED TO QUALIFIED INSTITUTIONAL INVESTORS.
** THESE SECURITIES HAVE BEEN PHYSICALLY SEGREGATED IN CONNECTION WITH OPEN
FUTURES CONTRACTS IN THE AMOUNT OF $1,060,375.
*** SECURITY PURCHASED ON A FORWARD COMMITMENT BASIS WITH AN APPROXIMATE
PRINCIPAL AMOUNT AND NO DEFINITE MATURITY DATE; THE ACTUAL PRINCIPAL
AMOUNT AND MATURITY DATE WILL BE DETERMINED UPON SETTLEMENT.
(a) PURCHASED ON A DISCOUNT BASIS. THE INTEREST RATE SHOWN HAS BEEN ADJUSTED
TO REFLECT A MONEY MARKET EQUIVALENT YIELD.
(b) COLLATERALIZED BY FEDERAL AGENCY AND U.S. TREASURY OBLIGATIONS.
(c) SECURITIES HAVE BEEN DESIGNATED AS COLLATERAL IN AN AMOUNT EQUAL TO
$155,100,721 IN CONNECTION WITH SECURITIES PURCHASED ON A FORWARD
COMMITMENT BASIS AND OPEN FUTURES CONTRACTS.
(d) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES IS $524,278,049. THE
AGGREGATE GROSS UNREALIZED APPRECIATION IS $2,627,202 AND THE AGGREGATE
GROSS UNREALIZED DEPRECIATION IS $7,210,617, RESULTING IN NET UNREALIZED
DEPRECIATION OF $4,583,415.
FUTURES CONTRACTS OPEN AT APRIL 30, 2004:
<Table>
<Caption>
UNREALIZED
NUMBER OF DESCRIPTION, DELIVERY UNDERLYING FACE APPRECIATION
CONTRACTS LONG/SHORT MONTH AND YEAR AMOUNT AT VALUE (DEPRECIATION)
- -----------------------------------------------------------------------------------------------------------------
32 Long U.S. Treasury Notes 2 Year, $ 6,801,500 $ (37,462)
June 2004
867 Short U.S. Treasury Notes 5 Year, (95,315,813) 1,527,085
June 2004
184 Short U.S. Treasury Notes 10 Year, (20,332,000) 465,086
June 2004
--------------
Net unrealized appreciation $ 1,954,709
==============
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
18
<Page>
MORGAN STANLEY LIMITED DURATION FUND
FINANCIAL STATEMENTS
STATEMENT OF ASSETS AND LIABILITIES
APRIL 30, 2004
<Table>
ASSETS:
Investments in securities, at value (cost $519,761,376) $ 519,694,634
Receivable for:
Interest 4,842,253
Shares of beneficial interest sold 1,472,411
Prepaid expenses and other assets 13,676
---------------
TOTAL ASSETS 526,022,974
---------------
LIABILITIES:
Payable for:
Investments purchased 35,926,085
Shares of beneficial interest redeemed 975,380
Investment management fee 288,147
Variation margin 231,479
Dividends to shareholders 109,829
Accrued expenses and other payables 83,408
---------------
TOTAL LIABILITIES 37,614,328
---------------
NET ASSETS $ 488,408,646
===============
COMPOSITION OF NET ASSETS:
Paid-in-capital $ 504,807,745
Net unrealized appreciation 1,887,967
Dividends in excess of net investment income (4,536,830)
Accumulated net realized loss (13,750,236)
---------------
NET ASSETS $ 488,408,646
===============
NET ASSET VALUE PER SHARE,
51,919,867 SHARES OUTSTANDING
(UNLIMITED SHARES AUTHORIZED OF $.01 PAR VALUE) $ 9.41
===============
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
19
<Page>
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED APRIL 30, 2004
<Table>
NET INVESTMENT INCOME:
INTEREST INCOME $ 13,500,178
---------------
EXPENSES
Investment management fee 3,645,583
Transfer agent fees and expenses 420,952
Registration fees 106,740
Custodian fees 75,873
Professional fees 74,908
Shareholder reports and notices 64,383
Trustees' fees and expenses 6,967
Other 19,112
---------------
TOTAL EXPENSES 4,414,518
Less: expense offset (75,873)
---------------
NET EXPENSES 4,338,645
---------------
NET INVESTMENT INCOME 9,161,533
---------------
NET REALIZED AND UNREALIZED GAIN (LOSS):
NET REALIZED GAIN (LOSS) ON:
Investments 2,139,416
Futures contracts (2,729,971)
---------------
NET REALIZED LOSS (590,555)
---------------
NET CHANGE IN UNREALIZED APPRECIATION/DEPRECIATION ON:
Investments (5,293,365)
Futures contracts 2,052,155
---------------
NET DEPRECIATION (3,241,210)
---------------
NET LOSS (3,831,765)
---------------
NET INCREASE $ 5,329,768
===============
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
20
<Page>
STATEMENT OF CHANGES IN NET ASSETS
<Table>
<Caption>
FOR THE YEAR FOR THE YEAR
ENDED ENDED
APRIL 30, 2004 APRIL 30, 2003
--------------- ---------------
INCREASE (DECREASE) IN NET ASSETS:
OPERATIONS:
Net investment income $ 9,161,533 $ 5,564,650
Net realized gain (loss) (590,555) 268,000
Net change in unrealized appreciation (3,241,210) 4,152,716
--------------- ---------------
NET INCREASE 5,329,768 9,985,366
Dividends to shareholders from net investment income (19,730,822) (8,187,421)
Net increase from transactions in shares of beneficial interest 73,400,520 260,980,399
--------------- ---------------
NET INCREASE 58,999,466 262,778,344
NET ASSETS:
Beginning of period 429,409,180 166,630,836
--------------- ---------------
END OF PERIOD
(Including dividends in excess of net investment income of
$4,536,830 and $1,194,723, respectively) $ 488,408,646 $ 429,409,180
=============== ===============
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
21
<Page>
MORGAN STANLEY LIMITED DURATION FUND
NOTES TO FINANCIAL STATEMENTS - APRIL 30, 2004
1. ORGANIZATION AND ACCOUNTING POLICIES
Morgan Stanley Limited Duration Fund (the "Fund") is registered under the
Investment Company Act of 1940, as amended, as a diversified, open-end
management investment company. The Fund's investment objective is to provide a
high level of current income consistent with the preservation of capital. The
Fund was organized as a Massachusetts business trust on October 22, 1993 and
commenced operations on January 10, 1994.
The following is a summary of significant accounting policies:
A. VALUATION OF INVESTMENTS -- (1) certain portfolio securities may be valued by
an outside pricing service approved by the Fund's Trustees (2) portfolio
securities for which over-the-counter market quotations are readily available
are valued at the mean between the last reported bid and asked price; (3)
futures are valued at the latest price published by the commodities exchange on
which they trade; (4) when market quotations are not readily available or Morgan
Stanley Investment Advisors Inc. (the "Investment Manager") determines that the
market quotations are not reflective of a security's market value, portfolio
securities are valued at their fair value as determined in good faith under
procedures established by and under the general supervision of the Fund's
Trustees; 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.
Discounts are accreted and premiums are amortized over the life of the
respective securities. Interest income is accrued daily.
C. REPURCHASE AGREEMENTS -- Pursuant to an Exemptive Order issued by the
Securities and Exchange Commission, the Fund, along with other affiliated
entities managed by the Investment 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, U.S. Treasury or federal agency obligations. The Fund may also invest
directly with institutions in repurchase agreements. The Fund's custodian
receives the collateral, which is marked-to-market daily to determine that the
value of the collateral does not decrease below the repurchase price plus
accrued interest.
D. FUTURES CONTRACTS -- A futures contract is an agreement between two parties
to buy and sell financial instruments or contracts based on financial indices at
a set price on a future date. Upon entering into such a contract, the Fund is
required to pledge to the broker cash, U.S. Government securities or other
liquid portfolio securities equal to the minimum initial margin requirements of
the
22
<Page>
applicable futures exchange. Pursuant to the contract, the Fund agrees to
receive from or pay to the broker an amount of cash equal to the daily
fluctuation in the value of the contract. Such receipts or payments known as
variation margin are recorded by the Fund as unrealized gains and losses. Upon
closing of the contract, the Fund realizes a gain or loss equal to the
difference between the value of the contract at the time it was opened and the
value at the time it was closed.
E. FEDERAL INCOME TAX POLICY -- It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute substantially all of its taxable income to its
shareholders. Accordingly, no federal income tax provision is required.
F. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- Dividends and distributions to
shareholders are recorded on the ex-dividend date.
G. USE OF ESTIMATES -- The preparation of financial statements in accordance
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts and disclosures.
Actual results could differ from those estimates.
2. INVESTMENT MANAGEMENT AGREEMENT
Pursuant to an Investment Management Agreement, the Fund pays the Investment
Manager a management fee, accrued daily and payable monthly, by applying the
annual rate of 0.70% to the net assets of the Fund determined as of the close of
each business day. Effective May 1, 2004, the agreement was amended to reduce
the annual rate as follows: 0.60% to the portion of the daily net assets not
exceeding $1 billion; 0.55% to the portion of daily net assets exceeding $1
billion but not exceeding $2 billion and 0.50% of the portion of daily net
assets exceeding $2 billion.
3. SECURITY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES
The cost of purchases and proceeds from sales/prepayments of portfolio
securities, excluding short-term investments, for the year ended April 30, 2004
were $1,482,663,846, and $1,312,562,178, respectively. Included in the
aforementioned are purchases and sales/prepayments of U.S. Government securities
of $1,291,448,764 and $1,291,670,674, respectively.
Morgan Stanley Trust, an affiliate of the Investment Manager, is the Fund's
transfer agent. At April 30, 2004, the Fund had transfer agent fees and expenses
payable of approximately $2,900.
Effective April 1, 2004, the Fund began an unfunded Deferred Compensation Plan
(the "Compensation Plan"), which allows each independent Trustee to defer
payment of all, or a portion, of the fees he receives for serving on the Board
of Trustees. Each eligible Trustee generally may elect to have the deferred
amounts credited with a return equal to the total return on one or more of the
Morgan Stanley
23
<Page>
funds that are offered as investment options under the Compensation Plan.
Appreciation/depreciation and distributions received from these investments are
recorded with an offsetting increase/decrease in the deferred compensation
obligation and do not affect the net asset value of the Fund.
4. SHARES OF BENEFICIAL INTEREST
Transactions in shares of beneficial interest were as follows:
<Table>
<Caption>
FOR THE YEAR FOR THE YEAR
ENDED ENDED
APRIL 30, 2004 APRIL 30, 2003
-------------------------------- --------------------------------
SHARES AMOUNT SHARES AMOUNT
------------- --------------- ------------- ---------------
Sold 48,705,797 $ 466,638,947 42,201,034 $ 407,738,435
Shares issued in connection with the acquisition
of Morgan Stanley North American Government
Income Trust -- -- 7,879,235 76,281,762
Reinvestment of dividends 1,560,045 14,878,957 631,058 6,098,602
------------- --------------- ------------- ---------------
50,265,842 481,517,904 50,711,327 490,118,799
Redeemed (42,728,082) (408,117,384) (23,709,068) (229,138,400)
------------- --------------- ------------- ---------------
Net increase 7,537,760 $ 73,400,520 27,002,259 $ 260,980,399
============= =============== ============= ===============
</Table>
5. FEDERAL INCOME TAX STATUS
The amount of dividends and distributions from net investment income and net
realized capital gains are determined in accordance with federal income tax
regulations which may differ from generally accepted accounting principles.
These "book/tax" differences are either considered temporary or permanent in
nature. To the extent these differences are permanent in nature, such amounts
are reclassified within the capital accounts based on their federal tax-basis
treatment; temporary differences do not require reclassification. Dividends and
distributions which exceed net investment income and net realized capital gains
for tax purposes are reported as distributions of paid-in-capital.
The tax character of distributions paid was as follows:
<Table>
<Caption>
FOR THE YEAR FOR THE YEAR
ENDED ENDED
APRIL 30, 2004 APRIL 30, 2003
-------------- --------------
Ordinary income $ 19,690,002 $ 8,187,421
</Table>
24
<Page>
As of April 30, 2004, the tax-basis components of accumulated losses were as
follows:
<Table>
Undistributed ordinary income $ 89,672
Undistributed long-term gains -
---------------
Net accumulated earnings 89,672
Capital loss carryforward* (7,680,764)
Post-October losses (4,114,763)
Temporary differences (109,829)
Net unrealized depreciation (4,583,415)
---------------
Total accumulated losses $ (16,399,099)
===============
</Table>
* As of April 30, 2004, the Fund had a net capital loss carryforward of
$7,680,764 of which $151,743 will expire on April 30, 2005, $1,656,930 will
expire on April 30, 2006, $20,504 will expire on April 30, 2007, $51,242 will
expire on April 30, 2008, $2,035,052 will expire on April 30, 2009, $1,582,163
will expire on April 30, 2011 and $2,183,130 will expire on April 30, 2012 to
offset future capital gains to the extent provided by regulations.
As part of the Fund's acquisition of the assets of Morgan Stanley North American
Government Income Trust ("North American"), the Fund obtained a net capital loss
carryforward of $18,760,440 from North American. Utilization of this
carryforward is subject to limitations imposed by the Internal Revenue Code and
Treasury Regulations, reducing the total carryforward available.
As of April 30, 2004, the Fund had temporary book/tax differences primarily
attributable to post-October losses (capital losses incurred after October 31
within the taxable year which are deemed to arise on the first business day of
the Fund's next taxable year), and book amortization of premiums on debt
securities and permanent book/tax differences primarily attributable to losses
on paydowns, tax adjustments on debt securities sold by the Fund and an expired
capital loss carryforward. To reflect reclassifications arising from the
permanent differences, paid-in-capital was charged $2,021,602, accumulated net
realized loss was charged $5,205,580 and dividends in excess of net investment
income was credited $7,227,182.
6. PURPOSES OF AND RISKS RELATING TO CERTAIN FINANCIAL INSTRUMENTS
To hedge against adverse interest rate and market risks on portfolio positions
or anticipated positions in U.S. Government securities, the Fund may enter into
interest rate futures contracts ("futures contracts").
These futures contracts involve elements of market risk in excess of the amount
reflected in the Statement and Assets and Liabilities. The Fund bears the risk
of an unfavorable change in the value of the underlying securities. Risks may
also arise upon entering into these contracts from the potential inability of
the counterparties to meet the terms of their contracts.
25
<Page>
7. EXPENSE OFFSET
The expense offset represents a reduction of the custodian fees for earnings on
cash balances maintained by the Fund.
8. ACQUISITION OF MORGAN STANLEY NORTH AMERICAN GOVERNMENT
On November 4, 2002, the Fund acquired all the net assets of Morgan Stanley
North American Government Income Trust ("North American") based on the
respective valuations as of the close of business on November 1, 2002, pursuant
to a plan of reorganization approved by the shareholders of North American on
October 23, 2002. The acquisition was accomplished by a tax-free exchange of
7,879,235 shares of the Fund at a net asset value of $9.68 per share for
8,837,891 shares of North American. The net assets of the Fund and North
American immediately before the acquisition were $273,925,042 and $76,281,762,
respectively, including unrealized appreciation of $982,393 for North American.
Immediately after the acquisition, the combined net assets of the Fund amounted
to $350,206,804.
9. LEGAL MATTERS
The Investment Manager, certain affiliates of the Investment Manager, certain
officers of such affiliates and certain investment companies advised by the
Investment Manager or its affiliates, including the Fund, are named as
defendants in a number of similar class action complaints which were recently
consolidated. This consolidated action also names as defendants certain
individual Trustees and Directors of the Morgan Stanley funds. The consolidated
amended complaint generally alleges that defendants, including the Fund,
violated their statutory disclosure obligations and fiduciary duties by failing
properly to disclose (i) that the Investment Manager and certain affiliates of
the Investment Manager allegedly offered economic incentives to brokers and
others to recommend the funds advised by the Investment Manager or its
affiliates to investors rather than funds managed by other companies, and (ii)
that the funds advised by the Investment Manager or its affiliates, including
the Fund, allegedly paid excessive commissions to brokers in return for their
efforts to recommend these funds to investors. The complaint seeks, among other
things, unspecified compensatory damages, rescissionary damages, fees and costs.
The defendants intend to move to dismiss the action and otherwise vigorously to
defend it. While the Fund believes that it has meritorious defenses, the
ultimate outcome of this matter is not presently determinable at this early
stage of the litigation, and no provision has been made in the Fund's financial
statements for the effect, if any, of this matter.
26
<Page>
MORGAN STANLEY LIMITED DURATION FUND
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of beneficial interest
outstanding throughout each period:
<Table>
<Caption>
FOR THE YEAR ENDED APRIL 30,
-------------------------------------------------------------------------------
2004 2003 2002 2001 2000
----------- ----------- ----------- ----------- -----------
SELECTED PER SHARE DATA:
Net asset value, beginning of period $ 9.68 $ 9.59 $ 9.44 $ 9.20 $ 9.49
----------- ----------- ----------- ----------- -----------
Income (loss) from investment operations:
Net investment income 0.17 0.24 0.41 0.55 0.51
Net realized and unrealized gain (loss) (0.07) 0.13 0.19 0.24 (0.29)
----------- ----------- ----------- ----------- -----------
Total income from investment
operations 0.10 0.37 0.60 0.79 0.22
----------- ----------- ----------- ----------- -----------
Less dividends from net investment
income: (0.37) (0.28) (0.45) (0.55) (0.51)
----------- ----------- ----------- ----------- -----------
Net asset value, end of period $ 9.41 $ 9.68 $ 9.59 $ 9.44 $ 9.20
=========== =========== =========== =========== ===========
TOTAL RETURN+ 0.99% 3.93% 6.50% 8.82% 2.36%
RATIOS TO AVERAGE NET ASSETS:
Expenses 0.85%(1) 0.84%(2) 0.80%(2) 0.80%(2) 0.80%(2)
Net investment income 1.75% 1.90% 3.94% 5.87% 5.43%
SUPPLEMENTAL DATA:
Net assets, end of period, in thousands $ 488,409 $ 429,409 $ 166,631 $ 109,917 $ 118,694
Portfolio turnover rate 240% 217% 327% 133% 71%
</Table>
- ----------
+ CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE
PERIOD.
(1) DOES NOT REFLECT THE EFFECT OF EXPENSE OFFSET OF 0.01%.
(2) IF THE FUND HAD BORNE ALL EXPENSES THAT WERE ASSUMED OR WAIVED BY THE
INVESTMENT MANAGER, THE ANNUALIZED EXPENSE AND NET INVESTMENT INCOME RATIOS
WOULD HAVE BEEN AS FOLLOWS:
<Table>
<Caption>
NET INVESTMENT
PERIOD ENDED EXPENSE RATIO INCOME RATIO
------------------------------------ ------------- --------------
April 30, 2003 0.87% 1.86%
April 30, 2002 0.92% 3.82%
April 30, 2001 0.92% 5.75%
April 30, 2000 0.90% 5.33%
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
27
<Page>
MORGAN STANLEY LIMITED DURATION FUND
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE SHAREHOLDERS AND BOARD OF
TRUSTEES OF MORGAN STANLEY LIMITED DURATION FUND:
We have audited the accompanying statement of assets and liabilities of Morgan
Stanley Limited Duration Fund (the "Fund"), including the portfolio of
investments, as of April 30, 2004, 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 the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. Our procedures included confirmation of
securities owned as of April 30, 2004, by correspondence with the custodian and
brokers. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Morgan
Stanley Limited Duration Fund as of April 30, 2004, the results of its
operations for the year then ended, the changes in its net assets for each of
the two years in the period then ended, and the financial highlights for each of
the five years in the period then ended, in conformity with accounting
principles generally accepted in the United States of America.
Deloitte & Touche LLP
NEW YORK, NEW YORK
JUNE 15, 2004
2004 FEDERAL TAX NOTICE (UNAUDITED)
Of the Fund's ordinary income dividends paid during the fiscal year
ended April 30, 2004, 36.78% 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.
28
<Page>
MORGAN STANLEY LIMITED DURATION FUND
TRUSTEE AND OFFICER INFORMATION
INDEPENDENT TRUSTEES:
<Table>
<Caption>
NUMBER OF
PORTFOLIOS
IN FUND
TERM OF COMPLEX
POSITION(S) OFFICE AND OVERSEEN
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) DURING BY OTHER DIRECTORSHIPS HELD
INDEPENDENT TRUSTEE REGISTRANT TIME SERVED* PAST 5 YEARS** TRUSTEE*** BY TRUSTEE
- ----------------------------------- ----------- ------------ ------------------------------ ---------- -----------------------------
Michael Bozic (63) Trustee Since Private Investor; Director or 208 Director of Weirton Steel
c/o Kramer Levin Naftalis & April 1994 Trustee of the Retail Funds Corporation.
Frankel LLP (since April 1994) and the
Counsel to the Independent Trustees Institutional Funds (since
919 Third Avenue July 2003); formerly Vice
New York, NY Chairman of Kmart Corporation
(December 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 (71) Trustee Since Director or Trustee of the 208 Director of Franklin Covey
c/o Summit Ventures LLC January 1993 Retail Funds (since January (time management systems),
1 Utah Center 1993) and the Institutional BMW Bank of North America,
201 S. Main Street Funds (since July 2003); Inc. (industrial loan
Salt Lake City, UT member of the Utah Regional corporation), United Space
Advisory Board of Pacific Alliance (joint venture
Corp.; formerly United States between Lockheed Martin and
Senator (R-Utah) (1974-1992) the Boeing Company) and
and Chairman, Senate Banking Nuskin Asia Pacific
Committee (1980-1986), Mayor (multilevel marketing);
of Salt Lake City, Utah member of the board of
(1971-1974), Astronaut, Space various civic and charitable
Shuttle Discovery (April organizations.
12-19, 1985), and Vice
Chairman, Huntsman Corporation
(chemical company).
Wayne E. Hedien (70) Trustee Since Retired; Director or Trustee 208 Director of The PMI Group
c/o Kramer Levin Naftalis & September of the Retail Funds (since Inc. (private mortgage
Frankel LLP 1997 September 1997) and the insurance); Trustee and Vice
Counsel to the Independent Trustees Institutional Funds (since Chairman of The Field Museum
919 Third Avenue July 2003); formerly of Natural History; director
New York, NY associated with the Allstate of various other business
Companies (1966-1994), most and charitable
recently as Chairman of The organizations.
Allstate Corporation (March
1993-December 1994) and
Chairman and Chief Executive
Officer of its wholly-owned
subsidiary, Allstate Insurance
Company (July 1989-December
1994).
</Table>
29
<Page>
<Table>
<Caption>
NUMBER OF
PORTFOLIOS
IN FUND
TERM OF COMPLEX
POSITION(S) OFFICE AND OVERSEEN
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) DURING BY OTHER DIRECTORSHIPS HELD
INDEPENDENT TRUSTEE REGISTRANT TIME SERVED* PAST 5 YEARS** TRUSTEE*** BY TRUSTEE
- ----------------------------------- ----------- ------------ ------------------------------ ---------- -----------------------------
Dr. Manuel H. Johnson (55) Trustee Since Senior Partner, Johnson 208 Director of NVR, Inc. (home
c/o Johnson Smick July 1991 Smick International, Inc., a construction); Chairman and
International, Inc. consulting firm; Chairman of Trustee of the Financial
2099 Pennsylvania Avenue, N.W. the Audit Committee and Accounting Foundation
Suite 950 Director or Trustee of the (oversight organization of
Washington, D.C. Retail Funds (since July the Financial Accounting
1991) and the Institutional Standards Board); Director
Funds (since July 2003); of RBS Greenwich Capital
Co-Chairman and a founder of Holdings (financial holding
the Group of Seven Council company).
(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.
Joseph J. Kearns (61) Trustee Since President, Kearns & 209 Director of Electro Rent
PMB754 July 2003 Associates LLC (investment Corporation (equipment
23852 Pacific Coast Highway consulting); Deputy Chairman leasing), The Ford Family
Malibu, CA of the Audit Committee and Foundation, and the UCLA
Director or Trustee of the Foundation.
Retail Funds (since July
2003) and the Institutional
Funds (since August 1994);
previously Chairman of the
Audit Committee of the
Institutional Funds (October
2001- July 2003); formerly
CFO of the J. Paul Getty
Trust.
Michael E. Nugent (67) Trustee Since General Partner of Triumph 208 Director of various business
c/o Triumph Capital, L.P. July 1991 Capital, L.P., a private organizations.
445 Park Avenue investment partnership;
New York, NY Chairman of the Insurance
Committee and Director or
Trustee of the Retail Funds
(since July 1991) and the
Institutional Funds (since
July2001); formerly Vice
President, Bankers Trust
Company and BT Capital
Corporation (1984-1988).
Fergus Reid (71) Trustee Since Chairman of Lumelite 209 Trustee and Director of
c/o Lumelite Plastics Corporation July 2003 Plastics Corporation; certain investment companies
85 Charles Colman Blvd. Chairman of the Governance in the JPMorgan Funds
Pawling, NY Committee and Director or complex managed by J.P.
Trustee of the Retail Funds Morgan Investment Management
(since July 2003) and the Inc.
Institutional Funds (since
June 1992).
</Table>
30
<Page>
INTERESTED TRUSTEES:
<Table>
<Caption>
NUMBER OF
PORTFOLIOS
IN FUND
TERM OF COMPLEX
POSITION(S) OFFICE AND OVERSEEN
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) DURING BY OTHER DIRECTORSHIPS HELD
INDEPENDENT TRUSTEE REGISTRANT TIME SERVED* PAST 5 YEARS** TRUSTEE*** BY TRUSTEE
- ----------------------------------- ----------- ------------ ------------------------------ ---------- -----------------------------
Charles A. Fiumefreddo (70) Chairman of Since Chairman and Director or 208 None
c/o Morgan Stanley Trust the Board July 1991 Trustee of the Retail Funds
Harborside Financial Center, and Trustee (since July 1991) and the
Plaza Two, Institutional Funds (since
Jersey City, NJ July 2003); formerly Chief
Executive Officer of the
Retail Funds and the TCW/DW
Term Trust 2003 (until
September 2002).
James F. Higgins (56) Trustee Since Director or Trustee of the 208 Director of AXA Financial,
c/o Morgan Stanley Trust June 2000 Retail Funds (since June Inc. and The Equitable Life
Harborside Financial Center, 2000) and the Institutional Assurance Society of the
Plaza Two, Funds (since July 2003); United States (financial
Jersey City, NJ Senior Advisor of Morgan services).
Stanley (since August 2000);
Director of the Distributor
and Dean Witter Realty Inc.;
previously President and
Chief Operating Officer of
the Private Client Group of
Morgan Stanley (May 1999-
August 2000), and President
and Chief Operating Officer
of Individual Securities of
Morgan Stanley (February
1997-May 1999).
</Table>
- ----------
* THIS IS THE EARLIEST DATE THE TRUSTEE BEGAN SERVING THE FUNDS ADVISED BY
MORGAN STANLEY INVESTMENT ADVISORS INC. (THE "INVESTMENT MANAGER ") (THE
"RETAIL FUNDS ").
** THE DATES REFERENCED BELOW INDICATING COMMENCEMENT OF SERVICES AS
DIRECTOR/TRUSTEE FOR THE RETAIL FUNDS AND THE FUNDS ADVISED BY MORGAN
STANLEY INVESTMENT MANAGEMENT INC. AND MORGAN STANLEY AIP GP LP (THE
"INSTITUTIONAL FUNDS") REFLECT THE EARLIEST DATE THE DIRECTOR/TRUSTEE BEGAN
SERVING THE RETAIL OR INSTITUTIONAL FUNDS AS APPLICABLE.
*** THE FUND COMPLEX INCLUDES ALL OPEN-END AND CLOSED-END FUNDS (INCLUDING ALL
OF THEIR PORTFOLIOS) ADVISED BY THE INVESTMENT MANAGER AND ANY FUNDS THAT
HAVE AN INVESTMENT ADVISOR THAT IS AN AFFILIATED PERSON OF THE INVESTMENT
MANAGER (INCLUDING BUT NOT LIMITED TO MORGAN STANLEY INVESTMENT MANAGEMENT
INC.).
31
<Page>
OFFICERS:
<Table>
<Caption>
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 (50) President Since May President and Chief Operating Officer of Morgan Stanley Investment
1221 Avenue of the Americas 1999 Management Inc.; President, Director and Chief Executive Officer of
New York, NY the Investment Manager and Morgan Stanley Services; Chairman and
Director of the Distributor; Chairman and Director of the Transfer
Agent; Director of various Morgan Stanley subsidiaries; President of
the Institutional Funds (since July 2003) and President of the Retail
Funds (since May 1999); Trustee (since July 2003) and President (since
December 2002) of the Van Kampen Closed-End Funds; Trustee (since May
1999) and President (since October 2002) of the Van Kampen Open-End
Funds.
Barry Fink (49) Vice Since General Counsel (since May 2000) and Managing Director (since December
1221 Avenue of the Americas President February 1997 2000) of Morgan Stanley Investment Management; Managing Director
New York, NY (since December 2000), Secretary (since February 1997) and Director
(since July 1998) of the Investment Manager and Morgan Stanley
Services; Vice President of the Retail Funds; Assistant Secretary of
Morgan Stanley DW; Vice President of the Institutional Funds (since
July 2003); Managing Director, Secretary and Director of the
Distributor; previously Secretary (February 1997-July 2003) and
General Counsel (February 1997-April 2004) of the Retail Funds; Vice
President and Assistant General Counsel of the Investment Manager and
Morgan Stanley Services (February 1997-December 2001).
Ronald E. Robison (65) Executive Since Principal Executive Officer-Office of the Funds (since November 2003);
1221 Avenue of the Americas Vice April 2003 Managing Director of Morgan Stanley & Co. Incorporated, Morgan Stanley
New York, NY President Investment Management Inc. and Morgan Stanley; Managing Director,
and Chief Administrative Officer and Director of the Investment Manager
Principal and Morgan Stanley Services; Chief Executive Officer and Director of
Executive the Transfer Agent; Managing Director and Director of the Distributor;
Officer Executive Vice President and Principal Executive Officer of the
Institutional Funds (since July 2003) and the Retail Funds (since
April 2003; Director of Morgan Stanley SICAV (since May 2004);
previously President and Director of the Institutional Funds (March
2001-July 2003) and Chief Global Operations Officer of Morgan Stanley
Investment Management Inc.
Joseph J. McAlinden (61) Vice Since July Managing Director and Chief Investment Officer of the Investment
1221 Avenue of the Americas President 1995 Manager and Morgan Stanley Investment Management Inc., Director of the
New York, NY Transfer Agent, Chief Investment Officer of the Van Kampen Funds; Vice
President of the Institutional Funds (since July 2003) and the Retail
Funds (since July 1995).
Stefanie V. Chang (37) Vice Since July Executive Director of Morgan Stanley & Co. Incorporated, Morgan
1221 Avenue of the Americas President 2003 Stanley Investment Management Inc. and the Investment Manager and Vice
New York, NY President of the Institutional Funds (since December 1997) and the
Retail Funds (since July 2003); formerly practiced law with the New
York law firm of Rogers & Wells (now Clifford Chance US LLP).
</Table>
32
<Page>
<Table>
<Caption>
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**
- --------------------------- ----------- ------------- ----------------------------------------------------------------------
Francis J. Smith (38) Treasurer Treasurer Executive Director of the Investment Manager and Morgan Stanley
c/o Morgan Stanley Trust and since July Services (since December 2001); previously Vice President of the
Harborside Financial Chief 2003 and Retail Funds (September 2002-July 2003) and the Investment Manager and
Center, Plaza Two, Financial Chief Morgan Stanley Services (August 2000-November 2001) and Senior Manager
Jersey City, NJ Officer Financial at PricewaterhouseCoopers LLP (January 1998-August 2000).
Officer
since
September
2002
Thomas F. Caloia (58) Vice Since Executive Director (since December 2002) and Assistant Treasurer of
c/o Morgan Stanley Trust President July 2003 the Investment Manager, the Distributor and Morgan Stanley Services;
Harborside Financial Center, previously Treasurer of the Retail Funds (April 1989-July 2003);
Plaza Two, formerly First Vice President of the Investment Manager, the
Jersey City, NJ Distributor and Morgan Stanley Services.
Mary E. Mullin (37) Secretary Since Executive Director of Morgan Stanley & Co. Incorporated, Morgan
1221 Avenue of the Americas July 2003 Stanley Investment Management Inc. and The Investment Manager;
New York, NY Secretary of the Institutional Funds (since June 1999) and the Retail
Funds (since July 2003); formerly practiced law with the New York law
firms of McDermott, Will & Emery and Skadden, Arps, Slate, Meagher &
Flom LLP.
</Table>
- ----------
* THIS IS THE EARLIEST DATE THE OFFICER BEGAN SERVING THE RETAIL FUNDS. EACH
OFFICER SERVES AN INDEFINITE TERM, UNTIL HIS OR HER SUCCESSOR IS ELECTED.
** THE DATES REFERENCED BELOW INDICATING COMMENCEMENT OF SERVICE AS AN OFFICER
FOR THE RETAIL AND INSTITUTIONAL FUNDS REFLECT THE EARLIEST DATE THE
OFFICER BEGAN SERVING THE RETAIL OR INSTITUTIONAL FUNDS AS APPLICABLE.
33
<Page>
(This page has been left blank intentionally.)
<Page>
(This page has been left blank intentionally.)
<Page>
TRUSTEES
Michael Bozic
Charles A. Fiumefreddo
Edwin J. Garn
Wayne E. Hedien
James F. Higgins
Dr. Manuel H. Johnson
Joseph J. Kearns
Michael E. Nugent
Fergus Reid
OFFICERS
Charles A. Fiumefreddo
CHAIRMAN OF THE BOARD
Mitchell M. Merin
PRESIDENT
Ronald E. Robison
EXECUTIVE VICE PRESIDENT and PRINCIPAL EXECUTIVE OFFICER
Barry Fink
VICE PRESIDENT
Joseph J. McAlinden
VICE PRESIDENT
Stefanie V. Chang
VICE PRESIDENT
Francis J. Smith
TREASURER and CHIEF FINANCIAL OFFICER
Thomas F. Caloia
VICE PRESIDENT
Mary E. Mullin
SECRETARY
TRANSFER AGENT
Morgan Stanley Trust
Harborside Financial Center, Plaza Two
Jersey City, New Jersey 07311
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP
Two World Financial Center
New York, New York 10281
INVESTMENT 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 Distributors Inc., member NASD.
(C) 2004 Morgan Stanley
[MORGAN STANLEY LOGO]
[GRAPHIC]
MORGAN STANLEY FUNDS
MORGAN STANLEY
LIMITED DURATION FUND
ANNUAL REPORT
APRIL 30, 2004
[MORGAN STANLEY LOGO]
37880RPT-RA04-00246P-Y04/04
<Page>
Item 2. Code of Ethics.
(a) The Fund has adopted a code of ethics (the "Code of Ethics") that applies to
its principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar functions,
regardless of whether these individuals are employed by the Fund or a third
party.
(b) No information need be disclosed pursuant to this paragraph.
(c) Not applicable.
(d) Not applicable.
(e) Not applicable.
(f)
(1) The Fund's Code of Ethics is attached hereto as Exhibit A.
(2) Not applicable.
(3) Not applicable.
Item 3. Audit Committee Financial Expert.
The Fund's Board of Trustees has determined that it has two "audit committee
financial experts" serving on its audit committee, each of whom are
"independent" Trustees: Dr. Manuel H. Johnson and Joseph J. Kearns. Under
applicable securities laws, a person who is determined to be an audit committee
financial expert will not be deemed an "expert" for any purpose, including
without limitation for the purposes of Section 11 of the Securities Act of 1933,
as a result of being designated or identified as an audit committee financial
expert. The designation or identification of a person as an audit committee
financial expert does not impose on such person any duties, obligations, or
liabilities that are greater than the duties, obligations, and liabilities
imposed on such person as a member of the audit committee and Board of Trustees
in the absence of such designation or identification.
<Page>
Item 4. Principal Accountant Fees and Services.
(a)(b)(c)(d) and (g). Based on fees billed for the periods shown:
2004
<Table>
<Caption>
REGISTRANT COVERED ENTITIES(1)
AUDIT FEES $ 32,170 N/A
NON-AUDIT FEES
AUDIT-RELATED FEES $ 684(2) $ 3,364,576(2)
TAX FEES $ 5,888(3) $ 652,431(4)
ALL OTHER FEES $ -- $ --
TOTAL NON-AUDIT FEES $ 6,572 $ 4,017,007
TOTAL $ 38,742 $ 4,017,007
</Table>
2003
<Table>
<Caption>
REGISTRANT COVERED ENTITIES(1)
AUDIT FEES $ 32,853 N/A
NON-AUDIT FEES
AUDIT-RELATED FEES $ 657(2) $ 2,620,902(2)
TAX FEES $ 6,045(3) $ 302,377(4)
ALL OTHER FEES $ -- $ 423,095(5)
TOTAL NON-AUDIT FEES $ 6,702 $ 3,346,374
TOTAL $ 39,555 $ 3,346,374
</Table>
N/A- Not applicable, as not required by Item 4.
(1) Covered Entities include the Adviser (excluding sub-advisors) and
any entity controlling, controlled by or under common control with
the Adviser that provides ongoing services to the Registrant.
(2) Audit-Related Fees represent assurance and related services
provided that are reasonably related to the performance of the
audit of the financial statements of the Covered Entities' and
funds advised by the Adviser or its affiliates, specifically data
verification and agreed-upon procedures related to asset
securitizations and agreed-upon procedures engagements.
(3) Tax Fees represent tax compliance, tax planning and tax advice
services provided in connection with the preparation and review of
the Registrant's tax returns.
(4) Tax Fees represent tax compliance, tax planning and tax advice
services provided in connection with the review of Covered
Entities' tax returns.
(5) All other fees represent project management for future business
applications and improving business and operational processes.
2
<Page>
(e)(1) The audit committee's pre-approval policies and procedures are as
follows:
AUDIT COMMITTEE
AUDIT AND NON-AUDIT SERVICES
PRE-APPROVAL POLICY AND PROCEDURES
OF THE
MORGAN STANLEY RETAIL AND INSTITUTIONAL FUNDS
AS ADOPTED JULY 31, 2003(1)
1. STATEMENT OF PRINCIPLES
The Audit Committee of the Board is required to review and, in its sole
discretion, pre-approve all Covered Services to be provided by the Independent
Auditors to the Fund and Covered Entities in order to assure that services
performed by the Independent Auditors do not impair the auditor's independence
from the Fund.
The SEC has issued rules specifying the types of services that an
independent auditor may not provide to its audit client, as well as the audit
committee's administration of the engagement of the independent auditor. The
SEC's rules establish two different approaches to pre-approving services, which
the SEC considers to be equally valid. Proposed services either: may be
pre-approved without consideration of specific case-by-case services by the
Audit Committee ("GENERAL PRE-APPROVAL"); or require the specific pre-approval
of the Audit Committee or its delegate ("SPECIFIC PRE-APPROVAL"). The Audit
Committee believes that the combination of these two approaches in this Policy
will result in an effective and efficient procedure to pre-approve services
performed by the Independent Auditors. As set forth in this Policy, unless a
type of service has received general pre-approval, it will require specific
pre-approval by the Audit Committee (or by any member of the Audit Committee to
which pre-approval authority has been delegated) if it is to be provided by the
Independent Auditors. Any proposed services exceeding pre-approved cost levels
or budgeted amounts will also require specific pre-approval by the Audit
Committee.
The appendices to this Policy describe the Audit, Audit-related, Tax and
All Other services that have the general pre-approval of the Audit Committee.
The term of any general pre-approval is 12 months from the date of pre-approval,
unless the Audit Committee considers and provides a different period and states
otherwise. The Audit Committee will annually review and pre-approve the services
that may be provided by the Independent Auditors without obtaining specific
pre-approval from the Audit Committee. The Audit Committee will add to or
subtract from the list of general pre-approved services from time to time, based
on subsequent determinations.
- ----------
(1) This Audit Committee Audit and Non-Audit Services Pre-Approval Policy
and Procedures (the "POLICY"), adopted as of the date above,
supercedes and replaces all prior versions that may have been adopted
from time to time.
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The purpose of this Policy is to set forth the policy and procedures by
which the Audit Committee intends to fulfill its responsibilities. It does not
delegate the Audit Committee's responsibilities to pre-approve services
performed by the Independent Auditors to management.
The Fund's Independent Auditors have reviewed this Policy and believes that
implementation of the Policy will not adversely affect the Independent Auditors'
independence.
2. DELEGATION
As provided in the Act and the SEC's rules, the Audit Committee may
delegate either type of pre-approval authority to one or more of its members.
The member to whom such authority is delegated must report, for informational
purposes only, any pre-approval decisions to the Audit Committee at its next
scheduled meeting.
3. AUDIT SERVICES
The annual Audit services engagement terms and fees are subject to the
specific pre-approval of the Audit Committee. Audit services include the annual
financial statement audit and other procedures required to be performed by the
Independent Auditors to be able to form an opinion on the Fund's financial
statements. These other procedures include information systems and procedural
reviews and testing performed in order to understand and place reliance on the
systems of internal control, and consultations relating to the audit. The Audit
Committee will approve, if necessary, any changes in terms, conditions and fees
resulting from changes in audit scope, Fund structure or other items.
In addition to the annual Audit services engagement approved by the Audit
Committee, the Audit Committee may grant general pre-approval to other Audit
services, which are those services that only the Independent Auditors reasonably
can provide. Other Audit services may include statutory audits and services
associated with SEC registration statements (on Forms N-1A, N-2, N-3, N-4,
etc.), periodic reports and other documents filed with the SEC or other
documents issued in connection with securities offerings.
The Audit Committee has pre-approved the Audit services in Appendix B.1.
All other Audit services not listed in Appendix B.1 must be specifically
pre-approved by the Audit Committee (or by any member of the Audit Committee to
which pre-approval has been delegated).
4. AUDIT-RELATED SERVICES
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Audit-related services are assurance and related services that are
reasonably related to the performance of the audit or review of the Fund's
financial statements and, to the extent they are Covered Services, the Covered
Entities or that are traditionally performed by the Independent Auditors.
Because the Audit Committee believes that the provision of Audit-related
services does not impair the independence of the auditor and is consistent with
the SEC's rules on auditor independence, the Audit Committee may grant general
pre-approval to Audit-related services. Audit-related services include, among
others, accounting consultations related to accounting, financial reporting or
disclosure matters not classified as "Audit services"; assistance with
understanding and implementing new accounting and financial reporting guidance
from rulemaking authorities; agreed-upon or expanded audit procedures related to
accounting and/or billing records required to respond to or comply with
financial, accounting or regulatory reporting matters; and assistance with
internal control reporting requirements under Forms N-SAR and/or N-CSR.
The Audit Committee has pre-approved the Audit-related services in Appendix
B.2. All other Audit-related services not listed in Appendix B.2 must be
specifically pre-approved by the Audit Committee (or by any member of the Audit
Committee to which pre-approval has been delegated).
5. TAX SERVICES
The Audit Committee believes that the Independent Auditors can provide Tax
services to the Fund and, to the extent they are Covered Services, the Covered
Entities, such as tax compliance, tax planning and tax advice without impairing
the auditor's independence, and the SEC has stated that the Independent Auditors
may provide such services.
Pursuant to the preceding paragraph, the Audit Committee has pre-approved
the Tax Services in Appendix B.3. All Tax services in Appendix B.3 must be
specifically pre-approved by the Audit Committee (or by any member of the Audit
Committee to which pre-approval has been delegated).
6. ALL OTHER SERVICES
The Audit Committee believes, based on the SEC's rules prohibiting the
Independent Auditors from providing specific non-audit services, that other
types of non-audit services are permitted. Accordingly, the Audit Committee
believes it may grant general pre-approval to those permissible non-audit
services classified as All Other services that it believes are routine and
recurring services, would not impair the independence of the auditor and are
consistent with the SEC's rules on auditor independence.
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The Audit Committee has pre-approved the All Other services in Appendix
B.4. Permissible All Other services not listed in Appendix B.4 must be
specifically pre-approved by the Audit Committee (or by any member of the Audit
Committee to which pre-approval has been delegated).
7. PRE-APPROVAL FEE LEVELS OR BUDGETED AMOUNTS
Pre-approval fee levels or budgeted amounts for all services to be provided
by the Independent Auditors will be established annually by the Audit Committee.
Any proposed services exceeding these levels or amounts will require specific
pre-approval by the Audit Committee. The Audit Committee is mindful of the
overall relationship of fees for audit and non-audit services in determining
whether to pre-approve any such services.
8. PROCEDURES
All requests or applications for services to be provided by the Independent
Auditors that do not require specific approval by the Audit Committee will be
submitted to the Fund's Chief Financial Officer and must include a detailed
description of the services to be rendered. The Fund's Chief Financial Officer
will determine whether such services are included within the list of services
that have received the general pre-approval of the Audit Committee. The Audit
Committee will be informed on a timely basis of any such services rendered by
the Independent Auditors. Requests or applications to provide services that
require specific approval by the Audit Committee will be submitted to the Audit
Committee by both the Independent Auditors and the Fund's Chief Financial
Officer, and must include a joint statement as to whether, in their view, the
request or application is consistent with the SEC's rules on auditor
independence.
The Audit Committee has designated the Fund's Chief Financial Officer to
monitor the performance of all services provided by the Independent Auditors and
to determine whether such services are in compliance with this Policy. The
Fund's Chief Financial Officer will report to the Audit Committee on a periodic
basis on the results of its monitoring. Both the Fund's Chief Financial Officer
and management will immediately report to the chairman of the Audit Committee
any breach of this Policy that comes to the attention of the Fund's Chief
Financial Officer or any member of management.
9. ADDITIONAL REQUIREMENTS
The Audit Committee has determined to take additional measures on an annual
basis to meet its responsibility to oversee the work of the Independent Auditors
and to assure the auditor's independence from the Fund, such as reviewing a
formal written statement from the Independent Auditors delineating all
relationships between the Independent Auditors and the Fund, consistent with
Independence Standards Board No.
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1, and discussing with the Independent Auditors its methods and procedures for
ensuring independence.
10. COVERED ENTITIES
Covered Entities include the Fund's investment adviser(s) and any entity
controlling, controlled by or under common control with the Fund's investment
adviser(s) that provides ongoing services to the Fund(s). Beginning with
non-audit service contracts entered into on or after May 6, 2003, the Fund's
audit committee must pre-approve non-audit services provided not only to the
Fund but also to the Covered Entities if the engagements relate directly to the
operations and financial reporting of the Fund. This list of Covered Entities
would include:
MORGAN STANLEY RETAIL FUNDS
---------------------------
Morgan Stanley Investment Advisors Inc.
Morgan Stanley & Co. Incorporated
Morgan Stanley DW Inc.
Morgan Stanley Investment Management
Morgan Stanley Investments LP
Van Kampen Asset Management Inc.
Morgan Stanley Services Company, Inc.
Morgan Stanley Distributors Inc.
Morgan Stanley Trust FSB
MORGAN STANLEY INSTITUTIONAL FUNDS
----------------------------------
Morgan Stanley Investment Management Inc.
Morgan Stanley Investments LP
Morgan Stanley & Co. Incorporated
Morgan Stanley Distribution, Inc.
Morgan Stanley AIP GP LP
Morgan Stanley Alternative Investment Partners LP
(e)(2) Beginning with non-audit service contracts entered into on or after May
6, 2003, the audit committee also is required to pre-approve services to Covered
Entities to the extent that the services are determined to have a direct impact
on the operations or financial reporting of the Registrant. 100% of such
services were pre-approved by the audit committee pursuant to the Audit
Committee's pre-approval policies and procedures (attached hereto).
(f) Not applicable.
(g) See table above.
(h) The audit committee of the Board of Trustees has considered whether the
provision of services other than audit services performed by the auditors to the
Registrant and
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Covered Entities is compatible with maintaining the auditors' independence in
performing audit services.
Item 5. Audit Committee of Listed Registrants.
Applicable only for reports covering periods ending on or after the earlier of
(i) the first annual shareholder meeting after January 15, 2004 or (ii) October
31, 2004.
Item 6. [Reserved.]
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies.
Applicable only to annual reports filed by closed-end funds.
Item 8. [Reserved.]
Item 9 - Controls and Procedures
(a) The Fund's principal executive officer and principal financial officer have
concluded that the Fund's disclosure controls and procedures are sufficient to
ensure that information required to be disclosed by the Fund in this Form N-CSR
was recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms, based
upon such officers' evaluation of these controls and procedures as of a date
within 90 days of the filing date of the report.
There were no significant changes or corrective actions with regard to
significant deficiencies or material weaknesses in the Fund's internal controls
or in other factors that could significantly affect the Fund's internal controls
subsequent to the date of their evaluation.
(b) There were no changes in the registrant's internal control over financial
reporting that occurred during the registrant's most recent fiscal half-year
(the registrant's second fiscal half-year in the case of an annual report) that
has materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting.
Item 10 Exhibits
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(a) The Code of Ethics for Principal Executive and Senior Financial Officers is
attached hereto.
(b) A separate certification for each principal executive officer and principal
financial officer of the registrant are attached hereto as part of EX-99.CERT.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
Morgan Stanley Limited Duration Fund
/s/ Ronald E. Robison
Ronald E. Robison
Principal Executive Officer
June 22, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed by the following
persons on behalf of the registrant and in the capacities and on the dates
indicated.
/s/ Ronald E. Robison
Ronald E. Robison
Principal Executive Officer
June 22, 2004
/s/ Francis Smith
Francis Smith
Principal Financial Officer
June 22, 2004
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