-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Oz2rHiNbYmoua369wNZbSDaMqUKFFuwpdORhqiTpDqke+FEWSAo7Dd4Ifg34yakz UcMPPGA+s/uIi6w6SwXzdQ== 0001047469-06-012578.txt : 20061010 0001047469-06-012578.hdr.sgml : 20061009 20061010092526 ACCESSION NUMBER: 0001047469-06-012578 CONFORMED SUBMISSION TYPE: N-CSRS PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20060731 FILED AS OF DATE: 20061010 DATE AS OF CHANGE: 20061010 EFFECTIVENESS DATE: 20061010 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MORGAN STANLEY ALLOCATOR FUND CENTRAL INDEX KEY: 0001201932 IRS NUMBER: 000000000 STATE OF INCORPORATION: MA FILING VALUES: FORM TYPE: N-CSRS SEC ACT: 1940 Act SEC FILE NUMBER: 811-21248 FILM NUMBER: 061135743 BUSINESS ADDRESS: STREET 1: 1221 AVENUE OF THE AMERICAS STREET 2: 22ND FLOOR CITY: NEW YORK STATE: NY ZIP: 10020 BUSINESS PHONE: 2127625065 MAIL ADDRESS: STREET 1: 1221 AVENUE OF THE AMERICAS STREET 2: 22ND FLOOR CITY: NEW YORK STATE: NY ZIP: 10020 0001201932 S000002385 NONE C000006307 A ALRAX C000006308 B ALRBX C000006309 C ALRCX C000006310 D ALRDX N-CSRS 1 a2173151zn-csrs.txt N-CSRS 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: 811-21248 Morgan Stanley Allocator 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: January 31, 2007 Date of reporting period: July 31, 2006 Item 1 - Report to Shareholders Welcome, Shareholder: In this report, you'll learn about how your investment in Morgan Stanley Allocator Fund performed during the semiannual period. We will provide an overview of the market conditions, and discuss some of the factors that affected performance during the reporting period. In addition, this report includes the Fund's financial statements and a list of Fund investments. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE FUND BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE FUND WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE FUND IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE FUND WILL DECLINE AND, THEREFORE, THE VALUE OF THE FUND'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS FUND. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT FOR THE SIX MONTHS ENDED JULY 31, 2006 TOTAL RETURN FOR THE 6 MONTHS ENDED JULY 31, 2006
LEHMAN LIPPER BROTHERS U.S. FLEXIBLE S&P 500(R) AGGREGATE PORTFOLIO CLASS A CLASS B CLASS C CLASS D INDEX(1) INDEX(2) FUNDS INDEX(3) -0.66% -1.03% -0.94% -0.48% 0.67% 0.61% 0.18%
THE PERFORMANCE OF THE FUND'S FOUR SHARE CLASSES VARIES BECAUSE EACH HAS DIFFERENT EXPENSES. THE FUND'S TOTAL RETURNS ASSUME THE REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE DEDUCTION OF ANY APPLICABLE SALES CHARGES. SUCH COSTS WOULD LOWER PERFORMANCE. SEE PERFORMANCE SUMMARY FOR STANDARDIZED PERFORMANCE AND BENCHMARK INFORMATION. MARKET CONDITIONS Equity market returns were relatively volatile during the six-month reporting period, retreating in the second quarter of 2006 as concerns over inflation and rising rates weighed heavily on investors. As the Federal Open Market Committee (the "Fed') hinted at further rate increases on the horizon, domestic equity markets began to retreat in the second week of May, and remained in negative territory through the close of the period. Although the S&P 500(R) Index reached a cyclical high in May, stocks barely managed positive returns for the six-month period ended July 31, 2006. Including dividends, the equity benchmark index returned 0.67 percent. After a long period of outperformance, small- and mid-cap stocks lagged large-cap stocks over the period. Value-oriented stocks outperformed growth-oriented stocks across all market-cap segments of the market. The sharp equity correction that began in the second week of May helped support the performance of defensive sectors for the period. Telecommunication services, consumer staples and utilities posted positive returns across all market caps. The telecommunications sector, in particular, posted impressive double-digit returns across both the large- and mid-cap segments. In contrast, information technology stocks struggled during the period, with semiconductors among the most lagging industries. A slowing housing market and rising interest rates exerted pressure on U.S. homebuilders over the six-month period. Concerns over a supply glut in housing stocks and declining demand for new and existing homes weighed heavily on the group. PERFORMANCE ANALYSIS Morgan Stanley Allocator Fund underperformed the S&P 500(R) Index, the Lehman Brothers U.S. Aggregate Index and the Lipper Flexible Portfolio Funds Index for the six months ended July 31, 2006, assuming no deduction of applicable sales charges. Over the entire period, on average, the Fund held approximately 80 percent of its assets in stocks and other equity securities and the remainder in fixed income, convertible securities and cash. While the Fund's emphasis on stocks proved beneficial as stocks outperformed bonds, sector allocation within the Fund's equity portion hindered overall performance. Compared to consensus expectations, management believed that, in general, both U.S. and global growth would remain durable, inflation pressures would continue to build, and therefore, interest rates would be higher. 2 Until a material turn in the data, however, the portfolio management team expected cyclical sectors to outperform. As such, in January 2006, the Fund reduced its holdings in the more defensive names within the consumer staples sector and increased its weighting in the more cyclical materials sector. This reallocation at the start of the year served the Fund well, as consumer staples underperformed and materials outperformed the broader market during the first half of the period under review. Throughout the first half of the period, the Fund's largest sector overweight was in the technology sector, with a focus on semiconductors. Despite the support from economic fundamentals, the semiconductor industry underperformed the broad market and the Fund's allocation to this industry group was a drag on performance. The Fund neutralized the position in the second half of the period and rotated into defensive sectors in anticipation of an increase in volatility and a correction in stock prices. With the Fed continuing to raise interest rates throughout the period, the Fund reduced its exposure to interest rate sensitive sectors, particularly those exposed to a softening housing market. This positioning resulted in a significant underweight in the banking sector -- specifically those companies with greater exposure to the mortgage lending business. The Fund benefited from this position as the thrifts and mortgage sector underperformed the broad market. THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM AS DISCUSSED HEREIN OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE FUND IN THE FUTURE. TOP 10 HOLDINGS U.S. Treasury Bonds/Notes 4.5% iShares Lehman 1-3 Year Treasury Bond Fund 4.3 Exxon Mobil Corp. 2.9 General Electric Co. 2.5 Citigroup, Inc. 2.1 Altria Group, Inc. 1.8 Proctor & Gamble Co. (The) 1.7 JPMorgan Chase & Co. 1.3 Pfizer, Inc. 1.3 Johnson & Johnson 1.3 PORTFOLIO COMPOSITION* Common Stocks 75.3% Short-Term Paper 15.5 Other Securities 1.2 U.S. Government Agencies & Obligations 5.2 Convertible Corp Nt/Bd 1.6 Corporate Notes/Bonds 1.2 * DOES NOT INCLUDE OPEN LONG FUTURES WITH AN UNDERLYING FACE AMOUNT OF $4,771,406 AND OPEN SHORT FUTURES WITH AN UNDERLYING FACE AMOUNT OF $4,399,282 WITH NET UNREALIZED APPRECIATION OF $2,268. DATA AS OF JULY 31, 2006. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES FOR TOP 10 HOLDINGS ARE AS A PERCENTAGE OF NET ASSETS AND ALL PERCENTAGES FOR PORTFOLIO COMPOSITION ARE AS A PERCENTAGE OF TOTAL INVESTMENTS. THESE DATA ARE PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE DEEMED A RECOMMENDATION TO BUY OR SELL THE SECURITIES MENTIONED. MORGAN STANLEY IS A FULL-SERVICE SECURITIES FIRM ENGAGED IN SECURITIES TRADING AND BROKERAGE ACTIVITIES, INVESTMENT BANKING, RESEARCH AND ANALYSIS, FINANCING AND FINANCIAL ADVISORY SERVICES. 3 INVESTMENT STRATEGY THE FUND'S "INVESTMENT ADVISER," MORGAN STANLEY INVESTMENT ADVISORS INC., ACTIVELY ALLOCATES THE FUND'S ASSETS AMONG THE THREE MAJOR ASSET CATEGORIES OF EQUITY SECURITIES (INCLUDING DEPOSITARY RECEIPTS), FIXED-INCOME SECURITIES AND MONEY MARKET INSTRUMENTS, THE COMBINATION OF WHICH WILL BE VARIED FROM TIME TO TIME BOTH WITH RESPECT TO INDUSTRY SECTOR WEIGHTINGS AND TYPES OF SECURITIES IN RESPONSE TO CHANGING MARKET AND ECONOMIC TRENDS. THERE IS NO LIMIT AS TO THE PERCENTAGE OF ASSETS THAT MAY BE ALLOCATED TO ANY ONE ASSET CLASS. THE FUND MAY INVEST 100 PERCENT OF ITS ASSETS IN ANY ONE OF THE THREE MAJOR ASSET CATEGORIES MENTIONED ABOVE AT ANY TIME. IT IS ANTICIPATED THAT THERE WILL BE SIGNIFICANT FLUCTUATIONS IN THE ALLOCATIONS OVER TIME AND THUS, THE FUND MAY EXHIBIT HIGHER VOLATILITY THAN OTHER FUNDS. FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY FUND PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE FUND'S SECOND AND FOURTH FISCAL QUARTERS. THE SEMIANNUAL REPORTS AND THE ANNUAL REPORTS ARE FILED ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC) ON FORM N-CSRS AND FORM N-CSR, RESPECTIVELY. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO FUND SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY FUND ALSO FILES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS WITH THE SEC FOR THE FUND'S FIRST AND THIRD FISCAL QUARTERS ON FORM N-Q. MORGAN STANLEY DOES NOT DELIVER THE REPORTS FOR THE FIRST AND THIRD FISCAL QUARTERS TO SHAREHOLDERS, NOR ARE THE REPORTS POSTED TO THE MORGAN STANLEY PUBLIC WEB SITE. YOU MAY, HOWEVER, OBTAIN THE FORM N-Q FILINGS (AS WELL AS THE FORM N-CSR AND N-CSRS FILINGS) BY ACCESSING THE SEC'S WEB SITE, http://www.sec.gov. YOU MAY ALSO REVIEW AND COPY THEM AT THE SEC'S PUBLIC REFERENCE ROOM IN WASHINGTON, DC. INFORMATION ON THE OPERATION OF THE SEC'S PUBLIC REFERENCE ROOM MAY BE OBTAINED BY CALLING THE SEC AT (800) SEC-0330. YOU CAN ALSO REQUEST COPIES OF THESE MATERIALS, UPON PAYMENT OF A DUPLICATING FEE, BY ELECTRONIC REQUEST AT THE SEC'S E-MAIL ADDRESS (publicinfo@sec.gov) OR BY WRITING THE PUBLIC REFERENCE SECTION OF THE SEC, WASHINGTON, DC 20549-0102. PROXY VOTING POLICY AND PROCEDURES AND PROXY VOTING RECORD YOU MAY OBTAIN A COPY OF THE FUND'S PROXY VOTING POLICY AND PROCEDURES WITHOUT CHARGE, UPON REQUEST, BY CALLING TOLL FREE (800) 869-NEWS OR BY VISITING THE MUTUAL FUND CENTER ON OUR WEB SITE AT www.morganstanley.com. IT IS ALSO AVAILABLE ON THE SECURITIES AND EXCHANGE COMMISSION'S WEB SITE AT http://www.sec.gov. YOU MAY OBTAIN INFORMATION REGARDING HOW THE FUND VOTED PROXIES RELATING TO PORTFOLIO SECURITIES DURING THE MOST RECENT TWELVE-MONTH PERIOD ENDED JUNE 30 WITHOUT CHARGE BY VISITING THE MUTUAL FUND CENTER ON OUR WEB SITE AT www.morganstanley.com. THIS INFORMATION IS ALSO AVAILABLE ON THE SECURITIES AND EXCHANGE COMMISSION'S WEB SITE AT http://www.sec.gov. HOUSEHOLDING NOTICE TO REDUCE PRINTING AND MAILING COSTS, THE FUND ATTEMPTS TO ELIMINATE DUPLICATE MAILINGS TO THE SAME ADDRESS. THE FUND DELIVERS A SINGLE COPY OF CERTAIN SHAREHOLDER DOCUMENTS, INCLUDING SHAREHOLDER REPORTS, PROSPECTUSES AND PROXY MATERIALS, TO INVESTORS WITH THE SAME LAST NAME WHO RESIDE AT THE SAME ADDRESS. YOUR PARTICIPATION IN THIS PROGRAM WILL CONTINUE FOR AN UNLIMITED PERIOD OF TIME UNLESS YOU INSTRUCT US OTHERWISE. YOU CAN REQUEST MULTIPLE COPIES OF THESE DOCUMENTS BY CALLING (800) 350-6414, 8:00 A.M. TO 8:00 P.M., ET. ONCE OUR CUSTOMER SERVICE CENTER HAS RECEIVED YOUR INSTRUCTIONS, WE WILL BEGIN SENDING INDIVIDUAL COPIES FOR EACH ACCOUNT WITHIN 30 DAYS. 4 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED JULY 31, 2006
CLASS A SHARES* CLASS B SHARES** CLASS C SHARES+ CLASS D SHARES@@ SINCE 02/26/03) (SINCE 02/26/03) (SINCE 02/26/03) (SINCE 02/26/03) SYMBOL ALRAX ALRBX ALRCX ALRDX - --------------- --------------- ---------------- ---------------- ----------------- 1 YEAR 4.07%(4) 3.28%(4) 3.28%(4) 4.33%(4) (1.39)(5) (1.72)(5) 2.28 -- SINCE INCEPTION 8.37(4) 7.56(4) 7.57(4) 8.65(4) 6.68(5) 7.07(5) 7.57(5) --
PERFORMANCE DATA QUOTED REPRESENTS PAST PERFORMANCE, WHICH IS NO GUARANTEE OF FUTURE RESULTS AND CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THE FIGURES SHOWN. FOR MOST RECENT MONTH-END PERFORMANCE FIGURES, PLEASE VISIT www.morganstanley.com OR SPEAK WITH YOUR FINANCIAL ADVISOR. INVESTMENT RETURNS AND PRINCIPAL VALUE WILL FLUCTUATE AND FUND SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. THE TABLE DOES NOT REFLECT THE DEDUCTION OF TAXES THAT A SHAREHOLDER WOULD PAY ON FUND DISTRIBUTIONS OR THE REDEMPTION OF FUND SHARES. PERFORMANCE FOR CLASS A, CLASS B, CLASS C, AND CLASS D SHARES WILL VARY DUE TO DIFFERENCES IN SALES CHARGES AND EXPENSES. * THE MAXIMUM FRONT-END SALES CHARGE FOR CLASS A IS 5.25%. ** THE MAXIMUM CONTINGENT DEFERRED SALES CHARGE (CDSC) FOR CLASS B IS 5.0%. THE CDSC DECLINES TO 0% AFTER SIX YEARS. + THE MAXIMUM CONTINGENT DEFERRED SALES CHARGE FOR CLASS C IS 1.0% FOR SHARES REDEEMED WITHIN ONE YEAR OF PURCHASE. @@ CLASS D HAS NO SALES CHARGE. (1) THE STANDARD & POOR'S 500 INDEX (S&P 500(R)) IS A BROAD-BASED INDEX, THE PERFORMANCE OF WHICH IS BASED ON THE PERFORMANCE OF 500 WIDELY-HELD COMMON STOCKS CHOSEN FOR MARKET SIZE, LIQUIDITY AND INDUSTRY GROUP REPRESENTATION. 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 LEHMAN BROTHERS U.S. AGGREGATE INDEX TRACKS THE PERFORMANCE OF U.S. GOVERNMENT AGENCY AND TREASURY SECURITIES, INVESTMENT-GRADE CORPORATE DEBT SECURITIES, AGENCY MORTGAGE-BACKED SECURITIES, ASSET-BACKED SECURITIES AND COMMERCIAL MORTGAGE-BASED SECURITIES. 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. (3) THE LIPPER FLEXIBLE PORTFOLIO FUNDS INDEX IS AN EQUALLY WEIGHTED PERFORMANCE INDEX OF THE LARGEST QUALIFYING FUNDS (BASED ON NET ASSETS) IN THE LIPPER FLEXIBLE PORTFOLIO 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. (4) FIGURE SHOWN ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS AND DOES NOT REFLECT THE DEDUCTION OF ANY SALES CHARGES. (5) FIGURE SHOWN ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS AND THE DEDUCTION OF THE MAXIMUM APPLICABLE SALES CHARGE. SEE THE FUND'S CURRENT PROSPECTUS FOR COMPLETE DETAILS ON FEES AND SALES CHARGES. 5 EXPENSE EXAMPLE As a shareholder of the Fund, you incur two types of costs: (1) transaction costs, including sales charges (loads) on purchase payments and redemption fees; and (2) ongoing costs, including advisory fees; distribution and service (12b-1) fees; and other Fund expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other mutual funds. The example is based on an investment of $1,000 invested at the beginning of the period and held for the entire period 02/01/06 - 07/31/06. ACTUAL EXPENSES The first line of the table below provides information about actual account values and actual expenses. You may use the information in this line, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the first line under the heading entitled "Expenses Paid During Period" to estimate the expenses you paid on your account during this period. HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES The second line of the table below provides information about hypothetical expenses based on the Fund's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Fund's actual return. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. You may use this information to compare the ongoing cost of investing in the Fund and other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the other funds. Please note that the expenses shown in the table are meant to highlight your ongoing costs only and do not reflect any transactional costs, such as sales charges (loads) and redemption fees. Therefore, the second line of the table is useful in comparing ongoing costs, and will not help you determine the relative total cost of owning different funds. In addition, if these transactional costs were included, your costs would have been higher.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD * ------------- ------------- --------------- 02/01/06 - 02/01/06 07/31/06 07/31/06 ------------- ------------- --------------- CLASS A Actual (-0.66% return) $1,000.00 $ 993.40 $ 6.87 Hypothetical (5% annual return before expenses) $1,000.00 $1,017.90 $ 6.95 CLASS B Actual (-1.03% return) $1,000.00 $ 989.70 $10.56 Hypothetical (5% annual return before expenses) $1,000.00 $1,014.18 $10.69 CLASS C Actual (-0.94% return) $1,000.00 $ 990.60 $10.22 Hypothetical (5% annual return before expenses) $1,000.00 $1,014.53 $10.34 CLASS D Actual (-0.48% return) $1,000.00 $ 995.20 $ 5.64 Hypothetical (5% annual return before expenses) $1,000.00 $1,019.14 $ 5.71
- ---------- * EXPENSES ARE EQUAL TO THE FUND'S ANNUALIZED EXPENSE RATIOS OF 1.39%, 2.14%, 2.07% AND 1.14% FOR CLASS A, CLASS B, CLASS C AND CLASS D SHARES, RESPECTIVELY, MULTIPLIED BY THE AVERAGE ACCOUNT VALUE OVER THE PERIOD, MULTIPLIED BY 181/365 (TO REFLECT THE ONE-HALF YEAR PERIOD). 6 INVESTMENT ADVISORY AGREEMENT APPROVAL NATURE, EXTENT AND QUALITY OF SERVICES The Board reviewed and considered the nature and extent of the investment advisory services provided by the Investment Adviser under the Advisory Agreement, including portfolio management, investment research and equity and fixed income securities trading. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Fund's Administrator under the Administration Agreement, including accounting, clerical, bookkeeping, compliance, business management and planning, and the provision of supplies, office space and utilities at the Investment Adviser's expense. (The Investment Adviser and the Administrator together are referred to as the "Adviser" and the Advisory and Administration Agreements together are referred to as the "Management Agreement.") The Board also compared the nature of the services provided by the Adviser with similar services provided by non-affiliated advisers as reported to the Board by Lipper Inc. ("Lipper"). The Board reviewed and considered the qualifications of the portfolio managers, the senior administrative managers and other key personnel of the Adviser who provide the advisory and administrative services to the Fund. The Board determined that the Adviser's portfolio managers and key personnel are well qualified by education and/or training and experience to perform the services in an efficient and professional manner. The Board concluded that the nature and extent of the advisory and administrative services provided were necessary and appropriate for the conduct of the business and investment activities of the Fund. The Board also concluded that the overall quality of the advisory and administrative services was satisfactory. PERFORMANCE RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS On a regular basis, the Board reviews the performance of all funds in the Morgan Stanley Fund Complex, including the Fund, compared to their peers, paying specific attention to the underperforming funds. In addition, the Board specifically reviewed the Fund's performance for the one-year period ended November 30, 2005 and for the period February 28, 2003 to November 30, 2005, as shown in a report provided by Lipper (the "Lipper Report"), compared to the performance of comparable funds selected by Lipper (the "performance peer group"). The Board also discussed with the Adviser the performance goals and the actual results achieved in managing the Fund. When a fund underperforms its performance peer group, the Board discusses with the Adviser the causes of the underperformance and, where necessary, specific changes to the fund's investment strategy or investment personnel. The Board concluded that the Fund can reasonably be expected to be competitive with that of its performance peer group based on recent action taken or proposed to be taken by the Adviser with respect to the Fund's investment strategy and/or investment personnel. FEES RELATIVE TO OTHER PROPRIETARY FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT STRATEGIES The Board noted that the Adviser did not manage any other proprietary funds with investment strategies comparable to those of the Fund. 7 FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS The Board reviewed the advisory and administrative fee (together, the "management fee") rate and total expense ratio of the Fund as compared to the average management fee rate and average total expense ratio for funds, selected by Lipper (the "expense peer group"), managed by other advisers with investment strategies comparable to those of the Fund, as shown in the Lipper Report. The Board concluded that the Fund's management fee rate and total expense ratio were competitive with those of its expense peer group. BREAKPOINTS AND ECONOMIES OF SCALE The Board reviewed the structure of the Fund's management fee schedule under the Management Agreement and noted that it does not include any breakpoints. The Board considered that the Fund's assets were relatively small. The Board concluded that it would be premature to consider economies of scale as a factor in approving the Management Agreement at the present time. PROFITABILITY OF THE ADVISER AND AFFILIATES The Board considered information concerning the costs incurred and profits realized by the Adviser and affiliates during the last year from their relationship with the Fund and during the last two years from their relationship with the Morgan Stanley Fund Complex and reviewed with the Adviser the cost allocation methodology used to determine the profitability of the Adviser and affiliates. Based on its review of the information it received, the Board concluded that the profits earned by the Adviser and affiliates were not excessive in light of the advisory, administrative and other services provided to the Fund. FALL-OUT BENEFITS The Board considered so-called "fall-out benefits" derived by the Adviser and affiliates from their relationship with the Fund and the Morgan Stanley Fund Complex, such as sales charges on sales of Class A shares and "float" benefits derived from handling of checks for purchases and sales of Fund shares, through a broker-dealer affiliate of the Adviser and "soft dollar" benefits (discussed in the next section). The Board also considered that a broker-dealer affiliate of the Adviser receives from the Fund 12b-1 fees for distribution and shareholder services. The Board also considered that an affiliate of the Adviser sold a joint venture that owned an electronic trading system network ("ECN"), which may be used by the Adviser for trading on behalf of the Fund. As part of the sale of the joint venture, the affiliate receives a 10-year payout based on the revenue stream from trading on the ECN. Although the affiliate disgorges the portion of the payout that is comprised of commissions received from trades executed by the Adviser on the ECN to a charitable organization, the Board considered the fact that trades by the Adviser would increase order flow, and, thus, result in a potential fall-out benefit to the affiliate. The Board concluded that the float benefits were relatively small, the sales charges and 12b-1 fees were competitive with those of other broker-dealers, the affiliate disgorged revenues in connection with the ECN-related revenue and the potential fall-out benefit from increased order flow was relatively small. 8 SOFT DOLLAR BENEFITS The Board considered whether the Adviser realizes any benefits as a result of brokerage transactions executed through "soft dollar" arrangements. Under such arrangements, brokerage commissions paid by the Fund and/or other funds managed by the Adviser would be used to pay for research that a securities broker obtains from third parties, or to pay for both research and execution services from securities brokers who effect transactions for the Fund. The Adviser informed the Board that it does not use Fund commissions to pay for third party research. It does use commissions to pay for research which is bundled with execution services. The Board recognized that the receipt of such research from brokers may reduce the Adviser's costs but concluded that the receipt of such research strengthens the investment management resources of the Adviser, which may ultimately benefit the Fund and other funds in the Morgan Stanley Fund Complex. ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE FUND'S NEEDS The Board considered whether the Adviser is financially sound and has the resources necessary to perform its obligations under the Management Agreement. The Board noted that the Adviser's operations remain profitable, although increased expenses in recent years have reduced the Adviser's profitability. The Board concluded that the Adviser has the financial resources necessary to fulfill its obligations under the Management Agreement. HISTORICAL RELATIONSHIP BETWEEN THE FUND AND THE ADVISER The Board also reviewed and considered the historical relationship between the Fund and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Fund's operations and the Board's confidence in the competence and integrity of the senior managers and key personnel of the Adviser. The Board concluded that it is beneficial for the Fund to continue its relationship with the Adviser. OTHER FACTORS AND CURRENT TRENDS The Board considered the controls and procedures adopted and implemented by the Adviser and monitored by the Fund's Chief Compliance Officer and concluded that the conduct of business by the Adviser indicates a good faith effort on its part to adhere to high ethical standards in the conduct of the Fund's business. GENERAL CONCLUSION After considering and weighing all of the above factors, the Board concluded that it would be in the best interest of the Fund and its shareholders to approve renewal of the Management Agreement for another year. 9 MORGAN STANLEY ALLOCATOR FUND PORTFOLIO OF INVESTMENTS - JULY 31, 2006 (UNAUDITED) NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- Common Stocks (75.5%) AEROSPACE & DEFENSE (1.4%) 5,261 Boeing Co. $ 407,307 2,648 General Dynamics Corp. 177,469 818 Goodrich Corp. 33,023 801 L-3 Communications Holdings, Inc. 58,994 2,403 Lockheed Martin Corp. 191,471 2,332 Northrop Grumman Corp. 154,355 2,964 Raytheon Co. 133,587 1,152 Rockwell Collins, Inc. 61,482 ---------- 1,217,688 ---------- AGRICULTURAL COMMODITIES/MILLING (1.7%) 9,571 Archer-Daniels-Midland Co. 421,124 18,972 Cermaq ASA (Norway) 264,804 91,900 Fjord Seafood ASA (Norway)* 124,989 2,662 MGP Ingredients, Inc. 61,306 532,518 Pan Fish ASA (Norway)* 588,566 ---------- 1,460,789 ---------- AIR FREIGHT/COURIERS (0.8%) 2,092 FedEx Corp. 219,053 7,606 United Parcel Service, Inc. (Class B) 524,129 ---------- 743,182 ---------- AIRLINES (1.0%) 6,682 Alaska Air Group, Inc.* 248,103 12,075 Delta Air Lines, Inc.* 8,453 52,452 Flyi Inc.* 525 14,000 Frontier Airlines Holdings, Inc.* 90,720 6,863 JetBlue Airways Corp.* 73,365 17,629 Mesa Air Group, Inc.* 149,141 7,219 SkyWest, Inc. 175,061 9,133 Southwest Airlines Co. 164,303 ---------- 909,671 ---------- ALUMINUM (0.4%) 12,943 Alcoa, Inc. 387,643 ---------- APPAREL/FOOTWEAR (0.5%) 4,163 Coach, Inc.* 119,520 1,286 Jones Apparel Group, Inc. 38,066 1,172 Liz Claiborne, Inc. 41,430 SEE NOTES TO FINANCIAL STATEMENTS 10 NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- 2,081 NIKE, Inc. (Class B) $164,399 976 V.F. Corp. 66,192 -------- 429,607 -------- AUTO PARTS: O.E.M. (0.1%) 803 Eaton Corp. 51,472 -------- BEVERAGES: ALCOHOLIC (1.0%) 11,195 Anheuser-Busch Companies, Inc. 539,039 116 Boston Beer Company, Inc. (The) (Class A)* 3,416 112 Brown-Forman Corp. (Class A) 8,280 1,209 Brown-Forman Corp. (Class B) 88,801 121 Compania Cervecerias Unidas S.A. (ADR) (Chile) 2,758 2,893 Constellation Brands Inc. (Class A)* 70,763 505 Diageo PLC (United Kingdom) 8,876 1,862 Foster's Group Ltd. (Australia) 7,672 207 Heineken NV (Netherlands) 9,723 882 Molson Coors Brewing Co. (Class B) 63,019 43 Pernod-Ricard SA (France) 8,943 9 Pyramid Breweries Inc.* 21 100 Redhook Ale Brewery, Inc.* 387 5,640 SABMiller PLC (United Kingdom) 113,251 -------- 924,949 -------- BEVERAGES: NON-ALCOHOLIC (0.6%) 11,432 Coca-Cola Co. (The) 508,724 1,689 Coca-Cola Enterprises Inc. 36,246 755 Pepsi Bottling Group, Inc. (The) 25,104 -------- 570,074 -------- BIOTECHNOLOGY (1.6%) 814 Affymetrix, Inc.* 17,558 4,965 Biogen Idec Inc.* 209,126 951 Cephalon, Inc.* 62,519 556 Charles River Laboratories International, Inc.* 19,738 2,111 Enzo Biochem, Inc.* 27,211 3,627 Genzyme Corp.* 247,652 6,467 Gilead Sciences, Inc.* 397,591 390 Invitrogen Corp.* 24,098 1,847 Martek Biosciences Corp.* 51,587 3,760 MedImmune, Inc.* 95,429 5,936 Millennium Pharmaceuticals, Inc.* 58,292 SEE NOTES TO FINANCIAL STATEMENTS 11 NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- 172 Millipore Corp.* $ 10,776 1,830 PDL BioPharma Inc.* 32,958 3,848 Regeneron Pharmaceuticals, Inc.* 52,564 471 Techne Corp.* 23,404 1,662 Vertex Pharmaceuticals Inc.* 55,710 ---------- 1,386,213 ---------- BUILDING PRODUCTS (0.1%) 986 American Standard Companies, Inc. 38,089 2,247 Masco Corp. 60,062 ---------- 98,151 ---------- CASINO/GAMING (0.2%) 1,227 Harrah's Entertainment, Inc. 73,755 2,255 International Game Technology 87,178 ---------- 160,933 ---------- CHEMICALS: SPECIALTY (0.2%) 1,443 Aventine Renewable Energy Holdings, Inc.* 42,713 1,395 Cambrex Corp. 29,727 2,271 VeraSun Energy Corp.* 55,640 5,242 Xethanol Corp.* 39,630 ---------- 167,710 ---------- COAL (0.1%) 1,170 CONSOL Energy, Inc. 48,157 ---------- COMMERCIAL PRINTING/FORMS (0.1%) 1,493 Donnelley (R.R.) & Sons Co. 43,581 ---------- COMPUTER COMMUNICATIONS (0.0%) 193 QLogic Corp.* 3,376 ---------- COMPUTER PERIPHERALS (0.1%) 2,614 EMC Corp.* 26,532 129 Lexmark International, Inc. (Class A)* 6,972 426 Network Appliance, Inc.* 12,648 ---------- 46,152 ---------- COMPUTER PROCESSING HARDWARE (0.3%) 947 Apple Computer, Inc.* 64,358 2,718 Dell Inc.* 58,926 335 Gateway, Inc.* 536 3,179 Hewlett-Packard Co. 101,442 SEE NOTES TO FINANCIAL STATEMENTS 12 NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- 217 NCR Corp.* $ 6,974 3,878 Sun Microsystems, Inc.* 16,869 ---------- 249,105 ---------- CONTAINERS/PACKAGING (0.3%) 1,590 Ball Corp. 60,897 1,601 Bemis Company, Inc. 49,151 2,127 Pactiv Corp.* 52,133 1,244 Sealed Air Corp. 58,767 1,678 Temple-Inland Inc. 71,382 ---------- 292,330 ---------- CONTRACT DRILLING (0.3%) 1,852 Nabors Industries, Ltd. (Bermuda)* 65,413 839 Noble Corp. (Cayman Islands) 60,198 664 Rowan Companies, Inc. 22,490 1,978 Transocean Inc. (Cayman Islands)* 152,761 ---------- 300,862 ---------- DATA PROCESSING SERVICES (0.1%) 141 Affiliated Computer Services, Inc. (Class A)* 7,181 633 Automatic Data Processing, Inc. 27,700 224 Computer Sciences Corp.* 11,735 168 Convergys Corp.* 3,205 847 First Data Corp. 34,600 220 Fiserv, Inc.* 9,605 373 Paychex, Inc. 12,749 ---------- 106,775 ---------- DISCOUNT STORES (1.2%) 3,693 Costco Wholesale Corp. 194,843 20,213 Wal-Mart Stores, Inc. 899,479 ---------- 1,094,322 ---------- DRUGSTORE CHAINS (1.7%) 10,689 CVS Corp. 349,744 6,200 Longs Drug Stores Corp. 254,944 61,855 Rite Aid Corp.* 261,028 13,212 Walgreen Co. 618,057 ---------- 1,483,773 ---------- SEE NOTES TO FINANCIAL STATEMENTS 13 NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- ELECTRIC UTILITIES (2.6%) 4,080 AES Corp. (The)* $ 81,029 1,028 Allegheny Energy, Inc.* 42,199 1,278 Ameren Corp. 65,817 2,479 American Electric Power Co., Inc. 89,541 2,026 CenterPoint Energy, Inc. 27,837 1,375 CMS Energy Corp.* 19,264 1,560 Consolidated Edison, Inc. 73,117 1,116 Constellation Energy Group 64,628 2,161 Dominion Resources, Inc. 169,595 1,110 DTE Energy Co. 46,975 7,585 Duke Energy Corp. 229,977 2,082 Edison International 86,153 1,262 Entergy Corp. 97,300 4,183 Exelon Corp. 242,196 2,059 FirstEnergy Corp. 115,304 2,537 FPL Group, Inc. 109,446 2,171 PG&E Corp. 90,487 605 Pinnacle West Capital Corp. 26,021 2,373 PPL Corp. 80,729 1,543 Progress Energy, Inc. 67,198 1,487 Public Service Enterprise Group 100,268 4,713 Southern Co. (The) 159,205 1,286 TECO Energy, Inc. 20,499 2,802 TXU Corp. 179,972 2,524 Xcel Energy, Inc. 50,581 ---------- 2,335,338 ---------- ELECTRICAL PRODUCTS (0.4%) 1,159 American Power Conversion Corp. 19,564 615 Cooper Industries Ltd. (Class A) (Bermuda) 52,988 2,725 Emerson Electric Co. 215,057 721 Molex Inc. 22,870 ---------- 310,479 ---------- ELECTRONIC COMPONENTS (0.1%) 904 Jabil Circuit, Inc. 20,882 222 SanDisk Corp.* 10,359 3,106 Sanmina-SCI Corp.* 10,747 4,767 Solectron Corp.* 14,396 ---------- 56,384 ---------- SEE NOTES TO FINANCIAL STATEMENTS 14 NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- ELECTRONIC EQUIPMENT/INSTRUMENTS (0.2%) 2,183 Agilent Technologies, Inc.* $ 62,084 1,175 Rockwell Automation, Inc. 72,827 1,409 Symbol Technologies, Inc. 15,569 450 Tektronix, Inc. 12,272 504 Thermo Electron Corp.* 18,653 1,046 Xerox Corp.* 14,738 ---------- 196,143 ---------- ELECTRONIC PRODUCTION EQUIPMENT (0.3%) 11,867 Applied Materials, Inc. 186,787 1,477 KLA-Tencor Corp. 62,315 1,001 Novellus Systems, Inc.* 25,335 1,522 Teradyne, Inc.* 19,999 ---------- 294,436 ---------- ELECTRONICS/APPLIANCES (0.1%) 3,134 Eastman Kodak Co. 69,732 403 Harman International Industries, Inc. 32,321 ---------- 102,053 ---------- ENERGY (0.5%) 24,000 Powershares Wilderhill Clean Energy Portfolio 421,440 ---------- ENGINEERING & CONSTRUCTION (0.1%) 2,396 Abengoa S. A. (Spain) 56,224 551 Fluor Corp. 48,394 ---------- 104,618 ---------- ENVIRONMENTAL SERVICES (0.2%) 1,545 Allied Waste Industries, Inc.* 15,697 591 Republic Services, Inc. 23,735 661 Waste Connections, Inc.* 24,708 3,773 Waste Management, Inc. 129,716 ---------- 193,856 ---------- FINANCE/RENTAL/LEASING (0.1%) 1,497 CIT Group, Inc. 68,727 443 Ryder System, Inc. 22,327 ---------- 91,054 ---------- FINANCIAL CONGLOMERATES (3.8%) 38,353 Citigroup, Inc. 1,852,833 26,059 JPMorgan Chase & Co. 1,188,812 SEE NOTES TO FINANCIAL STATEMENTS 15 NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- 1,577 Principal Financial Group, Inc. $ 85,158 2,788 Prudential Financial, Inc. 219,248 ---------- 3,346,051 ---------- FINANCIAL PUBLISHING/SERVICES (0.2%) 888 Equifax, Inc. 28,665 1,875 Moody's Corp. 102,900 ---------- 131,565 ---------- FOOD DISTRIBUTORS (0.2%) 4,987 Sysco Corp. 137,641 ---------- FOOD RETAIL (0.4%) 5,507 Kroger Co. (The) 126,276 3,531 Safeway Inc. 99,150 1,665 SUPERVALU, Inc. 45,138 1,111 Whole Foods Market, Inc. 63,894 ---------- 334,458 ---------- FOOD: MAJOR DIVERSIFIED (1.3%) 1,451 Campbell Soup Co. 53,223 4,044 ConAgra Foods, Inc. 86,946 2,796 General Mills, Inc. 145,112 2,612 Heinz (H.J.) Co. 109,626 1,900 Kellogg Co. 91,523 9,269 PepsiCo, Inc. 587,469 6,032 Sara Lee Corp. 101,941 ---------- 1,175,840 ---------- FOOD: MEAT/FISH/DAIRY (0.1%) 1,069 Dean Foods Co.* 40,120 1,780 Leroy Seafood Group ASA (Norway) 36,256 ---------- 76,376 ---------- FOOD: SPECIALTY/CANDY (0.3%) 960 Cosan SA Industria e Comercio (Brazil)* 62,067 1,381 Hershey Co. (The) 75,914 1,048 McCormick & Co., Inc. (Non-Voting) 36,743 1,739 Wrigley (Wm.) Jr. Co. 79,751 ---------- 254,475 ---------- FOREST PRODUCTS (0.3%) 1,634 Louisiana-Pacific Corp. 32,680 3,733 Weyerhaeuser Co. 218,978 ---------- 251,658 ---------- SEE NOTES TO FINANCIAL STATEMENTS 16 NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- GAS DISTRIBUTORS (0.2%) 2,793 Dynegy, Inc. (Class A)* $ 15,725 1,108 KeySpan Corp. 44,619 266 Nicor Inc. 11,656 1,659 NiSource, Inc. 37,742 243 Peoples Energy Corp. 10,257 1,624 Sempra Energy 78,374 ---------- 198,373 ---------- HOSPITAL/NURSING MANAGEMENT (0.1%) 1,240 HCA, Inc. 60,958 751 Health Management Associates, Inc. (Class A) 15,268 261 Manor Care, Inc. 13,063 1,540 Tenet Healthcare Corp.* 9,117 ---------- 98,406 ---------- HOTELS/RESORTS/CRUISELINES (0.5%) 2,899 Carnival Corp. (Panama) 112,945 2,169 Hilton Hotels Corp. 51,904 2,177 Marriott International, Inc. (Class A) 76,587 3,132 Starwood Hotels & Resorts Worldwide, Inc. 164,681 ---------- 406,117 ---------- HOUSEHOLD/PERSONAL CARE (2.5%) 623 Alberto-Culver Co. 30,365 3,658 Avon Products, Inc. 106,045 1,238 Clorox Co. (The) 74,206 4,178 Colgate-Palmolive Co. 247,839 981 Estee Lauder Companies, Inc. (The) (Class A) 36,611 3,745 Kimberly-Clark Corp. 228,632 26,387 Procter & Gamble Co. (The) 1,482,949 ---------- 2,206,647 ---------- INDUSTRIAL CONGLOMERATES (4.3%) 4,930 3M Co. 347,072 1,299 Danaher Corp. 84,695 67,835 General Electric Co.+ 2,217,526 5,499 Honeywell International, Inc. 212,811 1,783 Ingersoll-Rand Co. Ltd. (Class A) (Bermuda) 63,831 991 ITT Corp. 50,095 853 Textron, Inc. 76,693 SEE NOTES TO FINANCIAL STATEMENTS 17 NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- 13,249 Tyco International Ltd. (Bermuda) $ 345,666 6,697 United Technologies Corp. 416,486 ---------- 3,814,875 ---------- INDUSTRIAL MACHINERY (0.1%) 1,234 Illinois Tool Works Inc. 56,431 642 Parker Hannifin Corp. 46,378 ---------- 102,809 ---------- INFORMATION TECHNOLOGY SERVICES (0.2%) 216 Citrix Systems, Inc.* 6,862 614 Electronic Data Systems Corp. 14,675 1,716 International Business Machines Corp. 132,836 407 Unisys Corp.* 2,084 ---------- 156,457 ---------- INSURANCE BROKERS/SERVICES (0.2%) 1,835 AON Corp. 62,812 3,050 Marsh & McLennan Companies, Inc. 82,442 ---------- 145,254 ---------- INTEGRATED OIL (4.8%) 13,026 Chevron Corp. 856,850 9,763 ConocoPhillips 670,132 37,586 Exxon Mobil Corp. 2,546,076 1,401 Hess Corp. 74,113 1,042 Murphy Oil Corp. 53,621 ---------- 4,200,792 ---------- INTERNET SOFTWARE/SERVICES (0.1%) 164 Google, Inc. (Class A)* 63,402 318 VeriSign, Inc.* 5,702 1,469 Yahoo!, Inc.* 39,869 ---------- 108,973 ---------- INVESTMENT BANKS/BROKERS (0.5%) 635 CBOT Holdings, Inc. (Class A)* 79,565 292 Chicago Mercantile Exchange Holdings, Inc. 134,670 1,663 International Securities Exchange Holdings, Inc. 67,667 2,200 Nasdaq Stock Market Inc.* 60,566 1,024 NYSE Group Inc.* 63,683 ---------- 406,151 ---------- SEE NOTES TO FINANCIAL STATEMENTS 18 NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- INVESTMENT TRUSTS/MUTUAL FUNDS (5.4%) 46,905 iShares Lehman 1-3 Year Treasury Bond Fund $3,749,586 15,500 streetTRACKS Gold Trust* 978,980 ---------- 4,728,566 ---------- LIFE/HEALTH INSURANCE (0.7%) 2,775 AFLAC, Inc. 122,488 2,126 Genworth Financial Inc. (Class A) 72,922 1,618 Lincoln National Corp. 91,708 4,295 MetLife, Inc. 223,340 583 Torchmark Corp. 35,254 1,657 UnumProvident Corp. 26,893 ---------- 572,605 ---------- MAJOR BANKS (2.8%) 20,661 Bank of America Corp. 1,064,661 1,138 Comerica, Inc. 66,630 9,952 Wachovia Corp. 533,726 10,644 Wells Fargo & Co. 769,987 ---------- 2,435,004 ---------- MAJOR TELECOMMUNICATIONS (2.5%) 2,323 ALLTEL Corp. 128,160 22,744 AT&T Inc. 682,093 10,545 BellSouth Corp. 413,048 909 Embarq Corp. 41,132 18,525 Sprint Nextel Corp. 366,795 16,959 Verizon Communications, Inc. 573,553 ---------- 2,204,781 ---------- MANAGED HEALTH CARE (0.6%) 1,754 Aetna, Inc. 55,233 1,367 Caremark Rx, Inc. 72,178 370 CIGNA Corp. 33,763 488 Coventry Health Care, Inc.* 25,718 492 Humana, Inc.* 27,518 4,249 UnitedHealth Group Inc. 203,230 2,010 WellPoint Inc.* 149,745 ---------- 567,385 ---------- MEDICAL DISTRIBUTORS (0.2%) 628 AmerisourceBergen Corp. 27,004 1,284 Cardinal Health, Inc. 86,028 SEE NOTES TO FINANCIAL STATEMENTS 19 NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- 927 McKesson Corp. $ 46,712 428 Patterson Companies, Inc.* 14,235 ---------- 173,979 ---------- MEDICAL SPECIALTIES (1.5%) 1,430 Applera Corp. - Applied Biosystems Group 45,974 677 Bard (C.R.), Inc. 48,047 364 Bausch & Lomb, Inc. 17,217 4,216 Baxter International, Inc. 177,072 1,645 Becton, Dickinson & Co. 108,438 1,592 Biomet, Inc. 52,440 7,697 Boston Scientific Corp.* 130,926 370 Fisher Scientific International, Inc.* 27,421 975 Hospira, Inc.* 42,598 7,858 Medtronic, Inc. 396,986 725 Pall Corp. 18,908 428 PerkinElmer, Inc. 7,717 2,418 St. Jude Medical, Inc.* 89,224 1,892 Stryker Corp. 86,105 341 Waters Corp.* 13,872 1,624 Zimmer Holdings, Inc.* 102,702 ---------- 1,365,647 ---------- MISCELLANEOUS COMMERCIAL SERVICES (0.1%) 1,504 ABM Industries Inc. 24,816 950 Cintas Corp. 33,535 156 Sabre Holdings Corp. (Class A) 3,229 ---------- 61,580 ---------- MISCELLANEOUS MANUFACTURING (0.1%) 1,098 Dover Corp. 51,760 ---------- MULTI-LINE INSURANCE (1.3%) 14,469 American International Group, Inc. 877,834 1,693 Hartford Financial Services Group, Inc. (The) 143,634 2,300 Loews Corp. 85,238 687 SAFECO Corp. 36,906 ---------- 1,143,612 ---------- OFFICE EQUIPMENT/SUPPLIES (0.1%) 759 Avery Dennison Corp. 44,500 1,570 Pitney Bowes, Inc. 64,872 ---------- 109,372 ---------- SEE NOTES TO FINANCIAL STATEMENTS 20 NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- OIL & GAS PIPELINES (0.2%) 4,137 El Paso Corp. $ 66,192 605 Kinder Morgan, Inc. 61,710 3,524 Williams Companies, Inc. (The) 85,457 ---------- 213,359 ---------- OIL & GAS PRODUCTION (1.3%) 2,693 Anadarko Petroleum Corp. 123,178 1,927 Apache Corp. 135,796 2,500 Chesapeake Energy Corp. 82,250 2,578 Devon Energy Corp. 166,642 1,420 EOG Resources, Inc. 105,293 1,400 Green Plains Renewable Energy Inc.* 45,500 1,224 Kerr-McGee Corp. 85,925 2,539 Occidental Petroleum Corp. 273,577 2,169 XTO Energy, Inc. 101,921 ---------- 1,120,082 ---------- OIL REFINING/MARKETING (0.6%) 2,119 Marathon Oil Corp. 192,066 2,650 Pacific Ethanol Inc.* 49,688 773 Sunoco, Inc. 53,754 3,632 Valero Energy Corp. 244,906 ---------- 540,414 ---------- OILFIELD SERVICES/EQUIPMENT (1.2%) 2,076 Baker Hughes Inc. 165,976 1,927 BJ Services Co. 69,892 6,238 Halliburton Co. 208,100 1,071 National-Oilwell Varco, Inc.* 71,800 7,131 Schlumberger Ltd. (Netherlands Antilles) 476,707 2,253 Weatherford International Ltd. (Bermuda)* 105,531 ---------- 1,098,006 ---------- OTHER CONSUMER SERVICES (0.5%) 2,667 Apollo Group, Inc. (Class A)* 126,202 5,920 Block (H.&R.), Inc. 134,680 7,037 Cendant Corp. 105,625 1,756 Central Parking Corp. 27,007 1,318 eBay Inc.* 31,724 1,233 Rollins, Inc. 26,053 ---------- 451,291 ---------- SEE NOTES TO FINANCIAL STATEMENTS 21 NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- OTHER METALS/MINERALS (0.3%) 3,043 Phelps Dodge Corp. $ 265,776 ---------- OTHER TRANSPORTATION (0.2%) 400 Aeroports de Paris (ADP) (France)* 24,642 42,000 Beijing Capital International Airport Co., Ltd. (China) 26,161 380 Fraport AG (Germany) 27,638 8,500 Grupo Aeroportuario del Pacifico SA de CV (B Shares) (Mexico) 25,334 7,800 Grupo Aeroportuario del Sureste S.A.B. de C.V. (B Shares) (Mexico) 26,504 2,600 Japan Airport Terminal Co., Ltd. (Japan) 26,513 ---------- 156,792 ---------- PACKAGED SOFTWARE (0.4%) 686 Adobe Systems, Inc.* 19,558 277 Autodesk, Inc.* 9,448 258 BMC Software, Inc.* 6,042 547 CA Inc. 11,465 465 Compuware Corp.* 3,250 406 Intuit Inc.* 12,533 9,706 Microsoft Corp. 233,235 463 Novell, Inc.* 3,005 4,153 Oracle Corp.* 62,170 136 Parametric Technology Corp.* 2,103 1,205 Symantec Corp.* 20,931 ---------- 383,740 ---------- PERSONNEL SERVICES (0.1%) 1,471 Monster Worldwide, Inc.* 58,840 2,099 Robert Half International, Inc. 67,924 ---------- 126,764 ---------- PHARMACEUTICALS: GENERIC DRUGS (0.1%) 565 Barr Pharmaceuticals Inc.* 28,114 1,103 Mylan Laboratories, Inc. 24,222 552 Watson Pharmaceuticals, Inc.* 12,359 ---------- 64,695 ---------- PHARMACEUTICALS: MAJOR (5.0%) 9,098 Abbott Laboratories 434,611 11,667 Bristol-Myers Squibb Co. 279,658 17,648 Johnson & Johnson 1,103,882 6,732 Lilly (Eli) & Co. 382,176 12,864 Merck & Co., Inc. 518,033 SEE NOTES TO FINANCIAL STATEMENTS 22 NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- 44,130 Pfizer, Inc. $1,146,939 8,837 Schering-Plough Corp. 180,628 8,028 Wyeth 389,117 ---------- 4,435,044 ---------- PHARMACEUTICALS: OTHER (0.3%) 821 Allergan, Inc. 88,545 8,971 ArQule, Inc.* 46,290 1,758 Forest Laboratories, Inc.* 81,413 1,299 King Pharmaceuticals, Inc.* 22,109 10,032 Savient Pharmaceuticals Inc.* 59,189 ---------- 297,546 ---------- PRECIOUS METALS (0.5%) 2,792 Freeport-McMoRan Copper & Gold, Inc. (Class B) 152,332 6,449 Newmont Mining Corp. 330,382 ---------- 482,714 ---------- PROPERTY - CASUALTY INSURERS (0.8%) 1,844 ACE Ltd. (Cayman Islands) 95,021 3,655 Allstate Corp. (The) 207,677 2,254 Chubb Corp. (The) 113,647 977 Cincinnati Financial Corp. 46,075 1,114 Progressive Corp. (The) 26,948 3,929 St. Paul Travelers Companies, Inc. (The) 179,948 977 XL Capital Ltd. (Class A) (Cayman Islands) 62,235 ---------- 731,551 ---------- PULP & PAPER (0.4%) 7,432 International Paper Co. 255,141 2,725 MeadWestvaco Corp. 71,177 ---------- 326,318 ---------- RAILROADS (0.6%) 2,577 Burlington Northern Santa Fe Corp. 177,581 1,492 CSX Corp. 90,535 2,797 Norfolk Southern Corp. 121,446 1,827 Union Pacific Corp. 155,295 ---------- 544,857 ---------- REAL ESTATE DEVELOPMENT (0.0%) 3,500 AIRPORT FACILITIES Co., Ltd. (Japan) 23,905 ---------- SEE NOTES TO FINANCIAL STATEMENTS 23 NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- REAL ESTATE INVESTMENT TRUSTS (0.9%) 625 Apartment Investment & Management Co. (Class A) $ 30,056 1,385 Archstone-Smith Trust 72,671 588 Boston Properties, Inc. 57,742 2,639 Equity Office Properties Trust 100,044 1,898 Equity Residential 88,276 1,311 Kimco Realty Corp. 51,444 1,179 Plum Creek Timber Co., Inc. 40,157 1,591 ProLogis 88,062 535 Public Storage, Inc. 42,955 1,187 Simon Property Group, Inc. 101,524 765 Vornado Realty Trust 79,981 -------- 752,912 -------- RECREATIONAL PRODUCTS (0.2%) 1,073 Brunswick Corp. 31,729 1,946 Hasbro, Inc. 36,390 4,376 Mattel, Inc. 78,943 -------- 147,062 -------- REGIONAL BANKS (0.4%) 11,564 U.S. Bancorp 370,048 -------- RESTAURANTS (0.6%) 819 Darden Restaurants, Inc. 27,682 7,202 McDonald's Corp. 254,879 4,767 Starbucks Corp.* 163,317 666 Wendy's International, Inc. 40,067 1,602 Yum! Brands, Inc. 72,090 -------- 558,035 -------- SEMICONDUCTORS (2.2%) 3,552 Advanced Micro Devices, Inc.* 68,873 2,757 Altera Corp.* 47,724 2,726 Analog Devices, Inc. 88,132 3,274 Broadcom Corp. (Class A)* 78,543 3,000 Freescale Semiconductor Inc. (Class B)* 85,560 43,835 Intel Corp. 789,030 2,246 Linear Technology Corp. 72,658 2,826 LSI Logic Corp.* 23,173 2,403 Maxim Integrated Products, Inc. 70,600 4,892 Micron Technology, Inc.* 76,266 SEE NOTES TO FINANCIAL STATEMENTS 24 NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- 2,532 National Semiconductor Corp. $ 58,894 2,570 NVIDIA Corp.* 56,874 1,609 PMC - Sierra, Inc.* 8,222 11,856 Texas Instruments Inc. 353,072 2,505 Xilinx, Inc. 50,826 ---------- 1,928,447 ---------- SERVICES TO THE HEALTH INDUSTRY (0.2%) 449 Express Scripts, Inc.* 34,586 621 IMS Health Inc. 17,040 379 Laboratory Corp. of America Holdings* 24,415 930 Medco Health Solutions, Inc.* 55,177 490 Quest Diagnostics Inc. 29,459 399 Stericycle, Inc.* 26,805 ---------- 187,482 ---------- SPECIALTY INSURANCE (0.1%) 590 Ambac Financial Group, Inc. 49,035 754 MBIA Inc. 44,343 ---------- 93,378 ---------- SPECIALTY TELECOMMUNICATIONS (0.2%) 696 CenturyTel, Inc. 26,845 1,908 Citizens Communications Co. 24,480 9,241 Qwest Communications International, Inc.* 73,836 2,402 Windstream Corp. 30,095 ---------- 155,256 ---------- STEEL (0.5%) 1,282 Allegheny Technologies, Inc. 81,907 4,611 Nucor Corp. 245,167 1,641 United States Steel Corp. 103,498 ---------- 430,572 ---------- TELECOMMUNICATION EQUIPMENT (1.4%) 1,243 ADC Telecommunications, Inc.* 15,202 1,733 Andrew Corp.* 14,644 2,081 Comverse Technology, Inc.* 40,330 25,202 Motorola, Inc. 573,598 16,664 QUALCOMM, Inc. 587,573 ---------- 1,231,347 ---------- SEE NOTES TO FINANCIAL STATEMENTS 25
NUMBER OF SHARES VALUE - ----------------------------------------------------------------------------------------------- TOBACCO (2.0%) 19,472 Altria Group, Inc. $1,557,176 801 Reynolds American, Inc. 101,551 1,509 UST, Inc. 76,280 ---------- 1,735,007 ---------- TRUCKS/CONSTRUCTION/FARM MACHINERY (0.5%) 3,583 Caterpillar Inc. 253,927 247 Cummins Inc. 28,899 1,282 Deere & Co. 93,035 364 Navistar International Corp.* 8,139 890 PACCAR, Inc. 71,868 ---------- 455,868 ---------- WHOLESALE DISTRIBUTORS (0.0%) 482 Grainger (W.W.), Inc. 29,927 ---------- Total Common Stocks (COST $59,629,921) 66,587,720 ----------
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE - --------- ------ -------- Corporate Bonds (1.2%) ADVERTISING/MARKETING SERVICES (0.0%) $ 10 Interpublic Group of Companies, Inc. (The) 5.40% 11/15/09 9,075 10 WPP Finance (UK) Corp. - (United Kingdom) 5.875 06/15/14 9,803 ---------- 18,878 ---------- AEROSPACE & DEFENSE (0.1%) 15 Northrop Grumman Corp. 4.079 11/16/06 14,936 15 Systems 2001 Asset Trust - 144A** (Cayman Islands) 6.664 09/15/13 16,030 ---------- 30,966 ---------- AIR FREIGHT/COURIERS (0.0%) 10 Fedex Corp. 7.25 02/15/11 10,638 ---------- APPAREL/FOOTWEAR RETAIL (0.0%) 5 Limited Brands, Inc. 6.95 03/01/33 4,821 ---------- BEVERAGES: ALCOHOLIC (0.0%) 15 FBG Finance Ltd. - 144A** (Australia) 5.125 06/15/15 13,956 15 Miller Brewing Co. - 144A** 4.25 08/15/08 14,612 ---------- 28,568 ----------
SEE NOTES TO FINANCIAL STATEMENTS 26
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ---------------------------------------------------------------------------------------------- CABLE/SATELLITE TV (0.1%) $20 Comcast Cable Communications Inc. 6.75% 01/30/11 $ 20,788 20 Echostar DBS Corp. 6.375 10/01/11 19,600 -------- 40,388 -------- CHEMICALS: MAJOR DIVERSIFIED (0.0%) 15 ICI Wilmington Inc. 4.375 12/01/08 14,561 -------- CONTAINERS/PACKAGING (0.0%) 5 Sealed Air Corp. - 144A** 5.625 07/15/13 4,841 -------- ELECTRIC UTILITIES (0.1%) 5 Detroit Edison Co. (The) 6.125 10/01/10 5,094 10 Entergy Gulf States - 144A** 6.02@@ 12/08/08 10,019 10 Entergy Gulf States, Inc. 3.60 06/01/08 9,611 10 Entergy Gulf States, Inc. 5.631@@ 12/01/09 9,909 20 Monongahela Power Co. 5.00 10/01/06 19,975 5 Panhandle Eastern Pipe Line Co. (Series B) 2.75 03/15/07 4,910 30 PSEG Energy Holdings Inc. 8.625 02/15/08 31,012 10 Texas Eastern Transmission, LP 7.00 07/15/32 10,774 15 Wisconsin Electric Power Co. 3.50 12/01/07 14,631 -------- 115,935 -------- ELECTRICAL PRODUCTS (0.0%) 15 Cooper Industries, Inc. 5.25 11/15/12 14,684 -------- ELECTRONICS/APPLIANCES (0.0%) 10 LG Electronics Inc. - 144A** (South Korea) 5.00 06/17/10 9,573 -------- FINANCE/RENTAL/LEASING (0.1%) 20 Countrywide Home Loans, Inc. (Series MTN) 3.25 05/21/08 19,246 25 MBNA Corp. (Series MTNF) 5.58@@ 05/05/08 25,196 20 Nationwide Building Society - 144A** (United Kingdom) 4.25 02/01/10 19,199 20 Residential Capital Corp. 6.375 06/30/10 19,950 15 SLM Corp. 4.00 01/15/10 14,287 -------- 97,878 -------- FINANCIAL CONGLOMERATES (0.1%) 45 General Electric Capital Corp. 5.45 01/15/13 44,714 25 General Motors Acceptance Corp. 6.875 09/15/11 24,233 -------- 68,947 --------
SEE NOTES TO FINANCIAL STATEMENTS 27
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - --------------------------------------------------------------------------------------- FOOD: MAJOR DIVERSIFIED (0.0%) $ 10 ConAgra Foods, Inc. 7.00% 10/01/28 $10,337 ------- GAS DISTRIBUTORS (0.0%) 20 Nisource Finance Corp. 5.764@@ 11/23/09 20,047 10 Sempra Energy 4.621 05/17/07 9,929 ------- 29,976 ------- HOME FURNISHINGS (0.0%) 10 Mohawk Industries, Inc. (Series D) 7.20 04/15/12 10,386 ------- HOTELS/RESORTS/CRUISELINES (0.1%) 25 Hyatt Equities LLC - 144A** 6.875 06/15/07 25,171 10 Starwood Hotels & Resorts Worldwide, Inc. 7.375 05/01/07 10,113 ------- 35,284 ------- HOUSEHOLD/PERSONAL CARE (0.0%) 20 Clorox Co. (The) 5.444@@ 12/14/07 20,035 ------- INSURANCE BROKERS/SERVICES (0.1%) 100 Farmers Exchange Capital - 144A** 7.05 07/15/28 97,224 ------- MAJOR TELECOMMUNICATIONS (0.1%) 15 AT&T Corp. 8.00 11/15/31 17,553 5 Deutsche Telekom International Finance Corp. BV (Netherlands) 8.25 06/15/30 5,866 15 France Telecom S.A. (France) 8.50 03/01/31 18,559 10 SBC Communications, Inc. 6.15 09/15/34 9,325 10 Sprint Capital Corp. 8.75 03/15/32 12,215 15 Telecom Italia Capital SpA (Luxembourg) 4.00 01/15/10 14,130 10 Telefonica Europe BV (Netherlands) 8.25 09/15/30 11,607 ------- 89,255 ------- MANAGED HEALTH CARE (0.1%) 20 Health Net, Inc. 9.875 04/15/11 22,615 10 WellPoint Inc. 4.25 12/15/09 9,607 ------- 32,222 ------- MEDIA CONGLOMERATES (0.0%) 10 News America, Inc. 7.28 06/30/28 10,282 ------- MEDICAL DISTRIBUTORS (0.0%) 10 AmerisourceBergen Corp. 5.625 09/15/12 9,607 -------
SEE NOTES TO FINANCIAL STATEMENTS 28
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ----------------------------------------------------------------------------------------- MOTOR VEHICLES (0.0%) $ 5 DaimlerChrysler North American Holdings Co. 8.50% 01/18/31 $ 5,791 30 General Motors Corp. 8.375 07/15/33 24,750 ---------- 30,541 ---------- MULTI-LINE INSURANCE (0.1%) 35 AIG Sun America Global Finance VI - 144A** 6.30 05/10/11 36,115 10 American General Finance Corp. (Series MTNI) 4.625 05/15/09 9,767 10 AXA Financial, Inc. 6.50 04/01/08 10,119 ---------- 56,001 ---------- OTHER METALS/MINERALS (0.0%) 15 Brascan Corp. (Canada) 7.125 06/15/12 15,774 ---------- PROPERTY - CASUALTY INSURERS (0.1%) 10 Platinum Underwriters Finance Holdings, Ltd. (Series B) 7.50 06/01/17 9,936 10 Platinum Underwriters Holdings, Ltd. (Series B) (Bermuda) 6.371 11/16/07 9,922 20 St. Paul Travelers Companies, Inc. (The) 5.01 08/16/07 19,797 25 XLLIAC Global Funding - 144A** 4.80 08/10/10 24,223 ---------- 63,878 ---------- PULP & PAPER (0.0%) 5 Abitibi-Consolidated Inc. (Canada) 8.85 08/01/30 4,281 25 Bowater Canada Finance (Canada) 7.95 11/15/11 23,875 ---------- 28,156 ---------- RAILROADS (0.0%) 5 Union Pacific Corp. 6.625 02/01/08 5,078 ---------- REGIONAL BANKS (0.0%) 15 Marshall & Ilsley Bank (Series BKNT) 3.80 02/08/08 14,631 ---------- SAVINGS BANKS (0.1%) 35 Household Finance Corp. 8.00 07/15/10 37,979 13 Washington Mutual Inc. 8.25 04/01/10 14,021 ---------- 52,000 ---------- TRUCKS/CONSTRUCTION/FARM MACHINERY (0.0%) 20 Caterpillar Financial Services Corp. (Series MTNF) 5.259@@ 08/20/07 20,024 ---------- Total Corporate Bonds (COST $1,112,461) 1,091,369 ----------
SEE NOTES TO FINANCIAL STATEMENTS 29
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------ U.S. Government& Agencies Obligations (5.2%) Federal National Mortgage Assoc. $ 85 7.00% 07/01/29 $ 87,242 38 7.00 04/01/32 38,913 359 7.00 11/01/34 368,856 7 7.00 12/01/35 7,394 75 Federal National Mortgage Assoc. ARM 1.354 07/01/36 77,304 U.S. Treasury Bonds 1,125 6.125 08/15/29 1,271,514 85 6.375 08/15/27 98,049 50 8.125 08/15/21 65,336 U.S. Treasury Notes 400 3.50 11/15/06 398,219 2,130 5.625 05/15/08 2,153,215 ---------- Total U.S. Government & Agencies Obligations (COST $4,695,023) 4,566,042 ---------- Convertible Bonds (1.6%) AIRLINES (0.7%) 350 Continental Airlines Inc. 5.00 06/15/23 541,188 ---------- ELECTRONIC EQUIPMENT/INSTRUMENTS (0.3%) 300 JDS Uniphase Corp. 0.00 11/15/10 271,500 ---------- INTERNET RETAIL (0.3%) 300 Amazon.com, Inc. 4.75 02/01/09 293,250 ---------- OILFIELD SERVICES/EQUIPMENT (0.4%) 200 Schlumberger Ltd. 2.125 06/01/23 346,000 ---------- Total Convertible Bonds (COST $1,068,003) 1,451,938 ---------- Asset-Backed Securities (0.5%) FINANCE/RENTAL/LEASING 150 American Express Credit Account Master Trust 2002-3 A 5.479@@ 12/15/09 150,233 58 Capital Auto Receivables Asset Trust 2003-3 A3B 5.449@@ 01/15/08 57,943 100 GE Capital Credit Card Master Note Trust 2004-1 A 5.419 06/15/10 100,108 100 GE Capital Credit Card Master Note Trust 2004-2 A 5.409@@ 09/15/10 100,112
SEE NOTES TO FINANCIAL STATEMENTS 30
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------- $25 TXU Electric Delivery Transition Bond Co. LLC 2004-1 A2 4.81% 11/17/14 $ 24,235 -------- Total Asset-Backed Securities (COST $433,183) 432,631 -------- Collateralized Mortgage Obligations (0.4%) 67 Greenpoint Mortgage Funding Trust 2006-AR2 3A2 5.705@@ 03/25/36 67,238 49 Harborview Mortgage Loan Trust 2006-1 2A1A 5.61@@ 03/19/37 49,392 64 Structured Asset Mortgage Investments Inc. 2006-AR1 2A2 5.695@@ 02/25/36 64,642 69 Structured Asset Mortgage Investments Inc. 2006-AR2 A2 5.695@@ 02/25/36 69,415 46 Washington Mutual Bank 2005-AR6 2AB3 5.655@@ 04/25/45 46,544 45 Washington Mutual Bank 2005-AR15 A1B1 5.635@@ 11/25/45 44,897 -------- Total Collateralized Mortgage Obligations (COST $341,201) 342,128 --------
NUMBER OF SHARES - --------- Convertible Preferred Stock (0.3%) LIFE/HEALTH INSURANCE 8,800 MetLife, Inc. (Series B) $1.5938 (COST $227,920) 241,648 --------
NUMBER OF CONTRACTS - --------- Put Option Purchased (0.0%) 5,000 VIX Index August/2006 @ $125 (COST $10,150) 12,000 --------
SEE NOTES TO FINANCIAL STATEMENTS 31
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------- Short-Term Investments (15.6%) U.S. Government Agencies & Obligations (0.6%) (a) $ 500 Federal National Mortgage Assoc. 5.18% 08/03/06 $ 498,417 50 U.S. Treasury Bills+ 5.09 07/11/06 48,848 ----------- Total U.S. Government Agencies & Obligations (COST $547,265) 547,265 ----------- Repurchase Agreement (15.0%) 13,165 Joint repurchase agreement account (dated 07/31/06; proceeds $13,166,927) (b) (COST $13,165,000) 5.27 08/01/06 13,165,000 ----------- Total Short-Term Investments (COST $13,712,265) 13,712,265 ----------- Total Investments (COST $81,230,127) (c) (d) 100.3% 88,437,741 Liabilities in Excess of Other Assets (0.3) (266,793) ----- ----------- Net Assets 100.0% $88,170,948 ===== ===========
- ---------- ADR AMERICAN DEPOSITARY RECEIPT. ARM ADJUSTABLE RATE MORTGAGE. * NON-INCOME PRODUCING SECURITY. ** RESALE IS RESTRICTED TO QUALIFIED INSTITUTIONAL INVESTORS. + A PORTION OF THIS SECURITIES HAS BEEN PHYSICALLY SEGREGATED IN CONNECTION WITH OPEN FUTURES CONTRACTS IN THE AMOUNT OF $11,610. @@ RATE SHOWN IS THE RATE IN EFFECT AT JULY 31, 2006. (a) PURCHASED ON A DISCOUNT BASIS. THE INTEREST RATE SHOWN HAS BEEN ADJUSTED TO REFLECT A MONEY MARKET EQUIVALENT YIELD. (b) COLLATERALIZED BY FEDERAL AGENCY AND U.S. TREASURY OBLIGATIONS. (c) SECURITIES HAVE BEEN DESIGNATED AS COLLATERAL IN AN AMOUNT EQUAL TO $9,097,493 IN CONNECTION WITH OPEN FUTURES CONTRACTS. (d) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES APPROXIMATES THE AGGREGATE COST FOR BOOK PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION IS $8,972,559 AND THE AGGREGATE GROSS UNREALIZED DEPRECIATION IS $1,764,945, RESULTING IN NET UNREALIZED APPRECIATION OF $7,207,614. SEE NOTES TO FINANCIAL STATEMENTS 32 FUTURES CONTRACTS OPEN AT JULY 31, 2006:
UNREALIZED NUMBER OF DESCRIPTION, DELIVERY UNDERLYING FACE APPRECIATION CONTRACTS LONG/SHORT MONTH AND YEAR AMOUNT AT VALUE (DEPRECIATION) - --------------------------------------------------------------------------------------- 45 Long US Treasury Notes 10 Year, September 2006 $ 4,771,406 $ 31,912 7 Short US Treasury Notes 2 Year, September 2006 (1,424,281) 331 14 Short US Treasury Notes 5 Year, September 2006 (1,459,063) (7,218) 14 Short US Treasury Bonds 30 Year, September 2006 (1,515,938) (22,757) -------- Net Unrealized Appreciation $ 2,268 ========
SEE NOTES TO FINANCIAL STATEMENTS 33 MORGAN STANLEY ALLOCATOR FUND FINANCIAL STATEMENTS Statement of Assets and Liabilities JULY 31, 2006 (UNAUDITED) Assets: Investments in securities, at value (cost $81,230,127) (including repurchase agreement of $13,165,000) $88,437,741 Cash 3,361 Receivable for: Investments sold 401,889 Interest 96,272 Dividends 71,253 Shares of beneficial interest sold 9,675 Variation margin 531 Prepaid expenses and other assets 5,722 ----------- Total Assets 89,026,444 ----------- Liabilities: Payable for: Investments purchased 398,811 Shares of beneficial interest redeemed 226,737 Distribution fee 67,038 Investment advisory fee 50,589 Transfer agent fee 8,641 Administration fee 6,040 Accrued expenses and other payables 97,640 ----------- Total Liabilities 855,496 ----------- Net Assets $88,170,948 =========== Composition of Net Assets: Paid-in-capital $75,172,691 Net unrealized appreciation 7,209,882 Accumulated undistributed net investment income 94,721 Accumulated undistributed net realized gain 5,693,654 ----------- Net Assets $88,170,948 =========== Class A Shares: Net Assets $11,427,041 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 1,015,438 Net Asset Value Per Share $ 11.25 =========== Maximum Offering Price Per Share, (NET ASSET VALUE PLUS 5.54% OF NET ASSET VALUE) $ 11.87 =========== Class B Shares: Net Assets $65,395,101 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 5,922,404 Net Asset Value Per Share $ 11.04 =========== Class C Shares: Net Assets $ 9,979,563 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 903,764 Net Asset Value Per Share $ 11.04 =========== Class D Shares: Net Assets $ 1,369,243 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 120,984 Net Asset Value Per Share $ 11.32 =========== Statement of Operations FOR THE SIX MONTHS ENDED JULY 31, 2006 (UNAUDITED) Net Investment Income: Income Dividends (net of $2,393 foreign withholding tax) $ 721,948 Interest 338,579 ----------- Total Income 1,060,527 ----------- Expenses Distribution fee (Class A shares) 14,976 Distribution fee (Class B shares) 357,578 Distribution fee (Class C shares) 50,539 Investment advisory fee 322,513 Shareholder reports and notices 46,216 Transfer agent fees and expenses 43,526 Administration fee 38,509 Professional fees 37,093 Custodian fees 26,685 Registration fees 23,725 Trustees' fees and expenses 672 Other 8,586 ----------- Total Expenses 970,618 Less: expense offset (205) ----------- Net Expenses 970,413 ----------- Net Investment Income 90,114 ----------- Net Realized and Unrealized Gain (Loss): Net Realized Gain (Loss) on: Investments 6,855,445 Futures contracts (165,015) Option contracts (527,275) Foreign exchange transactions 74,992 ----------- Net Realized Gain 6,238,147 ----------- Net Change in Unrealized Appreciation/Depreciation on: Investments (7,062,671) Futures contracts 22,612 Option contracts 1,850 ----------- Net Depreciation (7,038,209) ----------- Net Loss (800,062) ----------- Net Decrease $ (709,948) =========== SEE NOTES TO FINANCIAL STATEMENTS 34 Statements of Changes in Net Assets
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JULY 31, 2006 JANUARY 31, 2006 ------------- ---------------- (UNAUDITED) Increase (Decrease) in Net Assets: Operations: Net investment income (loss) $ 90,114 $ (187,463) Net realized gain 6,238,147 1,661,513 Net change in unrealized appreciation/depreciation (7,038,209) 7,857,167 ------------ ------------ Net Increase (Decrease) (709,948) 9,331,217 ------------ ------------ Dividends and Distributions to Shareholders from: Net investment income Class A shares -- (30,703) Class B shares -- (106,787) Class C shares -- (20,999) Class D shares -- (8,201) Net realized gain Class A shares (24,564) (280,315) Class B shares (150,159) (1,746,235) Class C shares (23,036) (267,702) Class D shares (3,741) (61,375) ------------ ------------ Total Dividends and Distributions (201,500) (2,522,317) ------------ ------------ Net decrease from transactions in shares of beneficial interest (16,722,128) (55,804,778) ------------ ------------ Net Decrease (17,633,576) (48,995,878) Net Assets: Beginning of period 105,804,524 154,800,402 ------------ ------------ End of Period (INCLUDING ACCUMULATED UNDISTRIBUTED NET INVESTMENT INCOME OF $94,721 AND $4,607, RESPECTIVELY) $ 88,170,948 $105,804,524 ============ ============
SEE NOTES TO FINANCIAL STATEMENTS 35 MORGAN STANLEY ALLOCATOR FUND NOTES TO FINANCIAL STATEMENTS - JULY 31, 2006 (UNAUDITED) 1. Organization and Accounting Policies Morgan Stanley Allocator Fund (the "Fund") is registered under the Investment Company Act of 1940, as amended (the "Act"), as a diversified, open-end management investment company. The Fund's investment objective is selecting securities to maximize total investment return through different stages of an economic cycle. The Fund was organized as a Massachusetts business trust on October 25, 2002 and commenced operations on February 26, 2003. The Fund offers Class A shares, Class B shares, Class C shares and Class D shares. The four classes are substantially the same except that most Class A shares are subject to a sales charge imposed at the time of purchase and some Class A shares, and most Class B shares and Class C shares are subject to a contingent deferred sales charge imposed on shares redeemed within eighteen months, six years and one year, respectively. Class D shares are not subject to a sales charge. Additionally, Class A shares, Class B shares and Class C shares incur distribution expenses. The Fund will assess a 2% redemption fee, on Class A shares, Class B shares, Class C shares, and Class D shares, which is paid directly to the Fund, for shares redeemed within seven days of purchase, subject to certain exceptions. The redemption fee is designed to protect the Fund and its remaining shareholders from the effects of short-term trading. The following is a summary of significant accounting policies: A. Valuation of Investments -- (1) an equity portfolio security listed or traded on the New York Stock Exchange ("NYSE") or American Stock Exchange or other exchange is valued at its latest sale price prior to the time when assets are valued; if there were no sales that day, the security is valued at the mean between the last reported bid and asked price; (2) an equity portfolio security listed or traded on the Nasdaq is valued at the Nasdaq Official Closing Price; if there were no sales that day, the security is valued at the mean between the last reported bid and asked price; (3) all other portfolio securities for which over-the-counter market quotations are readily available are valued at the mean between the last reported bid and asked price. In cases where a security is traded on more than one exchange, the security is valued on the exchange designated as the primary market; (4) for equity securities traded on foreign exchanges, the last reported sale price or the latest bid price may be used if there were no sales on a particular day; (5) listed options are valued at the latest sale price on the exchange on which they are listed unless no sales of such options have taken place that day, in which case they are valued at the mean between their latest bid and asked price;(6) futures are valued at the latest price published by the commodities exchange on which they trade; (7) when market quotations are not readily available including circumstances under which Morgan Stanley Investment Advisors Inc. (the "Investment Adviser"), determines that the latest sale price, the bid price or the mean between the last reported bid and asked price do not reflect a security's market value, portfolio securities are valued at their fair 36 value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees. Occasionally, developments affecting the closing prices of securities and other assets may occur between the times at which valuations of such securities are determined (that is, close of the foreign market on which the securities trade) and the close of business on the NYSE. If developments occur during such periods that are expected to materially affect the value of such securities, such valuations may be adjusted to reflect the estimated fair value of such securities as of the close of the NYSE, as determined in good faith by the Fund's Trustees or by the Investment Adviser using a pricing service and/or procedures approved by the Trustees of the Fund; (8) certain portfolio securities may be valued by an outside pricing service approved by the Fund's Trustees; and (9) short-term debt securities having a maturity date of more than sixty days at time of purchase are valued on a mark-to-market basis until sixty days prior to maturity and thereafter at amortized cost based on their value on the 61st day. Short-term debt securities having a maturity date of sixty days or less at the time of purchase are valued at amortized cost. B. Accounting for Investments -- Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Realized gains and losses on security transactions are determined by the identified cost method. Dividend income and other distributions are recorded on the ex-dividend date. Discounts are accreted and premiums are amortized over the life of the respective securities. Interest income is accrued daily. C. Repurchase Agreements -- Pursuant to an Exemptive Order issued by the Securities and Exchange Commission, the Fund, along with other affiliated entities managed by the Investment Adviser, may transfer uninvested cash balances into one or more joint repurchase agreement accounts. These balances are invested in one or more repurchase agreements and are collateralized 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. 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. Option -- When the Fund writes a call option, an amount equal to the premium received is included in the Fund's Statement of Assets and Liabilities as a liability which is subsequently marked-to-market to reflect the current market value of the option written. If a written option either expires or the Fund enters into a closing purchase transaction, the Fund realizes a gain or loss without regard to any unrealized gain or loss on the underlying security and the liability related to such option is extinguished. 37 If a written call option is exercised, the Fund realizes a gain or loss from the sale of the underlying security and the proceeds from such sale are increased by the premium originally received. When the Fund purchases a call or put option, the premium paid is recorded as an investment and is subsequently marked-to-market to reflect the current market value. If a purchased option expires, the Fund will realize a loss to the extent of the premium paid. If the Fund enters into a closing sale transaction, a gain or loss is realized for the difference between the proceeds from the sale and the cost of the option. If a put option is exercised, the cost of the security or currency sold upon exercise will be increased by the premium originally paid. If a call option is exercised, the cost of the security purchased upon exercise will be increased by the premium originally paid. F. Futures Contracts -- A futures contract is an agreement between two parties to buy and sell financial instruments or contracts based on financial indices at a set price on a future date. Upon entering into such a contract, the Fund is required to pledge to the broker cash, U.S. Government securities or other liquid portfolio securities equal to the minimum initial margin requirements of the applicable futures exchange. Pursuant to the contract, the Fund agrees to receive from or pay to the broker an amount of cash equal to the daily fluctuation in the value of the contract. Such receipts or payments known as variation margin are recorded by the Fund as unrealized gains and losses. Upon closing of the contract, the Fund realizes a gain or loss equal to the difference between the value of the contract at the time it was opened and the value at the time it was closed. G. Foreign Currency Translation and Forward Foreign Currency Contracts -- The books and records of the Fund are maintained in U.S. dollars as follows: (1) the foreign currency market value of investment securities, other assets and liabilities and forward foreign currency contracts ("forward contracts") are translated at the exchange rates prevailing at the end of the period; and (2) purchases, sales, income and expenses are translated at the exchange rates prevailing on the respective dates of such transactions. The resultant exchange gains and losses are recorded as realized and unrealized gain/loss on foreign exchange transactions. Pursuant to U.S. federal income tax regulations, certain foreign exchange gains/losses included in realized and unrealized gain/loss are included in or are a reduction of ordinary income for federal income tax purposes. The Fund does not isolate that portion of the results of operations arising as a result of changes in the foreign exchange rates from the changes in the market prices of the securities. Forward contracts are valued daily at the appropriate exchange rates. The resultant unrealized exchange gains and losses are recorded as unrealized foreign currency gain or loss. The Fund records realized gains or losses on delivery of the currency or at the time the forward contract is extinguished (compensated) by entering into a closing transaction prior to delivery. 38 H. 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. I. Dividends and Distributions to Shareholders -- Dividends and distributions to shareholders are recorded on the ex-dividend date. J. Use of Estimates -- The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts and disclosures. Actual results could differ from those estimates. 2. Investment Advisory/Administration Agreements Pursuant to an Investment Advisory Agreement with the Investment Adviser, the Fund pays an advisory fee, accrued daily and payable monthly, by applying the following annual rate of 0.67% to the net assets of the Fund determined as of the close of each business day. Pursuant to an Administration Agreement with Morgan Stanley Services Company Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Fund pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.08% to the Fund's daily net assets. 3. Plan of Distribution Shares of the Fund are distributed by Morgan Stanley Distributors Inc. (the "Distributor"), an affiliate of the Investment Adviser and Administrator. The Fund has adopted a Plan of Distribution (the "Plan") pursuant to Rule 12b-1 under the Act. The Plan provides that the Fund will pay the Distributor a fee which is accrued daily and paid monthly at the following annual rates: (i) Class A -- up to 0.25% of the average daily net assets of Class A; (ii) Class B -- up to 1.0% of the average daily net assets of Class B; and (iii) Class C -- up to 1.0% 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 Trustees will consider at that time the manner in which to treat such expenses. The Distributor has advised the Fund that such excess amounts totaled $2,332,140 at July 31, 2006. 39 In the case of Class A shares and Class C shares, expenses incurred pursuant to the Plan in any calendar year in excess of 0.25% or 1.0% of the average daily net assets of Class A or Class C, respectively, will not be reimbursed by the Fund through payments in any subsequent year, except that expenses representing a gross sales credit to Morgan Stanley Financial Advisors and other authorized financial representatives at the time of sale may be reimbursed in the subsequent calendar year. For the six months ended July 31, 2006, the distribution fee was accrued for Class A shares and Class C shares at the annual rate of 0.25% and 0.93%, respectively. The Distributor has informed the Fund that for the six months ended July 31, 2006, it received contingent deferred sales charges from certain redemptions of the Fund's Class B shares and Class C shares of $148,528 and $35, respectively and received $10,838 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 six months ended July 31, 2006 aggregated $68,064,077 and $97,213,888, respectively. Included in the aforementioned transactions are purchases and sales of U.S. Government Securities of $3,569,778 and $5,095,479, respectively. For the six months ended July 31, 2006, the Fund incurred brokerage commissions of $37,388 with Morgan Stanley & Co., Inc., an affiliate of the Investment Adviser, Administrator and Distributor, for portfolio transactions executed on behalf of the Fund. Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and Distributor, is the Fund's transfer agent. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees they receive for serving on the Board of Trustees. Each eligible Trustee generally may elect to have their deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 40 5. Shares of Beneficial Interest Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JULY 31, 2006 JANUARY 31, 2006 -------------------------- -------------------------- (UNAUDITED) SHARES AMOUNT SHARES AMOUNT ---------- ------------ ---------- ------------ CLASS A SHARES Sold 71,215 $ 805,525 130,412 $ 1,398,758 Conversion from Class B 42,843 487,700 446,198 4,656,810 Reinvestment of distributions 1,974 21,856 26,104 284,217 Redeemed (219,686) (2,513,495) (945,211) (10,159,118) ---------- ------------ ---------- ------------ Net decrease -- Class A (103,654) (1,198,414) (342,497) (3,819,333) ---------- ------------ ---------- ------------ CLASS B SHARES Sold 34,482 391,153 193,023 2,051,630 Conversion to Class A (43,573) (487,700) (450,707) (4,656,810) Reinvestment of distributions 12,612 137,093 157,594 1,696,218 Redeemed (1,120,222) (12,550,717) (3,903,323) (41,668,802) ---------- ------------ ---------- ------------ Net decrease -- Class B (1,116,701) (12,510,171) (4,003,413) (42,577,764) ---------- ------------ ---------- ------------ CLASS C SHARES Sold 9,654 107,964 59,450 636,808 Reinvestment of distributions 1,980 21,524 24,827 267,182 Redeemed (185,136) (2,058,798) (612,837) (6,563,942) ---------- ------------ ---------- ------------ Net decrease -- Class C (173,502) (1,929,310) (528,560) (5,659,952) ---------- ------------ ---------- ------------ CLASS D SHARES Sold 9,600 110,878 12,403 135,637 Reinvestment of distributions 276 3,073 5,753 62,699 Redeemed (105,032) (1,198,184) (366,432) (3,946,065) ---------- ------------ ---------- ------------ Net decrease -- Class D (95,156) (1,084,233) (348,276) (3,747,729) ---------- ------------ ---------- ------------ Net decrease in Fund (1,489,013) $(16,722,128) (5,222,746) $(55,804,778) ========== ============ ========== ============
6. Expense Offset The expense offset represents a reduction of the transfer agent fees and expenses for earnings on cash balances maintained by the Fund. 7. Purposes of and Risks Relating to Certain Financial Instruments For hedging and investment purposes, the Fund may engage in transactions in listed and over-the-counter options and interest rate futures or in the case of forward contracts, to facilitate settlement of foreign 41 currency denominated portfolio transactions or to manage foreign currency exposure associated with foreign currency denominated securities ("derivative instruments"). These derivative instruments involve elements of market risk in excess of the amounts reflected in the Statement of Assets and Liabilities. The Fund bears the risk of an unfavorable change in the underlying securities or currencies. Risks may also arise upon entering into these contracts from the potential inability of the counterparties to meet the terms of their contracts. 8. Federal Income Tax Status The amount of dividends and distributions from net investment income and net realized capital gains are determined in accordance with federal income tax regulations which may differ from generally accepted accounting principles. These "book/tax" differences are either considered temporary or permanent in nature. To the extent these differences are permanent in nature, such amounts are reclassified within the capital accounts based on their federal tax-basis treatment; temporary differences do not require reclassification. Dividends and distributions which exceed net investment income and net realized capital gains for tax purposes are reported as distributions of paid-in-capital. As of January 31, 2006, the Fund had temporary book/tax differences primarily attributable to capital loss deferrals on wash sales and straddles, mark-to-market of open futures contracts and tax adjustment on real estate investment trusts held by the Fund. 9. Legal Matters The Investment Adviser, certain affiliates of the Investment Adviser, certain officers of such affiliates and certain investment companies advised by the Investment Adviser or its affiliates, including the Fund, are named as defendants in a consolidated class action. This consolidated action also names as defendants certain individual Trustees and Directors of the Morgan Stanley funds. The consolidated amended complaint, filed in the United States District Court Southern District of New York on April 16, 2004, generally alleges that defendants, including the Fund, violated their statutory disclosure obligations and fiduciary duties by failing properly to disclose (i) that the Investment Adviser and certain affiliates of the Investment Adviser allegedly offered economic incentives to brokers and others to recommend the funds advised by the Investment Adviser or its affiliates to investors rather than funds managed by other companies, and (ii) that the funds advised by the Investment Adviser 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 have moved to dismiss the action. On March 9, 2005, Plaintiffs sought leave to supplement their complaint to assert claims on behalf of other investors, which motion defendants opposed. On April 14, 2006, the Court 42 granted defendants' motion to dismiss in its entirety. Additionally, the Court denied Plaintiff's motion to supplement their complaint. This matter is now concluded. 10. New Accounting Pronouncement In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation 48, Accounting for Uncertainty in Income Taxes -- an interpretation of FASB Statement 109 (FIN 48). FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position must meet before being recognized in the financial statements. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Fund will adopt FIN 48 during 2007 and the impact to the Fund's financial statements, if any, is currently being assessed. 43 MORGAN STANLEY ALLOCATOR FUND FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE YEAR ENDED FOR THE PERIOD FOR THE SIX JANUARY 31, FEBRUARY 26, 2003* MONTHS ENDED ------------------ THROUGH JULY 31, 2006 2006 2005 JANUARY 31, 2004 ------------- ------- -------- ------------------ (UNAUDITED) Class A Shares Selected Per Share Data: Net asset value, beginning of period $ 11.34 $ 10.62 $ 11.39 $ 10.00 ------- ------- ------- ------- Income (loss) from investment operations: Net investment income++ 0.05 0.05 0.09 0.05 Net realized and unrealized gain (loss) (0.12) 0.91 0.32 1.67 ------- ------- ------- ------- Total income (loss) from investment operations (0.07) 0.96 0.41 1.72 ------- ------- ------- ------- Less dividends and distributions from: Net investment income -- (0.02) (0.10) -- Net realized gain (0.02) (0.22) (1.08) (0.33) ------- ------- ------- ------- Total dividends and distributions (0.02) (0.24) (1.18) (0.33) ------- ------- ------- ------- Net asset value, end of period $ 11.25 $ 11.34 $ 10.62 $ 11.39 ======= ======= ======= ======= Total Return+ (0.66)%(1) 9.25% 3.57% 17.16%(1) Ratios to Average Net Assets(3): Total expenses (before expense offset) 1.39%(2) 1.38% 1.23% 1.23%(2) Net investment income 0.81%(2) 0.49% 0.84% 0.47%(2) Supplemental Data: Net assets, end of period, in thousands $11,427 $12,691 $15,527 $22,141 Portfolio turnover rate 75%(1) 64% 126% 239%(1)
- ---------- * COMMENCEMENT OF OPERATIONS. ++ 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) NOT ANNUALIZED. (2) ANNUALIZED. (3) REFLECTS OVERALL FUND RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. SEE NOTES TO FINANCIAL STATEMENTS 44
FOR THE YEAR ENDED FOR THE PERIOD FOR THE SIX JANUARY 31, FEBRUARY 26, 2003* MONTHS ENDED ------------------ THROUGH JULY 31, 2006 2006 2005 JANUARY 31, 2004 ------------- ------- -------- ------------------ (UNAUDITED) Class B Shares Selected Per Share Data: Net asset value, beginning of period $ 11.17 $ 10.54 $ 11.31 $ 10.00 ------- ------- -------- -------- Income (loss) from investment operations: Net investment income (loss)++ 0.00 (0.03) 0.01 (0.03) Net realized and unrealized gain (loss) (0.11) 0.89 0.31 1.67 ------- ------- -------- -------- Total income (loss) from investment operations (0.11) 0.86 0.32 1.64 ------- ------- -------- -------- Less dividends and distributions from: Net investment income -- (0.01) (0.01) -- Net realized gain (0.02) (0.22) (1.08) (0.33) ------- ------- -------- -------- Total dividends and distributions (0.02) (0.23) (1.09) (0.33) ------- ------- -------- -------- Net asset value, end of period $ 11.04 $ 11.17 $ 10.54 $ 11.31 ======= ======= ======= ======== Total Return+ (1.03)%(1) 8.37% 2.84% 16.36%(1) Ratios to Average Net Assets(3): Total expenses (before expense offset) 2.14%(2) 2.13% 1.98% 2.02%(2) Net investment income (loss) 0.06%(2) (0.26)% 0.09% (0.32)%(2) Supplemental Data: Net assets, end of period, in thousands $65,395 $78,623 $116,344 $157,175 Portfolio turnover rate 75%(1) 64% 126% 239%(1)
- ---------- * COMMENCEMENT OF OPERATIONS. ++ 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) NOT ANNUALIZED. (2) ANNUALIZED. (3) REFLECTS OVERALL FUND RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. SEE NOTES TO FINANCIAL STATEMENTS 45
FOR THE YEAR ENDED FOR THE PERIOD FOR THE SIX JANUARY 31, FEBRUARY 26, 2003* MONTHS ENDED ------------------ THROUGH JULY 31, 2006 2006 2005 JANUARY 31, 2004 ------------- ------- -------- ------------------ (UNAUDITED) Class C Shares Selected Per Share Data: Net asset value, beginning of period $11.17 $ 10.54 $ 11.31 $ 10.00 ------ ------- ------- ------- Income (loss) from investment operations: Net investment income (loss)++ 0.01 (0.03) 0.01 (0.03) Net realized and unrealized gain (loss) (0.12) 0.90 0.32 1.67 ------ ------- ------- ------- Total income (loss) from investment operations (0.11) 0.87 0.33 1.64 ------ ------- ------- ------- Less dividends and distributions from: Net investment income -- (0.02) (0.02) -- Net realized gain (0.02) (0.22) (1.08) (0.33) ------ ------- ------- ------- Total dividends and distributions (0.02) (0.24) (1.10) (0.33) ------ ------- ------- ------- Net asset value, end of period $11.04 $ 11.17 $ 10.54 $ 11.31 ====== ======= ======= ======= Total Return+ (0.94)%(1) 8.41% 2.76% 16.36%(1) Ratios to Average Net Assets(3): Total expenses (before expense offset) 2.07%(2) 2.13% 1.96% 2.02%(2) Net investment income (loss) 0.13%(2) (0.26)% 0.11% (0.32)%(2) Supplemental Data: Net assets, end of period, in thousands $9,980 $12,029 $16,920 $21,927 Portfolio turnover rate 75%(1) 64% 126% 239%(1)
- ---------- * COMMENCEMENT OF OPERATIONS. ++ 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) NOT ANNUALIZED. (2) ANNUALIZED. (3) REFLECTS OVERALL FUND RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. SEE NOTES TO FINANCIAL STATEMENTS 46
FOR THE YEAR FOR THE PERIOD FOR THE SIX ENDED JANUARY 31, FEBRUARY 26, 2003* MONTHS ENDED ----------------- THROUGH JULY 31, 2006 2006 2005 JANUARY 31, 2004 ------------- ------ ------ ------------------ (UNAUDITED) Class D Shares Selected Per Share Data: Net asset value, beginning of period $11.39 $10.65 $11.42 $ 10.00 ------ ------ ------ ------- Income (loss) from investment operations: Net investment income++ 0.06 0.08 0.12 0.07 Net realized and unrealized gain (loss) (0.11) 0.90 0.32 1.68 ------ ------ ------ ------- Total income (loss) from investment operations (0.05) 0.98 0.44 1.75 ------ ------ ------ ------- Less dividends and distributions from: Net investment income -- (0.02) (0.13) -- Net realized gain (0.02) (0.22) (1.08) (0.33) ------ ------ ------ ------- Total dividends and distributions (0.02) (0.24) (1.21) (0.33) ------ ------ ------ ------- Net asset value, end of period $11.32 $11.39 $10.65 $ 11.42 ====== ====== ====== ======= Total Return+ (0.48)%(1) 9.44% 3.84% 17.46%(1) Ratios to Average Net Assets(3): Total expenses (before expense offset) 1.14%(2) 1.13% 0.98% 1.02%(2) Net investment income 1.06%(2) 0.74% 1.09% 0.68%(2) Supplemental Data: Net assets, end of period, in thousands $1,369 $2,462 $6,009 $13,006 Portfolio turnover rate 75%(1) 64% 126% 239%(1)
- ---------- * COMMENCEMENT OF OPERATIONS. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) NOT ANNUALIZED. (2) ANNUALIZED. (3) REFLECTS OVERALL FUND RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. SEE NOTES TO FINANCIAL STATEMENTS 47 TRUSTEES Frank L. Bowman Michael Bozic Kathleen A. Dennis Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael F. Klein Michael E. Nugent W. Allen Reed Fergus Reid OFFICERS Michael E. Nugent CHAIRMAN OF THE BOARD Ronald E. Robison PRESIDENT AND PRINCIPAL EXECUTIVE OFFICER J. David Germany VICE PRESIDENT Dennis F. Shea VICE PRESIDENT Barry Fink VICE PRESIDENT Amy R. Doberman VICE PRESIDENT Carsten Otto CHIEF COMPLIANCE OFFICER Stefanie V. Chang Yu VICE PRESIDENT Francis J. Smith TREASURER AND CHIEF FINANCIAL OFFICER Mary E. Mullin SECRETARY TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT ADVISER Morgan Stanley Investment Advisors Inc. 1221 Avenue of the Americas New York, New York 10020 The financial statements included herein have been taken from the records of the Fund without examination by the independent auditors and accordingly they do not express an opinion thereon. This report is submitted for the general information of the shareholders of the Fund. For more detailed information about the Fund, its fees and expenses and other pertinent information, please read its Prospectus. The Fund's Statement of Additional Information contains additional information about the Fund, including its trustees. It is available, without charge, by calling (800) 869-NEWS. This report is not authorized for distribution to prospective investors in the Fund unless preceded or accompanied by an effective Prospectus. Read the Prospectus carefully before investing. Investments and services offered through Morgan Stanley DW Inc., member SIPC. Morgan Stanley Distributors Inc., member NASD. (C) 2006 Morgan Stanley [Morgan Stanley LOGO] MORGAN STANLEY FUNDS Morgan Stanley Allocator Fund Semiannual Report July 31, 2006 [Morgan Stanley LOGO] ALRSAR-39947RPT-RA06-00838P-Y07/06 Item 2. Code of Ethics. Not applicable for semiannual reports. Item 3. Audit Committee Financial Expert. Not applicable for semiannual reports. Item 4. Principal Accountant Fees and Services Not applicable for semiannual reports. Item 5. Audit Committee of Listed Registrants. Not applicable for semiannual reports. Item 6. Refer to Item 1. Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies. Not applicable for semiannual reports. Item 8. Portfolio Managers of Closed-End Management Investment Companies Applicable only to reports filed by closed-end funds. Item 9. Closed-End Fund Repurchases Applicable to reports filed by closed-end funds. Item 10. Submission of Matters to a Vote of Security Holders Not applicable. Item 11. Controls and Procedures (a) The Fund's principal executive officer and principal financial officer have concluded that the Fund's disclosure controls and procedures are sufficient to ensure that information required to be disclosed by the Fund in this Form N-CSR was recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, based upon such officers' evaluation of these controls and procedures as of a date within 90 days of the filing date of the report. (b) There were no changes in the registrant's internal control over financial reporting that occurred during the second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. Item 12. Exhibits (a) Code of Ethics - Not applicable for semiannual reports. (b) A separate certification for each principal executive officer and principal financial officer of the registrant are attached hereto as part of EX-99.CERT. 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 Allocator Fund /s/ Ronald E. Robison - ------------------------------------- Ronald E. Robison Principal Executive Officer September 21, 2006 Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ Ronald E. Robison - ------------------------------------- Ronald E. Robison Principal Executive Officer September 21, 2006 /s/ Francis Smith - ------------------------------------- Francis Smith Principal Financial Officer September 21, 2006 EX-99.CERT 2 a2173151zex-99_cert.txt EX-99.CERT EXHIBIT 12 B1 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER CERTIFICATIONS I, Ronald E. Robison, certify that: 1. I have reviewed this report on Form N-CSR of Morgan Stanley Allocator Fund; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, changes in net assets, and cash flows (if the financial statements are required to include a statement of cash flows) of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940) and internal control over financial reporting (as defined in Rule 30a-3(d) under the Investment Company Act of 1940) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of a date within 90 days prior to the filing date of this report based on such evaluation; and d) disclosed in this report any change 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; and 5. The registrant's other certifying officer(s) and I have disclosed to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: September 21, 2006 /s/ Ronald E. Robison ---------------------------------------- Ronald E. Robison Principal Executive Officer EXHIBIT 12 B2 CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER CERTIFICATIONS I, Francis Smith, certify that: 1. I have reviewed this report on Form N-CSR of Morgan Stanley Allocator Fund; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, changes in net assets, and cash flows (if the financial statements are required to include a statement of cash flows) of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940) and internal control over financial reporting (as defined in Rule 30a-3(d) under the Investment Company Act of 1940) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of a date within 90 days prior to the filing date of this report based on such evaluation; and d) disclosed in this report any change 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; and 5. The registrant's other certifying officer(s) and I have disclosed to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: September 21, 2006 /s/ Francis Smith ---------------------------------------- Francis Smith Principal Financial Officer EX-99.906CERT 3 a2173151zex-99_906cert.txt EX-99.906CERT SECTION 906 CERTIFICATION Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Morgan Stanley Allocator Fund In connection with the Report on Form N-CSR (the "Report") of the above-named issuer for the period ended July 31, 2006 that is accompanied by this certification, the undersigned hereby certifies that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Issuer. Date: September 21, 2006 /s/ Ronald E. Robison ---------------------------------------- Ronald E. Robison Principal Executive Officer A signed original of this written statement required by Section 906 has been provided to Morgan Stanley Allocator Fund and will be retained by Morgan Stanley Allocator Fund and furnished to the Securities and Exchange Commission or its staff upon request. SECTION 906 CERTIFICATION Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Morgan Stanley Allocator Fund In connection with the Report on Form N-CSR (the "Report") of the above-named issuer for the period ended July 31, 2006 that is accompanied by this certification, the undersigned hereby certifies that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Issuer. Date: September 21, 2006 /s/ Francis Smith ---------------------------------------- Francis Smith Principal Financial Officer A signed original of this written statement required by Section 906 has been provided to Morgan Stanley Allocator Fund and will be retained by Morgan Stanley Allocator Fund and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----