-----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, RaayfJ4829+ZR67Ry1PyuQyOzNxrOEDD28CnTOnxBHqmxLEOP6ghxZtjjkzqXrUe SnKfdGa6CQEt0ghXcvJB4Q== 0001047469-05-022511.txt : 20050906 0001047469-05-022511.hdr.sgml : 20050905 20050906120634 ACCESSION NUMBER: 0001047469-05-022511 CONFORMED SUBMISSION TYPE: N-CSRS PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20050630 FILED AS OF DATE: 20050906 DATE AS OF CHANGE: 20050906 EFFECTIVENESS DATE: 20050906 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MORGAN STANLEY VARIABLE INVESTMENT SERIES CENTRAL INDEX KEY: 0000716716 IRS NUMBER: 133178476 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: N-CSRS SEC ACT: 1940 Act SEC FILE NUMBER: 811-03692 FILM NUMBER: 051069593 BUSINESS ADDRESS: STREET 1: C/O MORGAN STANLEY TRUST STREET 2: HARBORSIDE FINANCIAL CENTER, PLAZA TWO CITY: JERSEY CITY STATE: NJ ZIP: 07311 BUSINESS PHONE: (212) 869-6397 MAIL ADDRESS: STREET 1: C/O MORGAN STANLEY TRUST STREET 2: HARBORSIDE FINANCIAL CENTER, PLAZA TWO CITY: JERSEY CITY STATE: NJ ZIP: 07311 FORMER COMPANY: FORMER CONFORMED NAME: MORGAN STANLEY DEAN WITTER VARIABLE INVESTMENT SERIES DATE OF NAME CHANGE: 19980622 FORMER COMPANY: FORMER CONFORMED NAME: DEAN WITTER VARIABLE INVESTMENT SERIES DATE OF NAME CHANGE: 19930209 FORMER COMPANY: FORMER CONFORMED NAME: WITTER DEAN VARIABLE INVESTMENT SERIES DATE OF NAME CHANGE: 19920703 N-CSRS 1 a2161677zn-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: 811-03692 Morgan Stanley Variable Investment Series (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: December 31, 2005 Date of reporting period: June 30, 2005 Item 1 - Report to Shareholders WELCOME, SHAREHOLDER: IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY VARIABLE INVESTMENT SERIES -- AGGRESSIVE EQUITY PORTFOLIO 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 PORTFOLIO'S FINANCIAL STATEMENTS AND A LIST OF PORTFOLIO INVESTMENTS. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE PORTFOLIO BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE PORTFOLIO WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE PORTFOLIO IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE PORTFOLIO WILL DECLINE AND, THEREFORE, THE VALUE OF THE PORTFOLIO'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS PORTFOLIO. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT For the six months ended June 30, 2005 TOTAL RETURN FOR THE 6 MONTHS ENDED JUNE 30, 2005
RUSSELL 3000(R) CLASS X CLASS Y GROWTH INDEX(1) 2.15% 1.98% -1.88%
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. SEE PERFORMANCE SUMMARY FOR PERFORMANCE INFORMATION AND INDEX DEFINITIONS. MARKET CONDITIONS Following a brisk and upbeat close to 2004, the U.S. equity market slowed its pace in 2005. Sentiment shifted and stocks retreated as investors sold shares to lock in gains. Against the backdrop of rising oil prices, mixed economic data, continued increases to the federal funds target rate, and the prospect of a global economic slowdown, investors worried about the prospect of "stagflation" (a climate marked by both stagnant growth and inflation). Anxiety increased as disappointing news from corporate bellwethers General Motors and Ford Motor cast a shadow across the auto and auto related industries, and the market overall. After reaching a low point in April, the market rebounded during the final two months of the period. Encouraging retail sales and payroll data, an upward revision of first-quarter gross domestic product and strengthening consumer confidence were among the factors that raised investor sentiment. Investors also seemed encouraged by merger and acquisition activity and by signals that the Federal Reserve might be nearing the end of its rate tightening cycle. Mid- and small-cap stocks generally outperformed large-caps during the period, while growth-oriented stocks lagged their value counterparts. PERFORMANCE ANALYSIS The Aggressive Equity Portfolio outperformed the Russell 3000(R) Growth Index for the six-months period ended June 30, 2005. Stock selection drove outperformance, offsetting sector allocations, which detracted modestly. Areas of strength included financial services, consumer discretionary and energy stakes. In the financial services space, diversified financial services stocks contributed notably. Among consumer discretionary holdings, Internet and retail companies were particularly advantageous. The Portfolio was well served by positions in crude oil producers. In contrast, healthcare exposure was an area of weakness for the Portfolio. Biotechnology and drug and pharmaceuticals stocks detracted from relative performance due to a sector underweight and stock selection. Also on the downside, within its consumer staples exposure, the Portfolio's underweighted position in the drugs and grocery store chain industry hindered gains. Among consumer discretionary holdings, commercial services and hotel/motel positions limited overall gains, while the Portfolio's technology stake was slowed by computer services and software systems. THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM WELL OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE PORTFOLIO IN THE FUTURE. 2 TOP 10 HOLDINGS Google, Inc. (Class A) 5.4% Corporate Executive Board Co. (The) 5.2 Ultra Petroleum Corp. (Canada) 5.2 Getty Images, Inc. 4.0 eBay Inc. 3.9 Carnival Corp. (Panama) 3.9 Station Casinos, Inc. 3.7 America Movil S.A. de C.V. (Series L) (ADR) (Mexico) 3.2 Monsanto Co. 3.1 Electronic Arts Inc. 3.1
TOP FIVE INDUSTRIES Internet Software/Services 8.3% Casinos/Gaming 7.6 Advertising/Marketing Services 6.0 Other Consumer Services 5.9 Miscellaneous Commercial Services 5.2
DATA AS OF JUNE 30, 2005. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES FOR TOP 10 HOLDINGS AND TOP FIVE INDUSTRIES ARE AS A PERCENTAGE OF NET ASSETS. 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. INVESTMENT STRATEGY THE PORTFOLIO NORMALLY INVESTS AT LEAST 80% OF ITS ASSETS IN COMMON STOCKS AND OTHER EQUITY SECURITIES OF COMPANIES THAT THE "INVESTMENT ADVISER," MORGAN STANLEY INVESTMENT ADVISORS INC., BELIEVES OFFER THE POTENTIAL FOR SUPERIOR EARNINGS GROWTH. THE PORTFOLIO'S OTHER EQUITY SECURITIES MAY INCLUDE PREFERRED STOCK, DEPOSITARY RECEIPTS AND SECURITIES CONVERTIBLE INTO COMMON STOCK, RIGHTS AND WARRANTS. FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY PORTFOLIO PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE PORTFOLIO'S SECOND AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY PORTFOLIO 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. 3 PROXY VOTING POLICY AND PROCEDURES AND PROXY VOTING RECORD YOU MAY OBTAIN A COPY OF THE PORTFOLIO'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 PORTFOLIO VOTED PROXIES RELATING TO PORTFOLIO SECURITIES DURING THE MOST RECENT TWELVE-MONTH PERIOD ENDED JUNE 30 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. 4 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED JUNE 30, 2005
CLASS X SHARES CLASS Y SHARES (SINCE 05/04/99) (SINCE 06/05/00) 1 YEAR 10.87%(2) 10.67%(2) 5 YEARS (5.20)(2) (5.44)(2) SINCE INCEPTION 2.34(2) (4.91)(2)
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 THE 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 PORTFOLIO SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. THE PERFORMANCE OF THE PORTFOLIO'S TWO SHARE CLASSES VARIES BECAUSE EACH HAS DIFFERENT EXPENSES. THE PORTFOLIO'S TOTAL RETURN FIGURES ASSUME THE REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE IMPACT OF ANY CHARGES BY YOUR INSURANCE COMPANY. SUCH COSTS WOULD LOWER PERFORMANCE. (1) THE RUSSELL 3000(R) GROWTH INDEX MEASURES THE PERFORMANCE OF THOSE COMPANIES IN THE RUSSELL 3000(R) INDEX WITH HIGHER PRICE-TO-BOOK RATIOS AND HIGHER FORECASTED GROWTH VALUES. 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) FIGURE ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS FOR THE UNDERLYING PORTFOLIO BASED ON NET ASSET VALUE (NAV). IT DOES NOT REFLECT THE DEDUCTION OF INSURANCE EXPENSES, AN ANNUAL CONTRACT MAINTENANCE FEE, OR SURRENDER CHARGES. 5 EXPENSE EXAMPLE As a shareholder of the Portfolio, you incur two types of costs: (1) insurance company charges; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Portfolio expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Portfolio 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 01/01/05 - 06/30/05. 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 Portfolio's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Portfolio'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 Portfolio 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 insurance company charges. 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 insurance company charges were included, your costs would have been higher.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD * ------------- ------------- --------------- 01/01/05 - 01/01/05 06/30/05 06/30/05 ------------- ------------- --------------- CLASS X Actual (2.15% return) $ 1,000.00 $ 1,021.50 $ 4.16 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,020.68 $ 4.16 CLASS Y Actual (1.98% return) $ 1,000.00 $ 1,019.80 $ 5.41 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,019.44 $ 5.41
- ---------- * EXPENSES ARE EQUAL TO THE PORTFOLIO'S ANNUALIZED EXPENSE RATIO OF 0.83% AND 1.08% 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 fixed income securities trading. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Portfolio's Administrator under the Administration Agreement, including accounting, clerical, bookkeeping, compliance, business management and planning, and the provision of supplies, office space and utilities. (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 administrative and investment advisory services to the Portfolio. 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 Portfolio. 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 The Board reviewed the Portfolio's performance for the one-, three- and five-year periods ended November 30, 2004, as shown in reports provided by Lipper (the "Lipper Reports"), compared to the performance of comparable funds selected by Lipper (the "performance peer group"), and noted that the Portfolio's performance was better than its performance peer group average for all three periods. The Board concluded that the Portfolio's performance was satisfactory. FEES RELATIVE TO OTHER FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT STRATEGIES The Board reviewed the advisory and administrative fees (together, the "management fee") paid by the Fund under the Management Agreement. The Board noted that the rate was comparable to the management fee rates charged by the Adviser to any other funds it manages with investment strategies comparable to those of the Portfolio. FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS The Board reviewed the management fee rate and the total expense ratio of the Portfolio. The Board noted that: (i) the Portfolio's management fee rate was lower than the average management fee rate for funds, selected by Lipper (the "expense peer group"), managed by other advisers with investment strategies comparable to those of 7 the Portfolio, as shown in the Lipper Report for the Portfolio; and (ii) the Portfolio's total expense ratio was also lower than the average total expense ratio of the funds included in the Portfolio's expense peer group. The Board concluded that the Portfolio's management fee 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 Portfolio's management fee schedule under the Management Agreement and noted that it includes breakpoints. The Board also reviewed the level of the Portfolio's management fee and noted that the fee, as a percentage of the Portfolio's net assets, would decrease as net assets increase because the management fee includes breakpoints. The Board concluded that the Portfolio's management fee would reflect economies of scale as assets increase. PROFITABILITY OF ADVISER AND AFFILIATES The Board considered and reviewed information concerning the costs incurred and profits realized by the Adviser and its affiliates during the last two years from their relationship with the Portfolio and the Morgan Stanley Fund Complex and reviewed with the Controller of the Adviser the cost allocation methodology used to determine the Adviser's profitability. Based on their review of the information they received, the Board concluded that the profits earned by the Adviser and its affiliates were not excessive in light of the advisory, administrative and other services provided to the Portfolio. FALL-OUT BENEFITS The Board considered so-called "fall-out benefits" derived by the Adviser and its affiliates from their relationship with the Portfolio and the Morgan Stanley Fund Complex, such as "float" benefits derived from handling of checks for purchases and redemptions 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 Portfolio 12b-1 fees for distribution and shareholder services. The Board also considered that an affiliate of the Adviser, through a joint venture, receives revenue in connection with trading done on behalf of the Portfolio through an electronic trading system network ("ECN"). The Board concluded that the float benefits and the above-referenced ECN-related revenue were relatively small and that the 12b-1 fees were competitive with those of other broker-dealer affiliates of investment advisers of mutual funds. 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 Portfolio and/or other funds managed by the Adviser would be used to pay for research that a securities broker obtains 8 from third parties, or to pay for both research and execution services from securities brokers who effect transactions for the Portfolio. The Adviser informed the Board that it does not use Portfolio 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 Portfolio and other funds in the Morgan Stanley Fund Complex. ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE PORTFOLIO'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 PORTFOLIO AND THE ADVISER The Board also reviewed and considered the historical relationship between the Portfolio and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Portfolio'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 Portfolio 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 Portfolio'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 Portfolio's business. GENERAL CONCLUSION After considering and weighing all of the above factors, the Board concluded it would be in the best interest of the Portfolio and its shareholders to approve renewal of the Management Agreement for another year. 9 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- AGGRESSIVE EQUITY PORTFOLIO PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
NUMBER OF SHARES VALUE - ------------------------------------------------------------------- COMMON STOCKS (98.8%) ADVERTISING/ MARKETING SERVICES (6.0%) 32,800 Getty Images, Inc.* $ 2,435,728 28,700 Lamar Advertising Co. (Class A)* 1,227,499 -------------- 3,663,227 -------------- AIR FREIGHT/COURIERS (1.8%) 18,900 C.H. Robinson Worldwide, Inc. 1,099,980 -------------- CASINO/GAMING (7.6%) 53,900 International Game Technology 1,517,285 34,100 Station Casinos, Inc. 2,264,240 17,625 Wynn Resorts, Ltd.* 833,134 -------------- 4,614,659 -------------- CHEMICALS: AGRICULTURAL (3.1%) 29,870 Monsanto Co. 1,877,927 -------------- COMPUTER PROCESSING HARDWARE (2.0%) 30,400 Dell, Inc.* 1,201,104 -------------- CONSTRUCTION MATERIALS (1.2%) 13,500 Rinker Group Ltd. (ADR) (Australia) 716,715 -------------- DISCOUNT STORES (5.0%) 26,800 Costco Wholesale Corp. 1,201,176 12,400 Sears Holdings Corp.* 1,858,388 -------------- 3,059,564 -------------- ELECTRONIC PRODUCTION EQUIPMENT (2.1%) 39,000 Tessera Technologies, Inc.* 1,302,990 -------------- FINANCIAL CONGLOMERATES (1.5%) 23,200 Brascan Corp. (Class A) (Canada) 885,312 -------------- FINANCIAL PUBLISHING/ SERVICES (0.0%) 360 Moody's Corp. 16,186 -------------- GAS DISTRIBUTORS (1.0%) 9,400 Questar Corp. 619,460 -------------- HOME BUILDING (1.5%) 1,159 NVR, Inc.* $ 938,790 -------------- HOTELS/RESORTS/ CRUISELINES (3.9%) 43,700 Carnival Corp. (Panama) 2,383,835 -------------- INTERNET RETAIL (0.9%) 17,000 Amazon.com, Inc.* 562,360 -------------- INTERNET SOFTWARE/ SERVICES (8.3%) 11,250 Google, Inc. (Class A)* 3,309,188 50,200 Yahoo!, Inc.* 1,739,430 -------------- 5,048,618 -------------- INVESTMENT BANKS/ BROKERS (5.0%) 5,650 Chicago Mercantile Exchange (The) 1,669,575 34,280 Greenhill & Co., Inc. 1,388,683 -------------- 3,058,258 -------------- MANAGED HEALTH CARE (1.4%) 16,600 UnitedHealth Group Inc. 865,524 -------------- MEDICAL DISTRIBUTORS (1.5%) 20,200 Patterson Companies Inc.* 910,616 -------------- MEDICAL SPECIALTIES (1.7%) 1,000 Alcon, Inc. (Switzerland) 109,350 14,600 Dade Behring Holdings Inc. 949,146 -------------- 1,058,496 -------------- MISCELLANEOUS COMMERCIAL SERVICES (5.2%) 40,700 Corporate Executive Board Co. (The) 3,188,031 -------------- OIL & GAS PRODUCTION (5.2%) 104,980 Ultra Petroleum Corp. (Canada)* 3,187,193 -------------- OTHER CONSUMER SERVICES (5.9%) 72,500 eBay Inc.* 2,393,225 13,900 Strayer Education, Inc. 1,199,014 -------------- 3,592,239 --------------
SEE NOTES TO FINANCIAL STATEMENTS 10
NUMBER OF SHARES VALUE - -------------------------------------------------------------------- OTHER METALS/MINERALS (1.1%) 14,400 Cameco Corporation (Canada) $ 644,400 -------------- PACKAGED SOFTWARE (2.9%) 53,600 Red Hat, Inc.* 702,160 50,700 Salesforce.com Inc.* 1,038,336 -------------- 1,740,496 -------------- PERSONNEL SERVICES (2.3%) 48,700 Monster Worldwide, Inc.* 1,396,716 -------------- PROPERTY - CASUALTY INSURERS (2.9%) 403 Berkshire Hathaway, Inc. (Class B)* 1,121,750 1,000 White Mountains Insurance Group, Ltd. (Bermuda) 630,900 -------------- 1,752,650 -------------- REAL ESTATE INVESTMENT TRUSTS (1.5%) 24,800 Plum Creek Timber Co., Inc. 900,240 -------------- RECREATIONAL PRODUCTS (4.3%) 33,100 Electronic Arts Inc.* 1,873,791 19,800 Shanda Interactive Entertainment, Ltd. (ADR) (Cayman Islands)* 728,442 -------------- 2,602,233 -------------- RESTAURANTS (1.7%) 17,100 P.F. Chang's China Bistro, Inc.* 1,008,558 -------------- SEMICONDUCTORS (1.5%) 23,400 Marvell Technology Group, Ltd. (Bermuda)* 890,136 -------------- SERVICES TO THE HEALTH INDUSTRY (1.0%) 11,900 Stericycle, Inc.* 598,808 -------------- SPECIALTY TELECOMMUNICATIONS (2.3%) 70,157 Crown Castle International Corp.* 1,425,590 -------------- TELECOMMUNICATION EQUIPMENT (1.3%) 24,400 QUALCOMM Inc. $ 805,444 -------------- WHOLESALE DISTRIBUTORS (1.0%) 17,300 SCP Pool Corp. 607,057 -------------- WIRELESS TELECOMMUNICATIONS (3.2%) 32,900 America Movil S.A. de C.V. (Series L) (ADR) (Mexico) 1,961,169 -------------- TOTAL COMMON STOCKS (COST $53,386,382) 60,184,581 -------------- PRINCIPAL AMOUNT IN THOUSANDS - -------------- SHORT-TERM INVESTMENT (1.0%) REPURCHASE AGREEMENT $ 579 The Bank of New York 3.125% due 07/01/05 (dated 06/30/05; proceeds $578,809) (a) (COST $578,759) 578,759 -------------- TOTAL INVESTMENTS (COST $53,965,141) (b) 99.8% 60,763,340 OTHER ASSETS IN EXCESS OF LIABILITIES 0.2 102,609 ----- -------------- NET ASSETS 100.0% $ 60,865,949 ===== ==============
- ---------- ADR AMERICAN DEPOSITARY RECEIPT. * NON-INCOME PRODUCING SECURITY. (a) COLLATERALIZED BY FEDERAL NATIONAL MORTGAGE ASSOC. 4.126% DUE 07/01/18 VALUED AT $590,334. (b) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES APPROXIMATES THE AGGREGATE COST FOR BOOK PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION IS $8,254,095 AND THE AGGREGATE GROSS UNREALIZED DEPRECIATION IS $1,455,896, RESULTING IN NET UNREALIZED APPRECIATION OF $6,798,199. SEE NOTES TO FINANCIAL STATEMENTS 11 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- AGGRESSIVE EQUITY PORTFOLIO SUMMARY OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
PERCENT OF INDUSTRY VALUE NET ASSETS - -------------------------------------------------------------------- Internet Software/Services $ 5,048,618 8.3% Casino/Gaming 4,614,659 7.6 Advertising/Marketing Services 3,663,227 6.0 Other Consumer Services 3,592,239 5.9 Miscellaneous Commercial Services 3,188,031 5.2 Oil & Gas Production 3,187,193 5.2 Discount Stores 3,059,564 5.0 Investment Banks/Brokers 3,058,258 5.0 Recreational Products 2,602,233 4.3 Hotels/Resorts/Cruiselines 2,383,835 3.9 Wireless Telecommunications 1,961,169 3.2 Chemicals: Agricultural 1,877,927 3.1 Property-Casualty Insurers 1,752,650 2.9 Packaged Software 1,740,496 2.9 Specialty Telecommunications 1,425,590 2.3 Personnel Services 1,396,716 2.3 Electronic Production Equipment 1,302,990 2.1 Computer Processing Hardware 1,201,104 2.0 Air Freight/Couriers $ 1,099,980 1.8% Medical Specialties 1,058,496 1.7 Restaurants 1,008,558 1.7 Home Building 938,790 1.5 Medical Distributors 910,616 1.5 Real Estate Investment Trusts 900,240 1.5 Semiconductors 890,136 1.5 Financial Conglomerates 885,312 1.5 Managed Health Care 865,524 1.4 Telecommunication Equipment 805,444 1.3 Construction Materials 716,715 1.2 Other Metals/Minerals 644,400 1.1 Gas Distributors 619,460 1.0 Wholesale Distributors 607,057 1.0 Services To The Health Industry 598,808 1.0 Repurchase Agreement 578,759 1.0 Internet Retail 562,360 0.9 Financial Publishing/Services 16,186 0.0 ------------- ---- $ 60,763,340 99.8% ============= ====
SEE NOTES TO FINANCIAL STATEMENTS 12 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- AGGRESSIVE EQUITY PORTFOLIO FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 2005 (UNAUDITED) ASSETS: Investments in securities, at value (cost $53,965,141) $ 60,763,340 Receivable for: Investments sold 916,593 Dividends 14,996 Prepaid expenses and other assets 2,600 -------------- TOTAL ASSETS 61,697,529 -------------- LIABILITIES: Payable for: Investments purchased 768,393 Investment advisory fee 33,563 Distribution fee 5,425 Administration fee 4,007 Accrued expenses and other payables 20,192 -------------- TOTAL LIABILITIES 831,580 -------------- NET ASSETS $ 60,865,949 ============== COMPOSITION OF NET ASSETS: Paid-in-capital $ 103,616,399 Net unrealized appreciation 6,798,199 Accumulated net investment loss (133,426) Accumulated net realized loss (49,415,223) -------------- NET ASSETS $ 60,865,949 ============== CLASS X SHARES: Net Assets $ 34,405,359 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 3,013,143 NET ASSET VALUE PER SHARE $ 11.42 ============== CLASS Y SHARES: Net Assets $ 26,460,590 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 2,340,407 NET ASSET VALUE PER SHARE $ 11.31 ==============
SEE NOTES TO FINANCIAL STATEMENTS 13 STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2005 (UNAUDITED) NET INVESTMENT LOSS: INCOME Dividends (net of $3,854 foreign withholding tax) $ 141,235 Interest 10,368 -------------- TOTAL INCOME 151,603 -------------- EXPENSES Investment advisory fee 202,943 Distribution fee (Class Y shares) 32,494 Administration fee 24,232 Professional fees 12,912 Shareholder reports and notices 6,640 Custodian fees 4,285 Trustees' fees and expenses 413 Transfer agent fees and expenses 250 Other 1,217 -------------- TOTAL EXPENSES 285,386 -------------- NET INVESTMENT LOSS (133,783) -------------- NET REALIZED AND UNREALIZED GAIN (LOSS): Net realized gain 4,099,724 Net change in unrealized appreciation (2,972,130) -------------- NET GAIN 1,127,594 -------------- NET INCREASE $ 993,811 ==============
SEE NOTES TO FINANCIAL STATEMENTS 14 STATEMENT OF CHANGES IN NET ASSETS
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 -------------- ----------------- (UNAUDITED) INCREASE (DECREASE) IN NET ASSETS: OPERATIONS: Net investment loss $ (133,783) $ (168,837) Net realized gain 4,099,724 9,048,347 Net change in unrealized appreciation (2,972,130) (1,271,526) -------------- ----------------- NET INCREASE 993,811 7,607,984 -------------- ----------------- DIVIDENDS TO SHAREHOLDERS FROM NET INVESTMENT INCOME: Class X shares -- (4,053) -------------- ----------------- Net decrease from transactions in shares of beneficial interest (6,268,162) (10,346,386) -------------- ----------------- NET DECREASE (5,274,351) (2,742,455) NET ASSETS: Beginning of period 66,140,300 68,882,755 -------------- ----------------- END OF PERIOD (INCLUDING ACCUMULATED NET INVESTMENT LOSS OF $133,426 AND UNDISTRIBUTED INVESTMENT INCOME OF $357, RESPECTIVELY) $ 60,865,949 $ 66,140,300 ============== =================
SEE NOTES TO FINANCIAL STATEMENTS 15 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- AGGRESSIVE EQUITY PORTFOLIO NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) 1. ORGANIZATION AND ACCOUNTING POLICIES Morgan Stanley Variable Investment Series (the "Fund") -- Aggressive Equity Portfolio (the "Portfolio"), one of 15 separate portfolios, is registered under the Investment Company Act of 1940, as amended (the "Act"), as a diversified, open-end management investment company. The Fund is offered exclusively to life insurance companies in connection with particular life insurance and/or annuity contracts they offer. The Portfolio's investment objective is long-term capital growth. The Fund was organized as a Massachusetts business trust on February 25, 1983 and the Portfolio commenced operations on May 4, 1999. On June 5, 2000, the Portfolio commenced offering one additional class of shares (Class Y). The Portfolio offers Class X and Class Y shares. The two are identical except that Class Y shares incurs distribution expenses. Class X shares are generally available to holders of contracts offered by Metropolitan Life Insurance Company (formerly Paragon Life Insurance Company) and other contracts offered before May 1, 2000. Class Y shares are available to holders of contracts offered on or after June 5, 2000. 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) futures are valued at the latest price published by the commodities exchange on which they trade; (6) when market quotations are not readily available or Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") determines that the latest sale price, the bid price or the mean between the last reported bid and asked price do not reflect a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees. Occasionally, developments affecting the closing prices of securities and other assets may occur between the times at which valuations of such securities are determined (that is, close of the foreign market on which the securities trade) and the close of business on the NYSE. If developments occur during such periods that are expected to materially affect the value of such securities, such valuations may be adjusted to reflect 16 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; (7) certain portfolio securities may be valued by an outside pricing service approved by the Fund's Trustees; and (8) 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 -- The Fund may 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. FOREIGN CURRENCY TRANSLATION AND FORWARD FOREIGN CURRENCY CONTRACTS -- The books and records of the Portfolio 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 Portfolio 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 Portfolio 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. 17 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 Portfolio 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 Portfolio 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 Portfolio as unrealized gains and losses. Upon closing of the contract, the Portfolio 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. 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. H. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- Dividends and distributions to shareholders are recorded on the ex-dividend date. I. EXPENSES -- Direct expenses are charged to the Portfolio and general Fund expenses are allocated on the basis of relative net assets or equally among the Portfolios. 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 Advisor, the Portfolio pays the Investment Adviser an advisory fee, accrued daily and payable monthly, by applying the following annual rates to the net assets of the Portfolio determined at the close of each business day: 0.67% to the portion of the daily net assets not exceeding $500 million; 0.645% to the portion of the daily net assets exceeding $500 million but not exceeding $2 billion; 0.62% to the portion of the daily net assets exceeding $2 billion but not exceeding $3 billion; and 0.595% to the portion of the daily net assets in excess of $3 billion. Pursuant to an Administration Agreement with Morgan Stanley Services Company Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Portfolio pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.08% to the Portfolio's daily net assets. 18 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. Under the Plan, Class Y shares of the Portfolio will pay a distribution fee which is accrued daily and paid monthly at the annual rate of 0.25% of the average daily net assets of the class. 4. SECURITY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES The cost of purchases and the proceeds from sales of portfolio securities, excluding short-term investments, for the six months ended June 30, 2005, aggregated $35,852,837 and $42,191,852, respectively. Included in the aforementioned transactions are purchases with other Morgan Stanley funds of $23,907. For the six months ended June 30, 2005, the Portfolio incurred brokerage commissions of $852 with Morgan Stanley & Co., Inc., an affiliate of the Investment Adviser, Administrator and Distributor, for portfolio transactions executed on behalf of the Portfolio. Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and Distributor, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and compensation. Aggregate pension costs for the six months ended June 30, 2005, included in Trustees' fees and expenses in the Statement of Operations amounted to $56. At June 30, 2005, the Portfolio had an accrued pension liability of $990 which is included in accrued expenses in the Statement of Assets and Liabilities. On December 2, 2003, the Trustees voted to close the plan to new participants and eliminate the future benefits growth due to increases to compensation after July 31, 2003. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 19 5. SHARES OF BENEFICIAL INTEREST Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 ------------------------------ ------------------------------ (UNAUDITED) SHARES AMOUNT SHARES AMOUNT ------------- ------------- ------------- ------------- CLASS X SHARES Sold 453,878 $ 4,932,170 1,396,615 $ 14,288,798 Reinvestment of dividends -- -- 394 4,053 Redeemed (869,859) (9,427,600) (2,239,000) (22,783,383) ------------- ------------- ------------- ------------- Net decrease -- Class X (415,981) (4,495,430) (841,991) (8,490,532) ------------- ------------- ------------- ------------- CLASS Y SHARES Sold 151,062 1,614,554 390,968 3,914,063 Reinvestment of dividends -- -- -- -- Redeemed (317,578) (3,387,286) (574,466) (5,769,917) ------------- ------------- ------------- ------------- Net decrease -- Class Y (166,516) (1,772,732) (183,498) (1,855,854) ------------- ------------- ------------- ------------- Net decrease in Fund (582,497) $ (6,268,162) (1,025,489) $ (10,346,386) ============= ============= ============= =============
6. 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 December 31, 2004, the Portfolio had a net capital loss carryforward of approximately $53,481,000 of which $1,302,000 will expire on December 31, 2008, $39,094,000 will expire on December 31, 2009, and $13,085,000 will expire on December 31, 2010 to offset future capital gains to the extent provided by regulations. As of December 31, 2004, the Portfolio had temporary book/tax differences primarily attributable to capital loss deferrals on wash sales. 20 7. PURPOSES OF AND RISKS RELATING TO CERTAIN FINANCIAL INSTRUMENTS The Portfolio may enter into forward contracts to facilitate settlement of foreign currency denominated portfolio transactions or to manage foreign currency exposure associated with foreign currency denominated securities. To hedge against adverse interest rate, foreign currency and market risks, the Portfolio may purchase and sell interest rate, currency and index futures ("futures contracts"). Forward contracts and futures contracts involve elements of market risk in excess of the amount reflected in the Statement of Assets and Liabilities. The Portfolio bears the risk of an unfavorable change in the foreign exchange rates underlying the forward contracts. Risks may also rise upon entering into these contracts from the potential inability of the counterparties to meet the terms of their contracts. 21 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- AGGRESSIVE EQUITY PORTFOLIO FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED -------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- --------- --------- --------- --------- --------- (UNAUDITED) CLASS X SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 11.18 $ 9.92 $ 7.87 $ 10.20 $ 14.31 $ 14.57 ------------- --------- --------- --------- --------- --------- Income (loss) from investment operations: Net investment income (loss)++ (0.02) (0.02) 0.01 0.01 0.02 0.05 Net realized and unrealized gain (loss) 0.26 1.28 2.04 (2.31) (4.09) (0.30) ------------- --------- --------- --------- --------- --------- Total income (loss) from investment operations 0.24 1.26 2.05 (2.30) (4.07) (0.25) ------------- --------- --------- --------- --------- --------- Less dividends from net investment income - - - (0.03) (0.04) (0.01) ------------- --------- --------- --------- --------- --------- Net asset value, end of period $ 11.42 $ 11.18 $ 9.92 $ 7.87 $ 10.20 $ 14.31 ============= ========= ========= ========= ========= ========= TOTAL RETURN+ 2.15%(2) 12.71% 26.06% (22.60)% (28.46)% (1.75)% RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.83%(3) 0.85% 0.87% 0.84% 0.84% 0.82% Net investment income (loss) (0.33)%(3) (0.16)% 0.10% 0.07% 0.21% 0.32% SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 34,405 $ 38,347 $ 42,363 $ 39,724 $ 69,418 $ 138,657 Portfolio turnover rate 59%(2) 185% 195% 268% 409% 414%
- ---------- * PRIOR TO JUNE 5, 2000, THE PORTFOLIO ISSUED ONE CLASS OF SHARES. ALL SHARES OF THE PORTFOLIO HELD PRIOR TO MAY 1, 2000 HAVE BEEN DESIGNATED CLASS X SHARES. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 22
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED -------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- --------- --------- --------- --------- --------- (UNAUDITED) CLASS Y SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 11.09 $ 9.86 $ 7.84 $ 10.17 $ 14.29 $ 14.66 ------------- --------- --------- --------- --------- --------- Income (loss) from investment operations: Net investment income (loss)++ (0.03) (0.04) (0.01) (0.01) (0.01) 0.03 Net realized and unrealized gain (loss) 0.25 1.27 2.03 (2.31) (4.08) (0.39) ------------- --------- --------- --------- --------- --------- Total income (loss) from investment operations 0.22 1.23 2.02 (2.32) (4.09) (0.36) ------------- --------- --------- --------- --------- --------- Less dividends from net investment income - - - (0.01) (0.03) (0.01) ------------- --------- --------- --------- --------- --------- Net asset value, end of period $ 11.31 $ 11.09 $ 9.86 $ 7.84 $ 10.17 $ 14.29 ============= ========= ========= ========= ========= ========= TOTAL RETURN+ 1.98%(2) 12.47% 25.77% (22.83)% (28.61)% (2.48)%(2) RATIOS TO AVERAGE NET ASSETS(1): Expenses 1.08%(3) 1.10% 1.12% 1.09% 1.09% 1.05%(3) Net investment income (loss) (0.58)%(3) (0.41)% (0.15)% (0.18)% (0.04)% 0.32%(3) SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 26,461 $ 27,793 $ 26,519 $ 17,575 $ 18,652 $ 13,392 Portfolio turnover rate 59%(2) 185% 195% 268% 409% 414%
- ---------- * FOR THE PERIOD JUNE 5, 2000 (ISSUED DATE) THROUGH DECEMBER 31, 2000. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 23 TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo CHAIRMAN OF THE BOARD Mitchell M. Merin PRESIDENT Ronald E. Robison EXECUTIVE VICE PRESIDENT AND PRINCIPAL EXECUTIVE OFFICER Joseph J. McAlinden VICE PRESIDENT Barry Fink VICE PRESIDENT Amy R. Doberman VICE PRESIDENT Carsten Otto CHIEF COMPLIANCE OFFICER Stefanie V. Chang VICE PRESIDENT Francis J. Smith TREASURER AND CHIEF FINANCIAL OFFICER Thomas F. Caloia VICE PRESIDENT Mary E. Mullin SECRETARY TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT 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 Portfolio 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 Portfolio. For more detailed information about the Portfolio, its fees and expenses and other pertinent information, please read its Prospectus. The Portfolio's Statement of Additional Information contains additional information about the Portfolio, 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 Portfolio 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) 2005 Morgan Stanley [MORGAN STANLEY LOGO] RA05-00656P-Y06/05 [GRAPHIC] MORGAN STANLEY FUNDS MORGAN STANLEY VARIABLE INVESTMENT SERIES -- AGGRESSIVE EQUITY PORTFOLIO SEMIANNUAL REPORT JUNE 30, 2005 [MORGAN STANLEY LOGO] WELCOME, SHAREHOLDER: IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY VARIABLE INVESTMENT SERIES -- DIVIDEND GROWTH PORTFOLIO 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 PORTFOLIO'S FINANCIAL STATEMENTS AND A LIST OF PORTFOLIO INVESTMENTS. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE PORTFOLIO BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE PORTFOLIO WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE PORTFOLIO IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE PORTFOLIO WILL DECLINE AND, THEREFORE, THE VALUE OF THE PORTFOLIO'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS PORTFOLIO. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT For the six-months ended June 30, 2005 TOTAL RETURN FOR THE 6 MONTHS ENDED JUNE 30, 2005
S&P 500(R) CLASS X CLASS Y INDEX(1) -1.38% -1.50% -0.81%
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. SEE PERFORMANCE SUMMARY FOR PERFORMANCE INFORMATION AND INDEX DEFINITIONS. MARKET CONDITIONS Large-company U.S. stocks posted lackluster performance for the six- months ended June 30, 2005. Following an equity rally in the final months of 2004, 2005 opened on a much less optimistic note. Sentiment shifted and stocks retreated as investors sold shares to lock in gains. Against the backdrop of rising oil prices, mixed economic data, continued increases to the federal funds target rate, and the prospect of a global economic slowdown, investors began to worry about the prospect of "stagflation" (a climate marked by both stagnant growth and inflation). Anxiety increased as disappointing news from corporate bellwethers General Motors and Ford Motor cast a shadow across the auto and auto-related industries, and the market overall. However, after reaching a low point in April, the market rebounded during the final two months of the period. Encouraging retail sales and payroll data, an upward revision of first-quarter gross domestic product, and strengthening consumer confidence were among the factors that raised investor sentiment. Investors also seemed encouraged by merger and acquisition activity and by signals that the Federal Reserve might be nearing the end of its rate tightening cycle. During this period, large-cap stocks gained back ground, though not as much as their small- and mid-cap counterparts. Within the S&P 500(R) Index, the energy, utilities and health care sectors posted particularly good gains. Energy stocks profited as oil prices remained exceptionally high. Utilities also benefited from increasing energy costs, as well as from the market's hunger for yield-oriented investments. After struggling in 2004, health care stocks rebounded, driven by strength in healthcare providers and services. The group was helped by abating negative sentiment and the prospect of further industry consolidation. In contrast, the materials, technology and consumer discretionary sectors lagged. Materials stocks were hindered due to investors' anticipation of slowing worldwide growth, while technology languished as a long-awaited spending recovery had yet to take hold. The consumer discretionary sector was held back primarily by weakness in auto, auto-related and media stocks. PERFORMANCE ANALYSIS The Dividend Growth Portfolio underperformed the S&P 500(R) Index for the six-month period ended June 30, 2005. Factors contributing positively to relative performance included security selection within the consumer staples, health care, and consumer discretionary sectors. Among the Portfolio's consumer staples holdings, particular strength was seen in food and staples retailer and beverage exposure. The Portfolio was also well served by positions in healthcare providers and services and healthcare equipment stocks. Also on the upside, relative to the benchmark index, the Portfolio included less exposure to the struggling consumer discretionary sector. Moreover, in addition to its overall reduced emphasis, the Portfolio benefited from strong stock selection within this sector; 2 multi-line retail stock exposure enhanced returns markedly. In contrast to these positive factors, the Portfolio's focus on mega-cap names impeded relative performance. In the final months of the reporting period, mega-cap stocks did not regain as much ground as their large- and mid-cap counterparts. Within the Portfolio's energy stake, for example, a focus on mega-caps hindered performance relative to the benchmark. While the Portfolio's energy holdings performed quite well in absolute terms, they were not able to keep up with the more robust returns of other smaller energy stocks within the S&P 500(R) Index. Security selection within technology also detracted from performance, driven by company-specific weakness in certain hardware and telecommunications equipment holdings. The Portfolio's financial stocks tempered gains as well, with specific holdings in the consumer finance and capital markets industries being the primary detractors. THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM WELL OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE PORTFOLIO IN THE FUTURE. TOP 10 HOLDINGS Exxon Mobil Corp. 3.9% United Technologies Corp. 3.8 Target Corp. 3.7 PepsiCo, Inc. 3.3 BP PLC (ADR) (United Kingdom) 3.3 Bank of America Corp. 3.2 General Electric Co. 3.1 3M Co. 2.9 Procter & Gamble Co. (The) 2.8 Citigroup, Inc. 2.7
TOP FIVE INDUSTRIES Industrial Conglomerates 9.9% Pharmaceuticals: Major 7.6 Integrated Oil 7.2 Financial Conglomerates 4.9 Household/Personal Care 4.2
DATA AS OF JUNE 30, 2005. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES FOR TOP 10 HOLDINGS AND TOP FIVE INDUSTRIES ARE AS A PERCENTAGE OF NET ASSETS. 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 PORTFOLIO WILL NORMALLY INVEST AT LEAST 80% OF ITS ASSETS IN COMMON STOCKS OF COMPANIES WITH A RECORD OF PAYING DIVIDENDS AND THE POTENTIAL FOR INCREASING DIVIDENDS. THE PORTFOLIO'S "INVESTMENT ADVISER," MORGAN STANLEY INVESTMENT ADVISORS INC., INITIALLY EMPLOYS A QUANTITATIVE SCREENING PROCESS IN AN ATTEMPT TO IDENTIFY A NUMBER OF COMMON STOCKS WHICH ARE REASONABLY VALUED AND WHICH HAVE A RECORD OF PAYING DIVIDENDS. THE INVESTMENT ADVISER ALSO CONSIDERS OTHER FACTORS, SUCH AS AN ISSUER'S RETURN ON INVESTED CAPITAL AND LEVELS OF FREE CASH FLOW. THE INVESTMENT ADVISER THEN APPLIES QUALITATIVE ANALYSIS TO DETERMINE WHICH STOCKS IT BELIEVES HAVE ATTRACTIVE FUTURE GROWTH PROSPECTS AND THE POTENTIAL TO INCREASE DIVIDENDS AND, FINALLY, TO DETERMINE WHETHER ANY OF THE STOCKS SHOULD BE ADDED TO OR SOLD FROM THE PORTFOLIO'S PORTFOLIO. THE PORTFOLIO'S STOCK INVESTMENTS MAY INCLUDE FOREIGN SECURITIES HELD DIRECTLY (OR IN THE FORM OF DEPOSITARY RECEIPTS THAT ARE LISTED IN THE UNITED STATES ON A NATIONAL SECURITIES EXCHANGE). FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY PORTFOLIO PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE PORTFOLIO'S SECOND AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY PORTFOLIO 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 PORTFOLIO'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 PORTFOLIO VOTED PROXIES RELATING TO PORTFOLIO SECURITIES DURING THE MOST RECENT TWELVE-MONTH PERIOD ENDED JUNE 30 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. 4 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED JUNE 30, 2005
CLASS X SHARES CLASS Y SHARES (SINCE 03/01/90) (SINCE 06/05/00) 1 YEAR 4.74%(2) 4.42%(2) 5 YEARS 4.24(2) 3.98(2) 10 YEARS 8.30(2) -- SINCE INCEPTION 8.98(2) 2.47(2)
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 THE 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 PORTFOLIO SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. THE PERFORMANCE OF THE PORTFOLIO'S TWO SHARE CLASSES VARIES BECAUSE EACH HAS DIFFERENT EXPENSES. THE PORTFOLIO'S TOTAL RETURN FIGURES ASSUME THE REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE IMPACT OF ANY CHARGES BY YOUR INSURANCE COMPANY. SUCH COSTS WOULD LOWER PERFORMANCE. (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) FIGURE ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS FOR THE UNDERLYING PORTFOLIO BASED ON NET ASSET VALUE (NAV). IT DOES NOT REFLECT THE DEDUCTION OF INSURANCE EXPENSES, AN ANNUAL CONTRACT MAINTENANCE FEE, OR SURRENDER CHARGES. 5 EXPENSE EXAMPLE As a shareholder of the Portfolio, you incur two types of costs: (1) insurance company charges; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Portfolio expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Portfolio 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 01/01/05 - 06/30/05. 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 Portfolio's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Portfolio'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 Portfolio 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 insurance company charges. 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 insurance company charges were included, your costs would have been higher.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD * ------------- ------------- --------------- 01/01/05 - 01/01/05 06/30/05 06/30/05 ------------- ------------- --------------- CLASS X Actual (-1.38% return) $ 1,000.00 $ 986.20 $ 2.81 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,021.97 $ 2.86 CLASS Y Actual (-1.50% return) $ 1,000.00 $ 985.00 $ 4.04 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,020.73 $ 4.11
- ---------- * EXPENSES ARE EQUAL TO THE PORTFOLIO'S ANNUALIZED EXPENSE RATIO OF 0.57% AND 0.82% 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 fixed income securities trading. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Portfolio's Administrator under the Administration Agreement, including accounting, clerical, bookkeeping, compliance, business management and planning, and the provision of supplies, office space and utilities. (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 administrative and investment advisory services to the Portfolio. 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 Portfolio. 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 The Board reviewed the Portfolio's performance for the one-, three- and five-year periods ended November 30, 2004, as shown in reports provided by Lipper (the "Lipper Reports"), compared to the performance of comparable funds selected by Lipper (the "performance peer group"), and noted that the Portfolio's performance was better than its performance peer group average for all three periods. The Board concluded that the Portfolio's performance was satisfactory. FEES RELATIVE TO OTHER FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT STRATEGIES The Board reviewed the advisory and administrative fees (together, the "management fee") paid by the Fund under the Management Agreement. The Board noted that the rate was comparable to the management fee rates charged by the Adviser to any other funds it manages with investment strategies comparable to those of the Portfolio. FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS The Board reviewed the management fee rate and the total expense ratio of the Portfolio. The Board noted that: (i) the Portfolio's management fee rate was lower than the average management fee rate for funds, selected by Lipper (the "expense peer group"), managed by other advisers with investment strategies comparable to those of 7 the Portfolio, as shown in the Lipper Report for the Portfolio; and (ii) the Portfolio's total expense ratio was also lower than the average total expense ratio of the funds included in the Portfolio's expense peer group. The Board concluded that the Portfolio's management fee 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 Portfolio's management fee schedule under the Management Agreement and noted that it includes breakpoints. The Board also reviewed the level of the Portfolio's management fee and noted that the fee, as a percentage of the Portfolio's net assets, would decrease as net assets increase because the management fee includes breakpoints. The Board concluded that the Portfolio's management fee would reflect economies of scale as assets increase. PROFITABILITY OF ADVISER AND AFFILIATES The Board considered and reviewed information concerning the costs incurred and profits realized by the Adviser and its affiliates during the last two years from their relationship with the Portfolio and the Morgan Stanley Fund Complex and reviewed with the Controller of the Adviser the cost allocation methodology used to determine the Adviser's profitability. Based on their review of the information they received, the Board concluded that the profits earned by the Adviser and its affiliates were not excessive in light of the advisory, administrative and other services provided to the Portfolio. FALL-OUT BENEFITS The Board considered so-called "fall-out benefits" derived by the Adviser and its affiliates from their relationship with the Portfolio and the Morgan Stanley Fund Complex, such as "float" benefits derived from handling of checks for purchases and redemptions of Portfolio 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 Portfolio 12b-1 fees for distribution and shareholder services. The Board also considered that an affiliate of the Adviser, through a joint venture, receives revenue in connection with trading done on behalf of the Portfolio through an electronic trading system network ("ECN"). The Board concluded that the float benefits and the above-referenced ECN-related revenue were relatively small and that the 12b-1 fees were competitive with those of other broker-dealer affiliates of investment advisers of mutual funds. 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 Portfolio and/or other funds managed by the Adviser would be used to pay for research that a securities broker obtains 8 from third parties, or to pay for both research and execution services from securities brokers who effect transactions for the Portfolio. The Adviser informed the Board that it does not use Portfolio 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 Portfolio and other funds in the Morgan Stanley Fund Complex. ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE PORTFOLIO'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 PORTFOLIO AND THE ADVISER The Board also reviewed and considered the historical relationship between the Portfolio and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Portfolio'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 Portfolio 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 Portfolio'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 Portfolio's business. GENERAL CONCLUSION After considering and weighing all of the above factors, the Board concluded it would be in the best interest of the Portfolio and its shareholders to approve renewal of the Management Agreement for another year. 9 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- DIVIDEND GROWTH PORTFOLIO PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- COMMON STOCKS (98.4%) AEROSPACE & DEFENSE (0.9%) 127,177 Northrop Grumman Corp. $ 7,026,529 --------------- APPAREL/FOOTWEAR (1.8%) 240,808 V.F. Corp. 13,779,034 --------------- AUTO PARTS: O.E.M. (1.3%) 180,839 Johnson Controls, Inc. 10,186,661 --------------- BEVERAGES: NON-ALCOHOLIC (1.7%) 306,878 Coca-Cola Co. (The) 12,812,156 --------------- BIOTECHNOLOGY (0.4%) 41,048 Genentech, Inc.* 3,295,333 --------------- CASINO/GAMING (0.5%) 101,083 Las Vegas Sands Corp.* 3,613,717 --------------- CHEMICALS: AGRICULTURAL (1.1%) 136,792 Monsanto Co. 8,600,113 --------------- CHEMICALS: MAJOR DIVERSIFIED (1.9%) 273,068 Dow Chemical Co. (The) 12,159,718 63,382 Rohm & Haas Co. 2,937,122 --------------- 15,096,840 --------------- COMPUTER COMMUNICATIONS (1.4%) 438,915 Juniper Networks, Inc.* 11,051,880 --------------- COMPUTER PROCESSING HARDWARE (2.9%) 210,013 Apple Computer, Inc.* 7,730,579 369,226 Dell, Inc.* 14,588,119 --------------- 22,318,698 --------------- DATA PROCESSING SERVICES (0.8%) 149,097 First Data Corp. 5,984,754 --------------- DISCOUNT STORES (3.7%) 529,386 Target Corp. 28,803,892 --------------- DRUGSTORE CHAINS (2.7%) 715,403 CVS Corp. 20,796,765 --------------- ELECTRIC UTILITIES (3.5%) 354,854 Exelon Corp. $ 18,214,656 212,375 FPL Group, Inc. 8,932,493 --------------- 27,147,149 --------------- FINANCE/RENTAL/LEASING (0.8%) 70,206 Freddie Mac 4,579,537 72,700 MBNA Corp. 1,901,832 --------------- 6,481,369 --------------- FINANCIAL CONGLOMERATES (4.9%) 457,009 Citigroup, Inc. 21,127,526 187,082 JPMorgan Chase & Co. 6,607,736 40,324 Prudential Financial, Inc. 2,647,674 102,465 UBS AG (ADR) (Switzerland) 7,976,900 --------------- 38,359,836 --------------- FINANCIAL PUBLISHING/ SERVICES (0.8%) 139,481 McGraw-Hill Companies, Inc. (The) 6,172,034 --------------- FOOD: MAJOR DIVERSIFIED (3.3%) 479,756 PepsiCo, Inc. 25,873,241 --------------- HOME IMPROVEMENT CHAINS (1.3%) 260,867 Home Depot, Inc. (The) 10,147,726 --------------- HOTELS/RESORTS/ CRUISELINES (0.6%) 79,629 Carnival Corp. (Panama) 4,343,762 --------------- HOUSEHOLD/PERSONAL CARE (4.2%) 271,500 Avon Products, Inc. 10,276,275 418,546 Procter & Gamble Co. (The) 22,078,302 --------------- 32,354,577 --------------- INDUSTRIAL CONGLOMERATES (9.9%) 315,500 3M Co. 22,810,650 700,506 General Electric Co. 24,272,533 570,744 United Technologies Corp. 29,307,704 --------------- 76,390,887 ---------------
SEE NOTES TO FINANCIAL STATEMENTS 10
NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- INFORMATION TECHNOLOGY SERVICES (1.7%) 175,669 International Business Machines Corp. $ 13,034,640 --------------- INTEGRATED OIL (7.2%) 412,755 BP PLC (ADR) (United Kingdom) 25,747,657 520,907 Exxon Mobil Corp. 29,936,525 --------------- 55,684,182 --------------- INTERNET SOFTWARE/ SERVICES (0.9%) 211,134 Yahoo!, Inc.* 7,315,793 --------------- INVESTMENT BANKS/ BROKERS (2.5%) 79,115 Goldman Sachs Group Inc. (The) 8,071,312 211,577 Merrill Lynch & Co., Inc. 11,638,851 --------------- 19,710,163 --------------- INVESTMENT MANAGERS (1.6%) 441,499 Mellon Financial Corp. 12,666,606 --------------- LIFE/HEALTH INSURANCE (1.5%) 241,015 Lincoln National Corp. 11,308,424 --------------- MAJOR BANKS (3.2%) 535,796 Bank of America Corp. 24,437,656 --------------- MAJOR TELECOMMUNICATIONS (1.8%) 402,172 Verizon Communications Inc. 13,895,043 --------------- MANAGED HEALTH CARE (3.0%) 189,214 Caremark Rx, Inc.* 8,423,807 291,369 UnitedHealth Group, Inc. 15,191,980 --------------- 23,615,787 --------------- MEDIA CONGLOMERATES (0.5%) 247,733 News Corp. (Class B) 4,176,778 --------------- MEDICAL SPECIALTIES (2.2%) 21,093 Alcon, Inc. (Switzerland) 2,306,520 98,639 Fisher Scientific International, Inc.* 6,401,671 163,572 Medtronic, Inc. 8,471,394 --------------- 17,179,585 --------------- MULTI-LINE INSURANCE (0.7%) 88,676 American International Group, Inc. $ 5,152,076 --------------- OFFICE EQUIPMENT/SUPPLIES (2.3%) 415,030 Pitney Bowes, Inc. 18,074,557 --------------- OIL & GAS PRODUCTION (1.3%) 290,162 XTO Energy Inc. 9,862,606 --------------- OILFIELD SERVICES/ EQUIPMENT (1.0%) 129,141 Halliburton Co. 6,175,523 20,400 Schlumberger Ltd. (Netherlands Antilles) 1,549,176 --------------- 7,724,699 --------------- OTHER CONSUMER SERVICES (0.7%) 156,024 eBay, Inc.* 5,150,352 --------------- PACKAGED SOFTWARE (2.6%) 597,834 Microsoft Corp. 14,850,197 118,181 SAP AG (ADR) (Germany) 5,117,237 --------------- 19,967,434 --------------- PHARMACEUTICALS: MAJOR (7.6%) 119,939 Abbott Laboratories 5,878,210 385,149 Bristol-Myers Squibb Co. 9,621,022 213,615 Johnson & Johnson 13,884,975 420,159 Pfizer, Inc. 11,587,985 404,380 Wyeth 17,994,910 --------------- 58,967,102 --------------- PROPERTY - CASUALTY INSURERS (0.2%) 19,438 Progressive Corp. (The) 1,920,669 --------------- SEMICONDUCTORS (3.4%) 495,369 Intel Corp. 12,909,316 189,834 Marvell Technology Group, Ltd. (Bermuda)* 7,221,285 213,305 Texas Instruments Inc. 5,987,471 --------------- 26,118,072 --------------- TELECOMMUNICATION EQUIPMENT (0.8%) 184,975 QUALCOMM Inc. 6,106,025 ---------------
SEE NOTES TO FINANCIAL STATEMENTS 11
NUMBER OF SHARES VALUE - -------------------------------------------------------------------------------- TOBACCO (0.7%) 89,644 Altria Group, Inc. $ 5,796,381 --------------- TRUCKS/CONSTRUCTION/ FARM MACHINERY (0.6%) 66,173 Deere & Co. 4,333,670 --------------- TOTAL COMMON STOCKS (COST $592,990,687) 762,835,253 --------------- PRINCIPAL AMOUNT IN THOUSANDS - --------- SHORT TERM INVESTMENT (1.5%) U.S. GOVERNMENT AGENCY $ 11,900 Federal Home Loan Mortgage Corp. 2.60% due 07/01/05 (a) (COST $11,900,000) 11,900,000 --------------- TOTAL INVESTMENTS (COST $604,890,687) (b) 99.9% 774,735,253 OTHER ASSETS IN EXCESS OF LIABILITIES 0.1 647,543 ----- --------------- NET ASSETS 100.0% $ 775,382,796 ===== ===============
- ---------- ADR AMERICAN DEPOSITARY RECEIPT. * NON-INCOME PRODUCING SECURITY. (a) PURCHASED ON A DISCOUNT BASIS. THE INTEREST RATE SHOWN HAS BEEN ADJUSTED TO REFLECT A MONEY MARKET EQUIVALENT YIELD. (b) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES APPROXIMATES THE AGGREGATE COST FOR BOOK PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION IS $180,130,756 AND THE AGGREGATE GROSS UNREALIZED DEPRECIATION IS $10,286,190, RESULTING IN NET UNREALIZED APPRECIATION OF $169,844,566. SEE NOTES TO FINANCIAL STATEMENTS 12 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- DIVIDEND GROWTH PORTFOLIO SUMMARY OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
PERCENT OF INDUSTRY VALUE NET ASSETS - ----------------------------------------------------------------------------------- Industrial Conglomerates $ 76,390,887 9.9% Pharmaceuticals: Major 58,967,102 7.6 Integrated Oil 55,684,182 7.2 Financial Conglomerates 38,359,836 4.9 Household/Personal Care 32,354,577 4.2 Discount Stores 28,803,892 3.7 Electric Utilities 27,147,149 3.5 Semiconductors 26,118,072 3.4 Food: Major Diversified 25,873,241 3.3 Major Banks 24,437,656 3.2 Managed Health Care 23,615,787 3.0 Computer Processing Hardware 22,318,698 2.9 Drugstore Chains 20,796,765 2.7 Packaged Software 19,967,434 2.6 Investment Banks/Brokers 19,710,163 2.5 Office Equipment/Supplies 18,074,557 2.3 Medical Specialties 17,179,585 2.2 Chemicals: Major Diversified 15,096,840 1.9 Major Telecommunications 13,895,043 1.8 Apparel/Footwear 13,779,034 1.8 Information Technology Services 13,034,640 1.7 Beverages: Non-Alcoholic 12,812,156 1.7 Investment Managers 12,666,606 1.6 U.S. Government Agency 11,900,000 1.5 Life/Health Insurance 11,308,424 1.5 Computer Communications 11,051,880 1.4 Auto Parts: O.E.M. 10,186,661 1.3 Home Improvement Chains 10,147,726 1.3 Oil & Gas Production 9,862,606 1.3 Chemicals: Agricultural 8,600,113 1.1 Oilfield Services/ Equipment 7,724,699 1.0 Internet Software/Services 7,315,793 0.9 Aerospace & Defense 7,026,529 0.9 Finance/Rental/Leasing 6,481,369 0.8 Financial Publishing/ Services 6,172,034 0.8 Telecommunication Equipment $ 6,106,025 0.8% Data Processing Services 5,984,754 0.8 Tobacco 5,796,381 0.7 Multi-Line Insurance 5,152,076 0.7 Other Consumer Services 5,150,352 0.7 Hotels/Resorts/Cruiselines 4,343,762 0.6 Trucks/Construction/ Farm Machinery 4,333,670 0.6 Media Conglomerates 4,176,778 0.5 Casino/Gaming 3,613,717 0.5 Biotechnology 3,295,333 0.4 Property - Casualty Insurers 1,920,669 0.2 --------------- ---- $ 774,735,253 99.9% =============== ====
SEE NOTES TO FINANCIAL STATEMENTS 13 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- DIVIDEND GROWTH PORTFOLIO FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 2005 (UNAUDITED) ASSETS: Investments in securities, at value (cost $586,166,482) $ 753,607,727 Investment in affiliates (cost $18,724,205) 21,127,526 Cash 35,862 Receivable for: Investments sold 4,850,987 Dividends 562,581 Foreign withholding taxes reclaimed 33,631 Prepaid expenses and other assets 26,232 --------------- TOTAL ASSETS 780,244,546 --------------- LIABILITIES: Payable for: Investments purchased 4,407,071 Investment advisory fee 299,736 Administration fee 52,200 Distribution fee 29,599 Shares of beneficial interest redeemed 113 Accrued expenses and other payables 73,031 --------------- TOTAL LIABILITIES 4,861,750 --------------- NET ASSETS $ 775,382,796 =============== COMPOSITION OF NET ASSETS: Paid-in-capital $ 990,733,229 Net unrealized appreciation 169,844,566 Accumulated net investment loss (10) Accumulated net realized loss (385,194,989) --------------- NET ASSETS $ 775,382,796 =============== CLASS X SHARES: Net Assets $ 633,787,166 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 44,685,071 NET ASSET VALUE PER SHARE $ 14.18 =============== CLASS Y SHARES: Net Assets $ 141,595,630 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 9,997,000 NET ASSET VALUE PER SHARE $ 14.16 ===============
SEE NOTES TO FINANCIAL STATEMENTS 14 STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2005 (UNAUDITED) NET INVESTMENT INCOME: INCOME Dividends (net of $29,359 foreign withholding tax) $ 7,208,605 Dividends from affiliates 423,676 Interest 293,692 --------------- TOTAL INCOME 7,925,973 --------------- EXPENSES Investment advisory fee 1,865,422 Administration fee 325,801 Distribution fee (Class Y shares) 171,012 Shareholder reports and notices 42,739 Custodian fees 23,411 Professional fees 18,414 Trustees' fees and expenses 6,087 Transfer agent fees and expenses 250 Other 22,300 --------------- TOTAL EXPENSES 2,475,436 --------------- NET INVESTMENT INCOME 5,450,537 --------------- NET REALIZED AND UNREALIZED GAIN (LOSS): Net Realized Gain 41,180,981 Net Change in Unrealized Appreciation (58,218,377) --------------- NET LOSS (17,037,396) --------------- NET DECREASE $ (11,586,859) ===============
SEE NOTES TO FINANCIAL STATEMENTS 15 STATEMENT OF CHANGES IN NET ASSETS
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 --------------- ----------------- (UNAUDITED) INCREASE (DECREASE) IN NET ASSETS: OPERATIONS: Net investment income $ 5,450,537 $ 14,318,310 Net realized gain 41,180,981 63,450,866 Net change in unrealized appreciation (58,218,377) (7,427,592) --------------- --------------- NET INCREASE (DECREASE) (11,586,859) 70,341,584 --------------- --------------- DIVIDENDS TO SHAREHOLDERS FROM NET INVESTMENT INCOME Class X shares (4,636,199) (12,469,448) Class Y shares (809,302) (1,855,979) --------------- --------------- TOTAL DIVIDENDS (5,445,501) (14,325,427) --------------- --------------- Net decrease from transactions in shares of beneficial interest (85,162,395) (161,922,253) --------------- --------------- NET DECREASE (102,194,755) (105,906,096) NET ASSETS: Beginning of period 877,577,551 983,483,647 --------------- --------------- END OF PERIOD (INCLUDING ACCUMULATED NET INVESTMENT LOSSES OF $10 AND $5,046, RESPECTIVELY) $ 775,382,796 $ 877,577,551 =============== ===============
SEE NOTES TO FINANCIAL STATEMENTS 16 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- DIVIDEND GROWTH PORTFOLIO NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) 1. ORGANIZATION AND ACCOUNTING POLICIES Morgan Stanley Variable Investment Series (the "Fund") -- Dividend Growth Portfolio (the "Portfolio"), one of 15 separate portfolios, is registered under the Investment Company Act of 1940, as amended (the "Act"), as a diversified, open-end management investment company. The Fund is offered exclusively to life insurance companies in connection with particular life insurance and/or annuity contracts they offer. The Portfolio's investment objective is to provide reasonable current income and long-term growth of income and capital. The Fund was organized as a Massachusetts business trust on February 25, 1983 and the Portfolio commenced operations on March 1, 1990. On June 5, 2000, the Portfolio commenced offering one additional class of shares (Class Y). The Portfolio offers Class X shares and Class Y shares. The two are identical except that Class Y shares incur distribution expenses. Class X shares are generally available to holders of contracts offered by Metropolitan Life Insurance Company (formerly Paragon Life Insurance Company) and other contracts offered before May 1, 2000. Class Y shares are available to holders of contracts offered on or after June 5, 2000. 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) when market quotations are not readily available or Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") determines that the latest sale price, the bid price or the mean between the last reported bid and asked price do not reflect a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees. Occasionally, developments affecting the closing prices of securities and other assets may occur between the times at which valuations of such securities are determined (that is, close of the foreign market on which the securities trade) and the close of business on the NYSE. If developments occur during such periods that are expected to materially affect the value of such securities, such valuations may be adjusted to reflect the estimated fair value of such securities as of the close of the NYSE, as determined in good faith by 17 the Fund's Trustees or by the Investment Adviser using a pricing service and/or procedures approved by the Trustees of the Fund; (6) certain portfolio securities may be valued by an outside pricing service approved by the Fund's Trustees; and (7) 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 -- The Fund may 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. FEDERAL INCOME TAX POLICY -- It is the Fund's policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute substantially all of its taxable income to its shareholders. Accordingly, no federal income tax provision is required. F. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- Dividends and distributions to shareholders are recorded on the ex-dividend date. G. EXPENSES -- Direct expenses are charged to the Portfolio and general Fund expenses are allocated on the basis of relative net assets or equally among the Portfolios. H. 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, the Portfolio pays the Investment Adviser an advisory fee, accrued daily and payable monthly, by applying the following annual rates to the net assets of the Portfolio determined at the close of each business day: 0.545% to the portion of daily net assets not 18 exceeding $250 million; 0.42% to the portion of daily net assets exceeding $250 million but not exceeding $1 billion; 0.395% to the portion of daily net assets exceeding $1 billion but not exceeding $2 billion; and 0.37% to the portion of daily net assets in excess of $2 billion. Pursuant to an Administration Agreement with Morgan Stanley Services Company Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Portfolio pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.08% to the Portfolio'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. Under the Plan, Class Y shares of the Portfolio will pay a distribution fee which is accrued daily and paid monthly at the annual rate of 0.25% of the average daily net assets of the class. 4. SECURITY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES The cost of purchases and the proceeds from sales of portfolio securities, excluding short-term investments, for the six months ended June 30, 2005 aggregated $176,470,776 and $256,657,749, respectively. Included in the aforementioned transactions are purchases and sales with other Morgan Stanley funds of $246,240 and $1,039,805, respectively, including a realized gain of $739,488. Included in the aforementioned transactions are purchases and sales with Citigroup Inc., an affiliate of the Fund, for $4,151,057 and $5,694,842, respectively, including a realized gain of $2,684,113, income of $423,676, and a value of $21,127,526. For the six months ended June 30, 2005, the Portfolio incurred brokerage commissions of $59,533 with Morgan Stanley & Co., Inc., an affiliate of the Investment Adviser, Administrator and Distributor, for portfolio transactions executed on behalf of the Fund. At June 30, 2005, the Portfolio's receivable for investments sold and payable for investments purchased included unsettled trades with Morgan Stanley & Co., Inc. of $1,722,605 and $1,200,854, respectively. Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and Distributor, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and 19 compensation. Aggregate pension costs for the six months ended June 30, 2005 included in Trustees' fees and expenses in the Statement of Operations amounted to $780. At June 30, 2005, the Portfolio had an accrued pension liability of $11,062 which is included in accrued expenses in the Statement of Assets and Liabilities. On December 2, 2003, the Trustees voted to close the plan to new participants and eliminate the future benefits growth due to increases to compensation after July 31, 2003. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 5. SHARES OF BENEFICIAL INTEREST Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 ---------------------------------- ---------------------------------- (UNAUDITED) SHARES AMOUNT SHARES AMOUNT --------------- --------------- --------------- --------------- CLASS X SHARES Sold 1,653,400 $ 23,666,522 3,736,535 $ 51,539,866 Reinvestment of dividends 325,799 4,636,199 891,212 12,469,448 Redeemed (8,263,852) (118,148,313) (17,393,738) (238,665,966) --------------- --------------- --------------- --------------- Net decrease -- Class X (6,284,653) (89,845,592) (12,765,991) (174,656,652) --------------- --------------- --------------- --------------- CLASS Y SHARES Sold 1,215,016 17,361,287 2,291,289 31,327,046 Reinvestment of dividends 56,947 809,302 132,372 1,855,979 Redeemed (944,650) (13,487,392) (1,492,305) (20,448,626) --------------- --------------- --------------- --------------- Net increase -- Class Y 327,313 4,683,197 931,356 12,734,399 --------------- --------------- --------------- --------------- Net decrease in the Portfolio (5,957,340) $ (85,162,395) (11,834,635) $ (161,922,253) =============== =============== =============== ===============
20 6. 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 December 31, 2004, the Portfolio had a net capital loss carryforward of approximately $413,323,000 of which $175,052,000 will expire on December 31, 2008, $55,108,000 will expire on December 31, 2009, $134,941,000 will expire on December 31, 2010 and $48,222,000 will expire on December 31, 2011 to offset future capital gains to the extent provided by regulations. As of December 31, 2004, the Portfolio had temporary book/tax differences primarily attributable to capital loss deferrals on wash sales. 21 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- DIVIDEND GROWTH PORTFOLIO FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ----------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ----------- ----------- ----------- ----------- ----------- (UNAUDITED) CLASS X SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 14.48 $ 13.57 $ 10.82 $ 13.48 $ 14.50 $ 18.32 ------------- ----------- ----------- ----------- ----------- ----------- Income (loss) from investment operations: Net investment income++ 0.10 0.22 0.22 0.25 0.26 0.31 Net realized and unrealized gain (loss) (0.30) 0.92 2.76 (2.66) (1.02) 0.02 ------------- ----------- ----------- ----------- ----------- ----------- Total income (loss) from investment operations (0.20) 1.14 2.98 (2.41) (0.76) 0.33 ------------- ----------- ----------- ----------- ----------- ----------- Less dividends and distributions from: Net investment income (0.10) (0.23) (0.23) (0.25) (0.26) (0.33) Net realized gain - - - - - (3.82) ------------- ----------- ----------- ----------- ----------- ----------- Total dividends and distributions (0.10) (0.23) (0.23) (0.25) (0.26) (4.15) ------------- ----------- ----------- ----------- ----------- ----------- Net asset value, end of period $ 14.18 $ 14.48 $ 13.57 $ 10.82 $ 13.48 $ 14.50 ============= =========== =========== =========== =========== =========== TOTAL RETURN+ (1.38)%(2) 8.46% 27.89% (18.01)% (5.20)% 5.30% RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.57%(3) 0.58% 0.59% 0.57% 0.55% 0.54% Net investment income 1.38%(3) 1.60% 1.92% 1.98% 1.86% 2.07% SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 633,787 $ 737,801 $ 865,039 $ 819,935 $ 1,258,863 $ 1,552,724 Portfolio turnover rate 22%(2) 43% 42% 21% 19% 34%
- ---------- * PRIOR TO JUNE 5, 2000, THE PORTFOLIO ISSUED ONE CLASS OF SHARES. ALL SHARES OF THE PORTFOLIO HELD PRIOR TO MAY 1, 2000 HAVE BEEN DESIGNATED CLASS X SHARES. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 22
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED -------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* (UNAUDITED) ------------- ---------- ---------- ---------- ---------- ---------- CLASS Y SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 14.46 $ 13.55 $ 10.81 $ 13.47 $ 14.49 $ 17.79 ------------- ---------- ---------- ---------- ---------- ---------- Income (loss) from investment operations: Net investment income++ 0.08 0.19 0.19 0.22 0.22 0.12 Net realized and unrealized gain (loss) (0.30) 0.92 2.75 (2.66) (1.01) 0.62 ------------- ---------- ---------- ---------- ---------- ---------- Total income (loss) from investment operations (0.22) 1.11 2.94 (2.44) (0.79) 0.74 ------------- ---------- ---------- ---------- ---------- ---------- Less dividends and distributions from: Net investment income (0.08) (0.20) (0.20) (0.22) (0.23) (0.22) Net realized gain - - - - - (3.82) ------------- ---------- ---------- ---------- ---------- ---------- Total dividends and distributions (0.08) (0.20) (0.20) (0.22) (0.23) (4.04) ------------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period $ 14.16 $ 14.46 $ 13.55 $ 10.81 $ 13.47 $ 14.49 ============= ========== ========== ========== ========== ========== TOTAL RETURN+ (1.50)%(2) 8.21% 27.52% (18.23)% (5.42)% 7.65%(2) RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.82%(3) 0.83% 0.84% 0.82% 0.80% 0.79%(3) Net investment income 1.13%(3) 1.35% 1.67% 1.73% 1.61% 1.59%(3) SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 141,596 $ 139,777 $ 118,445 $ 70,844 $ 60,393 $ 19,083 Portfolio turnover rate 22%(2) 43% 42% 21% 19% 34%
- ---------- * FOR THE PERIOD JUNE 5, 2000 (ISSUED DATE) THROUGH DECEMBER 31, 2000. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 23 TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo CHAIRMAN OF THE BOARD Mitchell M. Merin PRESIDENT Ronald E. Robison EXECUTIVE VICE PRESIDENT AND PRINCIPAL EXECUTIVE OFFICER Joseph J. McAlinden VICE PRESIDENT Barry Fink VICE PRESIDENT Amy R. Doberman VICE PRESIDENT Carsten Otto CHIEF COMPLIANCE OFFICER Stefanie V. Chang VICE PRESIDENT Francis J. Smith TREASURER AND CHIEF FINANCIAL OFFICER Thomas F. Caloia VICE PRESIDENT Mary E. Mullin SECRETARY TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT 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 Portfolio 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 Portfolio. For more detailed information about the Portfolio, its fees and expenses and other pertinent information, please read its Prospectus. The Portfolio's Statement of Additional Information contains additional information about the Portfolio, 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 Portfolio 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) 2005 Morgan Stanley [MORGAN STANLEY LOGO] RA05-00642P-Y06/05 [GRAPHIC] MORGAN STANLEY FUNDS MORGAN STANLEY VARIABLE INVESTMENT SERIES -- DIVIDEND GROWTH PORTFOLIO SEMIANNUAL REPORT JUNE 30, 2005 [MORGAN STANLEY LOGO] WELCOME, SHAREHOLDER: IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY VARIABLE INVESTMENT SERIES -- EQUITY PORTFOLIO 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 PORTFOLIO'S FINANCIAL STATEMENTS AND A LIST OF PORTFOLIO INVESTMENTS. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE PORTFOLIO BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE PORTFOLIO WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE PORTFOLIO IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE PORTFOLIO WILL DECLINE AND, THEREFORE, THE VALUE OF THE PORTFOLIO'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS PORTFOLIO. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT For the six months ended June 30, 2005 TOTAL RETURN FOR THE 6 MONTHS ENDED JUNE 30, 2005
RUSSELL 3000(R) CLASS X CLASS Y GROWTH INDEX(1) 0.17% 0.04% -1.88%
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. SEE PERFORMANCE SUMMARY FOR PERFORMANCE INFORMATION AND INDEX DEFINITIONS. MARKET CONDITIONS Following a brisk and upbeat close to 2004, the U.S. equity market slowed its pace in 2005. Sentiment shifted and stocks retreated as investors sold shares to lock in gains. Against the backdrop of rising oil prices, mixed economic data, continued increases to the federal funds target rate, and the prospect of a global economic slowdown, investors worried about the prospect of "stagflation" (a climate marked by both stagnant growth and inflation). Anxiety increased as disappointing news from corporate bellwethers General Motors and Ford Motor cast a shadow across the auto and auto related industries, and the market overall. After reaching a low point in April, the market rebounded during the final two months of the period. Encouraging retail sales and payroll data, an upward revision of first-quarter gross domestic product and strengthening consumer confidence were among the factors that raised investor sentiment. Investors also seemed encouraged by merger and acquisition activity and by signals that the Federal Reserve might be nearing the end of its rate tightening cycle. Mid- and small-cap stocks generally outperformed large-caps during the period, while growth-oriented stocks lagged their value counterparts. PERFORMANCE ANALYSIS The Equity Portfolio outperformed the Russell 3000(R) Growth Index for the six-month period ended June 30, 2005. Stock selection across a wide range of sectors contributed to relative performance, as did overall sector allocations. Within its energy stake, the Portfolio benefited from its positions in crude oil producers and coal companies. International integrated oil stocks further enhanced performance. Among financial services holdings, securities brokerage and services, and diversified financial services companies contributed gains. Other sources of upside performance included medical and dental instruments and supplies and telecommunications equipment. Also, the Portfolio's technology exposure enhanced performance with computer technology stocks contributing notably. In contrast, areas of weakness for the Portfolio included the materials and processing sector, where stock selection in gold companies had the largest negative impact. Within the consumer discretionary sector, hotel and motel companies tempered gains. Additionally, stock selection and an overweighted position in Internet stocks relative to the Russell index also hindered the Portfolio's pace. THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM WELL OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE PORTFOLIO IN THE FUTURE. 2 TOP 10 HOLDINGS Google, Inc. 4.9% Ultra Petroleum Corp. 4.8 WMS Industries, Inc. 3.1 Alcon, Inc. 3.1 Yahoo!, Inc. 3.1 eBay, Inc. 3.1 Intel Corp. 2.7 Marvell Technology Group, Ltd. 2.6 Dade Behring Holdings Inc. 2.4 Station Casinos Inc. 2.2
TOP FIVE INDUSTRIES Medical Specialties 8.5% Internet Software/Services 8.0 Semiconductors 5.3 Other Consumer Services 5.3 Biotechnology 5.0
DATA AS OF JUNE 30, 2005. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES FOR TOP 10 HOLDINGS AND TOP FIVE INDUSTRIES ARE AS A PERCENTAGE OF NET ASSETS. 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. INVESTMENT STRATEGY THE PORTFOLIO WILL NORMALLY INVEST AT LEAST 80% OF ITS ASSETS IN EQUITY SECURITIES AND SECURITIES CONVERTIBLE INTO EQUITY SECURITIES. IN SELECTING INVESTMENTS, THE "INVESTMENT ADVISER," MORGAN STANLEY INVESTMENT ADVISORS INC., MAY EMPLOY VALUATION MODELS BASED ON VARIOUS ECONOMIC AND MARKET INDICATORS. THE INVESTMENT ADVISER CURRENTLY UTILIZES A PROCESS, KNOWN AS SECTOR ROTATION, THAT EMPHASIZES INDUSTRY SELECTION OVER INDIVIDUAL COMPANY SELECTION. THE INVESTMENT ADVISER INVESTS IN THOSE INDUSTRIES THAT IT BELIEVES WILL HAVE THE STRONGEST RELATIVE EARNINGS GROWTH POTENTIAL GIVEN THE PROJECTED ECONOMIC OUTLOOK. AFTER SELECTING THE PORTFOLIO'S TARGET INDUSTRIES, THE INVESTMENT ADVISER THEN SELECTS SPECIFIC COMPANIES WITHIN THOSE INDUSTRIES WHOSE PROSPECTS ARE DEEMED ATTRACTIVE AFTER ASSESSING COMPANY FUNDAMENTALS AND VALUATION SCREENS. FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY PORTFOLIO PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE PORTFOLIO'S SECOND AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY PORTFOLIO 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 3 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 PORTFOLIO'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 PORTFOLIO VOTED PROXIES RELATING TO PORTFOLIO SECURITIES DURING THE MOST RECENT TWELVE-MONTH PERIOD ENDED JUNE 30 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. 4 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED JUNE 30, 2005
CLASS X SHARES CLASS Y SHARES (SINCE 03/09/84) (SINCE 06/05/00) 1 YEAR 7.14%(2) 6.83%(2) 5 YEARS (5.85)(2) (6.09)(2) 10 YEARS 10.16(2) -- SINCE INCEPTION 11.82(2) (5.58)(2)
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 THE 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 PORTFOLIO SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. THE PERFORMANCE OF THE PORTFOLIO'S TWO SHARE CLASSES VARIES BECAUSE EACH HAS DIFFERENT EXPENSES. THE PORTFOLIO'S TOTAL RETURN FIGURES ASSUME THE REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE IMPACT OF ANY CHARGES BY YOUR INSURANCE COMPANY. SUCH COSTS WOULD LOWER PERFORMANCE. (1) THE RUSSELL 3000(R) GROWTH INDEX MEASURES THE PERFORMANCE OF THOSE COMPANIES IN THE RUSSELL 3000(R) INDEX WITH HIGHER PRICE-TO-BOOK RATIOS AND HIGHER FORECASTED GROWTH VALUES. 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) FIGURE ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS FOR THE UNDERLYING PORTFOLIO BASED ON NET ASSET VALUE (NAV). IT DOES NOT REFLECT THE DEDUCTION OF INSURANCE EXPENSES, AN ANNUAL CONTRACT MAINTENANCE FEE, OR SURRENDER CHARGES. 5 EXPENSE EXAMPLE As a shareholder of the Portfolio, you incur two types of costs: (1) insurance company charges; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Portfolio expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Portfolio 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 01/01/05 - 06/30/05. 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 Portfolio's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Portfolio'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 Portfolio 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 insurance company charges. 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 insurance company charges were included, your costs would have been higher.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD * ------------- ------------- --------------- 01/01/05 - 01/01/05 06/30/05 06/30/05 ------------- ------------- --------------- CLASS X Actual (0.17% return) $ 1,000.00 $ 1,001.70 $ 2.63 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,022.17 $ 2.66 CLASS Y Actual (0.04% return) $ 1,000.00 $ 1,000.40 $ 3.87 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,020.93 $ 3.91
- ---------- * EXPENSES ARE EQUAL TO THE PORTFOLIO'S ANNUALIZED EXPENSE RATIO OF 0.53% AND 0.78% 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 fixed income securities trading. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Portfolio's Administrator under the Administration Agreement, including accounting, clerical, bookkeeping, compliance, business management and planning, and the provision of supplies, office space and utilities. (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 administrative and investment advisory services to the Portfolio. 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 Portfolio. 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 The Board reviewed the Portfolio's performance for the one-, three- and five-year periods ended November 30, 2004, as shown in reports provided by Lipper (the "Lipper Reports"), compared to the performance of comparable funds selected by Lipper (the "performance peer group"), and noted that the Portfolio's performance was lower than its performance peer group average for the five-year period but better for the one- and three-year periods. The Board concluded that the Portfolio's overall performance was competitive with its performance peer group. FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS The Board reviewed the management fee rate and the total expense ratio of the Portfolio. The Board noted that: (i) the Portfolio's management fee rate was lower than the average management fee rate for funds, selected by Lipper (the "expense peer group"), managed by other advisers with investment strategies comparable to those of the Portfolio, as shown in the Lipper Report for the Portfolio; and (ii) the Portfolio's total expense ratio was also lower than the average total expense ratio of the funds included in the Portfolio's expense peer group. The Board concluded that the Portfolio's management fee and total expense ratio were competitive with those of its expense peer group. 7 BREAKPOINTS AND ECONOMIES OF SCALE The Board reviewed the structure of the Portfolio's management fee schedule under the Management Agreement and noted that it includes breakpoints. The Board also reviewed the level of the Portfolio's management fee and noted that the fee, as a percentage of the Portfolio's net assets, would decrease as net assets increase because the management fee includes breakpoints. The Board concluded that the Portfolio's management fee would reflect economies of scale as assets increase. PROFITABILITY OF ADVISER AND AFFILIATES The Board considered and reviewed information concerning the costs incurred and profits realized by the Adviser and its affiliates during the last two years from their relationship with the Portfolio and the Morgan Stanley Fund Complex and reviewed with the Controller of the Adviser the cost allocation methodology used to determine the Adviser's profitability. Based on their review of the information they received, the Board concluded that the profits earned by the Adviser and its affiliates were not excessive in light of the advisory, administrative and other services provided to the Portfolio. FALL-OUT BENEFITS The Board considered so-called "fall-out benefits" derived by the Adviser and its affiliates from their relationship with the Portfolio and the Morgan Stanley Fund Complex, such as "float" benefits derived from handling of checks for purchases and redemptions of Portfolio 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 Portfolio 12b-1 fees for distribution and shareholder services. The Board also considered that an affiliate of the Adviser, through a joint venture, receives revenue in connection with trading done on behalf of the Portfolio through an electronic trading system network ("ECN"). The Board concluded that the float benefits and the above-referenced ECN-related revenue were relatively small and that the 12b-1 fees were competitive with those of other broker-dealer affiliates of investment advisers of mutual funds. 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 Portfolio 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 Portfolio. The Adviser informed the Board that it does not use Portfolio 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 8 that the receipt of such research strengthens the investment management resources of the Adviser, which may ultimately benefit the Portfolio and other funds in the Morgan Stanley Fund Complex. ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE PORTFOLIO'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 PORTFOLIO AND THE ADVISER The Board also reviewed and considered the historical relationship between the Portfolio and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Portfolio'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 Portfolio 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 Portfolio'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 Portfolio's business. GENERAL CONCLUSION After considering and weighing all of the above factors, the Board concluded it would be in the best interest of the Portfolio and its shareholders to approve renewal of the Management Agreement for another year. 9 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- EQUITY PORTFOLIO PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ COMMON STOCKS (96.3%) ADVERTISING/MARKETING SERVICES (1.4%) 112,500 Getty Images, Inc.* $ 8,354,250 ------------- APPAREL/FOOTWEAR (1.3%) 234,200 Coach, Inc.* 7,862,094 ------------- APPAREL/FOOTWEAR RETAIL (2.1%) 257,500 Chico's FAS, Inc.* 8,827,100 55,400 Urban Outfitters, Inc.* 3,140,626 ------------- 11,967,726 ------------- BIOTECHNOLOGY (5.0%) 67,300 Amgen Inc.* 4,068,958 116,800 Genentech, Inc.* 9,376,704 144,700 Genzyme Corp.* 8,695,023 154,530 Gilead Sciences, Inc.* 6,797,775 ------------- 28,938,460 ------------- CASINO/GAMING (3.3%) 195,000 Station Casinos, Inc. 12,948,000 135,300 Wynn Resorts, Ltd.* 6,395,631 ------------- 19,343,631 ------------- CHEMICALS: AGRICULTURAL (3.2%) 164,100 Monsanto Co. 10,316,967 86,800 Potash Corp. of Saskatchewan, Inc. (Canada) 8,296,344 ------------- 18,613,311 ------------- COAL (0.6%) 63,400 Peabody Energy Corp. 3,299,336 ------------- COMPUTER PROCESSING HARDWARE (2.9%) 185,100 Apple Computer, Inc.* 6,813,531 250,800 Dell, Inc.* 9,909,108 ------------- 16,722,639 ------------- DATA PROCESSING SERVICES (1.2%) 213,400 CheckFree Corp.* 7,268,404 ------------- DISCOUNT STORES (0.5%) 49,400 Target Corp. $ 2,687,854 ------------- ELECTRONICS/APPLIANCE STORES (1.5%) 129,400 Best Buy Co., Inc. 8,870,370 ------------- FINANCIAL PUBLISHING/ SERVICES (1.8%) 229,600 Moody's Corp. 10,322,816 ------------- FOOD: MAJOR DIVERSIFIED (1.7%) 93,800 Campbell Soup Co. 2,886,226 77,500 Kellogg Co. 3,444,100 62,200 PepsiCo, Inc. 3,354,446 ------------- 9,684,772 ------------- HOME IMPROVEMENT CHAINS (0.4%) 65,000 Home Depot, Inc. (The) 2,528,500 ------------- HOTELS/RESORTS/ CRUISELINES (2.1%) 159,800 Carnival Corp. (Panama) 8,717,090 69,200 Royal Caribbean Cruises Ltd. (Liberia) 3,346,512 ------------- 12,063,602 ------------- INDUSTRIAL CONGLOMERATES (0.6%) 64,200 United Technologies Corp. 3,296,670 ------------- INFORMATION TECHNOLOGY SERVICES (0.7%) 83,400 Cognizant Technology Solutions Corp. (Class A)* 3,930,642 ------------- INTEGRATED OIL (1.5%) 188,200 Suncor Energy, Inc. (Canada) 8,905,624 ------------- INTERNET SOFTWARE/ SERVICES (8.0%) 97,325 Google, Inc. (Class A)* 28,628,149 514,700 Yahoo!, Inc.* 17,834,355 ------------- 46,462,504 -------------
SEE NOTES TO FINANCIAL STATEMENTS 10
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ INVESTMENT BANKS/ BROKERS (4.9%) 10,200 Chicago Mercantile Exchange (The) $ 3,014,100 114,150 Goldman Sachs Group Inc. (The) 11,645,583 145,000 Greenhill & Co., Inc. 5,873,950 76,550 Legg Mason, Inc. 7,969,621 ------------- 28,503,254 ------------- MAJOR TELECOMMUNICATIONS (1.9%) 439,700 Sprint Corp. 11,032,073 ------------- MANAGED HEALTH CARE (1.3%) 149,000 UnitedHealth Group, Inc. 7,768,860 ------------- MEDICAL SPECIALTIES (8.5%) 163,800 Alcon, Inc. (Switzerland) 17,911,530 214,000 Dade Behring Holdings Inc. 13,912,140 83,400 INAMED Corp.* 5,585,298 43,600 Kinetic Concepts, Inc.* 2,616,000 121,700 Medtronic, Inc. 6,302,843 72,500 St. Jude Medical, Inc.* 3,161,725 ------------- 49,489,536 ------------- MEDICAL/NURSING SERVICES (0.6%) 134,600 VCA Antech, Inc.* 3,264,050 ------------- MISCELLANEOUS COMMERCIAL SERVICES (2.2%) 310,500 Bright Horizons Family Solutions, Inc.* 12,643,560 ------------- MULTI-LINE INSURANCE (1.0%) 75,600 Hartford Financial Services Group, Inc. (The) 5,653,368 ------------- OIL & GAS PRODUCTION (4.8%) 921,000 Ultra Petroleum Corp. (Canada)* 27,961,560 ------------- OTHER CONSUMER SERVICES (5.3%) 165,040 Apollo Group, Inc. (Class A)* $ 12,909,429 537,100 eBay, Inc.* 17,729,671 ------------- 30,639,100 ------------- OTHER METALS/MINERALS (1.1%) 148,100 Cameco Corporation (Canada) 6,627,475 ------------- PACKAGED SOFTWARE (0.9%) 181,300 Adobe Systems, Inc. 5,188,806 ------------- PERSONNEL SERVICES (0.1%) 29,600 Monster Worldwide Inc.* 848,928 ------------- PHARMACEUTICALS: MAJOR (2.2%) 145,100 Johnson & Johnson 9,431,500 169,400 Schering-Plough Corp. 3,228,764 ------------- 12,660,264 ------------- PROPERTY - CASUALTY INSURERS (1.1%) 2,299 Berkshire Hathaway, Inc. (Class A)* 6,399,266 ------------- RECREATIONAL PRODUCTS (3.8%) 109,800 Shanda Interactive Entertainment, Ltd. (ADS) (Cayman Islands)* 4,039,542 536,100 WMS Industries, Inc.* 18,093,375 ------------- 22,132,917 ------------- RESTAURANTS (1.9%) 101,700 P.F. Chang's China Bistro, Inc.* 5,998,266 173,900 Sonic Corp.* 5,309,167 ------------- 11,307,433 ------------- SEMICONDUCTORS (5.3%) 606,100 Intel Corp. 15,794,966 393,500 Marvell Technology Group, Ltd. (Bermuda)* 14,968,740 ------------- 30,763,706 -------------
SEE NOTES TO FINANCIAL STATEMENTS 11
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ SPECIALTY STORES (3.2%) 311,600 Claire's Stores, Inc. $ 7,493,980 66,500 Dick's Sporting Goods, Inc.* 2,566,235 57,300 Guitar Center, Inc.* 3,344,601 188,900 Toys 'R' Us, Inc.* 5,002,072 ------------- 18,406,888 ------------- SPECIALTY TELECOMMUNICATIONS (2.2%) 628,861 Crown Castle International Corp.* 12,778,455 ------------- TELECOMMUNICATION EQUIPMENT (1.3%) 144,000 Corning Inc.* 2,393,280 159,000 QUALCOMM Inc. 5,248,590 ------------- 7,641,870 ------------- WIRELESS TELECOMMUNICATIONS (2.9%) 129,300 America Movil S.A. de C.V. (Series L) (ADR) (Mexico) 7,707,573 282,300 Nextel Communications, Inc. (Class A)* 9,121,113 ------------- 16,828,686 ------------- Total Common Stocks (COST $473,221,034) 559,663,260 ------------- PRINCIPAL AMOUNT IN THOUSANDS VALUE - ------------------------------------------------------------------------ Short-Term Investment (a) (2.3%) U.S. GOVERNMENT AGENCY $ 13,000 Federal Home Loan Mortgage Corp. 2.60% due 07/01/05 (COST $13,300,000) $ 13,300,000 ------------- Total Investments (COST $486,521,034) (b) 98.6% 572,963,260 Other Assets in Excess of Liabilities 1.4 7,961,422 ----- ------------- Net Assets 100.0% $ 580,924,682 ===== =============
- ---------- ADR AMERICAN DEPOSITARY RECEIPT. ADS AMERICAN DEPOSITARY SHARES. * NON-INCOME PRODUCING SECURITY (a) PURCHASED ON A DISCOUNT BASIS. THE INTEREST RATE SHOWN HAS BEEN ADJUSTED TO REFLECT A MONEY MARKET EQUIVALENT YIELD. (b) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES APPROXIMATES THE AGGREGATE COST FOR BOOK PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION IS $94,096,406 AND THE AGGREGATE GROSS UNREALIZED DEPRECIATION IS $7,654,180, RESULTING IN NET UNREALIZED APPRECIATION OF $86,442,226. SEE NOTES TO FINANCIAL STATEMENTS 12 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- EQUITY PORTFOLIO SUMMARY OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
PERCENT OF INDUSTRY VALUE NET ASSETS - ------------------------------------------------------------------------ Medical Specialties $ 49,489,536 8.5% Internet Software/Services 46,462,504 8.0 Semiconductors 30,763,706 5.3 Other Consumer Services 30,639,100 5.3 Biotechnology 28,938,460 5.0 Investment Banks/Brokers 28,503,254 4.9 Oil & Gas Production 27,961,560 4.8 Recreational Products 22,132,917 3.8 Casino/Gaming 19,343,631 3.3 Chemicals: Agricultural 18,613,311 3.2 Specialty Stores 18,406,888 3.2 Wireless Telecommunications 16,828,686 2.9 Computer Processing Hardware 16,722,639 2.9 U.S. Government Agency 13,300,000 2.3 Specialty Telecommunications 12,778,455 2.2 Pharmaceuticals: Major 12,660,264 2.2 Miscellaneous Commercial Services 12,643,560 2.2 Hotels/Resorts/Cruiselines 12,063,602 2.1 Apparel/Footwear Retail 11,967,726 2.1 Restaurants 11,307,433 1.9 Major Telecommunications 11,032,073 1.9 Financial Publishing/ Services 10,322,816 1.8 Food: Major Diversified $ 9,684,772 1.7% Integrated Oil 8,905,624 1.5 Electronics/Appliance Stores 8,870,370 1.5 Advertising/Marketing Services 8,354,250 1.4 Apparel/Footwear 7,862,094 1.3 Managed Health Care 7,768,860 1.3 Telecommunication Equipment 7,641,870 1.3 Data Processing Services 7,268,404 1.2 Other Metals/Minerals 6,627,475 1.1 Property - Casualty Insurers 6,399,266 1.1 Multi-Line Insurance 5,653,368 1.0 Packaged Software 5,188,806 0.9 Information Technology Services 3,930,642 0.7 Coal 3,299,336 0.6 Industrial Conglomerates 3,296,670 0.6 Medical/Nursing Services 3,264,050 0.6 Discount Stores 2,687,854 0.5 Home Improvement Chains 2,528,500 0.4 Personnel Services 848,928 0.1 --------------- ---------- $ 572,963,260 98.6% =============== ==========
SEE NOTES TO FINANCIAL STATEMENTS 13 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- EQUITY PORTFOLIO FINANCIAL STATEMENTS Statement of Assets and Liabilities JUNE 30, 2005 (UNAUDITED) ASSETS: Investments in securities, at value (cost $486,521,034) $ 572,963,260 Cash 24,130 Receivable for: Investments sold 8,915,106 Dividends 164,580 Prepaid expenses and other assets 28,659 --------------- TOTAL ASSETS 582,095,735 --------------- LIABILITIES: Payable for: Investments purchased 853,537 Investment advisory fee 202,575 Administration fee 38,586 Distribution fee 23,065 Shares of beneficial interest redeemed 372 Accrued expenses and other payables 52,918 --------------- TOTAL LIABILITIES 1,171,053 --------------- NET ASSETS $ 580,924,682 =============== COMPOSITION OF NET ASSETS: Paid-in-capital $ 1,025,138,778 Net unrealized appreciation 86,442,226 Accumulated undistributed net investment income 87,162 Accumulated net realized loss (530,743,484) --------------- NET ASSETS $ 580,924,682 =============== CLASS X SHARES: Net Assets $ 469,334,768 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 19,468,884 NET ASSET VALUE PER SHARE $ 24.11 =============== CLASS Y SHARES: Net Assets $ 111,589,914 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 4,641,832 NET ASSET VALUE PER SHARE $ 24.04 ===============
SEE NOTES TO FINANCIAL STATEMENTS 14 Statement of Operations FOR THE SIX MONTHS ENDED JUNE 30, 2005 (UNAUDITED) NET INVESTMENT INCOME: INCOME Dividends (net of $64,886 foreign withholding tax) $ 1,461,179 Interest 334,769 --------------- TOTAL INCOME 1,795,948 --------------- EXPENSES Investment advisory fee 1,239,428 Administration fee 236,081 Distribution fee (Class Y shares) 136,615 Shareholder reports and notices 30,947 Custodian fees 19,630 Professional fees 17,362 Trustees' fees and expenses 4,461 Transfer agent fees and expenses 250 Other 16,820 --------------- TOTAL EXPENSES 1,701,594 --------------- NET INVESTMENT INCOME 94,354 --------------- Net Realized and Unrealized Gain (Loss): Net realized gain 13,819,757 Net change in unrealized appreciation (15,630,266) --------------- NET LOSS (1,810,509) --------------- NET DECREASE $ (1,716,155) ===============
SEE NOTES TO FINANCIAL STATEMENTS 15 Statement of Changes in Net Assets
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 --------------- ------------------ (UNAUDITED) INCREASE (DECREASE) IN NET ASSETS: OPERATIONS: Net investment income $ 94,354 $ 2,481,521 Net realized gain 13,819,757 53,801,550 Net change in unrealized appreciation (15,630,266) 11,361,803 --------------- ------------------ NET INCREASE (DECREASE) (1,716,155) 67,644,874 --------------- ------------------ Dividends and Distributions to Shareholders from: Net investment income Class X shares -- (2,254,627) Class Y shares -- (228,122) Net realized gain Class X shares -- (55,240) Class Y shares -- (11,990) --------------- ------------------ TOTAL DIVIDENDS AND DISTRIBUTIONS -- (2,549,979) --------------- ------------------ Net decrease from transactions in shares of beneficial interest (70,185,950) (128,695,663) --------------- ------------------ NET DECREASE (71,902,105) (63,600,768) Net Assets: Beginning of period 652,826,787 716,427,555 --------------- ------------------ End of Period (INCLUDING ACCUMULATED UNDISTRIBUTED NET INVESTMENT INCOME OF $87,162 AND ACCUMULATED NET INVESTMENT LOSS OF $7,192, RESPECTIVELY) $ 580,924,682 $ 652,826,787 =============== ==================
SEE NOTES TO FINANCIAL STATEMENTS 16 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- EQUITY PORTFOLIO NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) 1. ORGANIZATION AND ACCOUNTING POLICIES Morgan Stanley Variable Investment Series (the "Fund") -- Equity Portfolio (the "Portfolio"), one of 15 separate portfolios, is registered under the Investment Company Act of 1940, as amended (the "Act"), as a diversified, open-end management investment company. The Fund is offered exclusively to life insurance companies in connection with particular life insurance and/or annuity contracts they offer. The Portfolio's primary investment objective is growth of capital and, as secondary objective, income, but only when consistent with its primary objective. The Fund was organized as a Massachusetts business trust on February 25, 1983 and the Portfolio commenced operations on March 9, 1984. On June 5, 2000, the Portfolio commenced offering one additional class of shares (Class Y shares). The Portfolio offers Class X shares and Class Y shares. The two are identical except that Class Y shares incur distribution expenses. Class X shares are generally available to holders of contracts offered by Metropolitan Life Insurance Company (formerly Paragon Life Insurance Company) and other contracts offered before May 1, 2000. Class Y shares are available to holders of contracts offered on or after June 5, 2000. 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) when market quotations are not readily available or Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") determines that the latest sale price, the bid price or the mean between the last reported bid and asked price do not reflect a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees. Occasionally, developments affecting the closing prices of securities and other assets may occur between the times at which valuations of such securities are determined (that is, close of the foreign market on which the securities trade) and the close of business on the NYSE. If developments occur during such periods that are expected to materially affect the value of such securities, such valuations may be adjusted to reflect the estimated fair value of such securities as of the close of the NYSE, as determined in good faith by 17 the Fund's Trustees or by the Investment Adviser using a pricing service and/or procedures approved by the Morgan Stanley Variable Investment Series -- Equity Portfolio Trustees of the Fund; (6) certain portfolio securities may be valued by an outside pricing service approved by the Fund's Trustees; and (7) 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 -- The Fund may 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. FEDERAL INCOME TAX POLICY -- It is the Fund's policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute substantially all of its taxable income to its shareholders. Accordingly, no federal income tax provision is required. F. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- Dividends and distributions to shareholders are recorded on the ex-dividend date. G. EXPENSES -- Direct expenses are charged to the Portfolio and general Fund expenses are allocated on the basis of relative net assets or equally among Portfolios. H. 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 Portfolio pays the Investment Adviser an advisory fee, accrued daily and payable monthly, by applying the following annual rates to the net assets of the Portfolio determined at the close of each business day: 0.42% to the 18 portion of the daily net assets not exceeding $1 billion; 0.395% to the portion of the daily net assets exceeding $1 billion but not exceeding $2 billion and 0.37% to the portion of the daily net assets in excess of $2 billion. Pursuant to an Administration Agreement with Morgan Stanley Services Company Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Portfolio pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.08% to the Portfolio'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 Class Y shares of the Portfolio will pay a distribution fee which is accrued daily and paid monthly at the annual rate of 0.25% of the average daily net assets of the class. 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 June 30, 2005 aggregated $322,564,565 and $383,313,146, respectively. Included in the aforementioned are purchases and sales with other Morgan Stanley funds of $1,951,434 and $310,080 respectively, including a net realized gain of $1,551. For the six months ended June 30, 2005, the Portfolio incurred brokerage commissions of $69,583 with Morgan Stanley & Co., Inc., an affiliate of the Investment Adviser, Administrator and Distributor, for transactions executed on behalf of the Portfolio. At June 30, 2005, the Portfolio's receivable for investments sold included unsettled trades with Morgan Stanley & Co., Inc. of $2,145,755. Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and Distributor, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and compensation. Aggregate pension costs for the six months ended June 30, 2005 included in Trustees' fees and expenses in the Statement of Operations amounted to $576. At June 30, 2005, the Portfolio had an accrued pension liability of $6,712 which is included in accrued expenses in the Statement of Assets and Liabilities. On December 2, 2003, the Trustees voted to close the plan to new participants and eliminate the future benefits growth due to increases to compensation after July 31, 2003. 19 The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 5. SHARES OF BENEFICIAL INTEREST Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 -------------------------------------- ------------------------------------- (UNAUDITED) SHARES AMOUNT SHARES AMOUNT ----------------- ----------------- ----------------- ----------------- CLASS X SHARES Sold 744,356 $ 17,337,875 1,593,619 $ 35,668,551 Reinvestment of dividends and distributions -- -- 95,965 2,309,867 Redeemed (3,588,166) (83,470,107) (7,702,311) (170,755,440) ----------------- ----------------- ----------------- ----------------- Net decrease -- Class X (2,843,810) (66,132,232) (6,012,727) (132,777,022) ----------------- ----------------- ----------------- ----------------- CLASS Y SHARES Sold 329,762 7,643,254 1,197,646 26,214,646 Reinvestment of dividends and distributions -- -- 9,992 240,112 Redeemed (503,710) (11,696,972) (1,014,296) (22,373,399) ----------------- ----------------- ----------------- ----------------- Net increase (decrease) -- Class Y (173,948) (4,053,718) 193,342 4,081,359 ----------------- ----------------- ----------------- ----------------- Net decrease in Portfolio (3,017,758) $ (70,185,950) (5,819,385) $ (128,695,663) ================= ================= ================= =================
6. 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. 20 As of December 31, 2004, the Portfolio had a net capital loss carryforward of approximately $543,428,000 of which $412,622,000 will expire on December 31, 2009 and $130,806,000 will expire on December 31, 2010 to offset future capital gains to the extent provided by regulations. As of December 31, 2004, the Portfolio had temporary book/tax differences primarily attributable to capital loss deferrals on wash sales. 21 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- EQUITY PORTFOLIO FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ---------------------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ---------- ---------- ---------- ------------- ------------- (UNAUDITED) CLASS X SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 24.07 $ 21.75 $ 17.78 $ 22.66 $ 39.68 $ 53.88 ------------ ---------- ---------- ---------- ------------- ------------- Income (loss) from investment operations: Net investment income++ 0.01 0.09 0.07 0.07 0.15 0.30 Net realized and unrealized gain (loss) 0.03 2.33 3.97 (4.87) (10.12) (6.46) ------------ ---------- ---------- ---------- ------------- ------------- Total income (loss) from investment operations 0.04 2.42 4.04 (4.80) (9.97) (6.16) ------------ ---------- ---------- ---------- ------------- ------------- Less dividends and distributions from: Net investment income -- (0.10) (0.07) (0.08) (0.16) (0.29) Net realized gain -- -- -- -- (6.89) (7.75) ------------ ---------- ---------- ---------- ------------- ------------- Total dividends and distributions -- (0.10) (0.07) (0.08) (7.05) (8.04) ------------ ---------- ---------- ---------- ------------- ------------- Net asset value, end of period $ 24.11 $ 24.07 $ 21.75 $ 17.78 $ 22.66 $ 39.68 ============ ========== ========== ========== ============= ============= TOTAL RETURN+ 0.17%(2) 11.14% 22.80% (21.21)% (26.87)% (12.35)% RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.53%(3) 0.53% 0.52% 0.51% 0.51% 0.50% Net investment income 0.08%(3) 0.41% 0.38% 0.36% 0.55% 0.62% SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 469,335 $ 537,086 $ 616,027 $ 622,133 $ 1,022,335 $ 1,818,134 Portfolio turnover rate 56%(2) 137% 210% 223% 329% 402%
- ---------- * PRIOR TO JUNE 5, 2000, THE PORTFOLIO ISSUED ONE CLASS OF SHARES. ALL SHARES OF THE PORTFOLIO HELD PRIOR TO MAY 1, 2000 HAVE BEEN DESIGNATED CLASS X SHARES. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 22
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ------------------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ---------- ---------- ---------- ------------- ------------ (UNAUDITED) CLASS Y SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 24.03 $ 21.72 $ 17.75 $ 22.64 $ 39.66 $ 49.12 ------------ ---------- ---------- ---------- ------------- ------------ Income (loss) from investment operations: Net investment income++ (0.02) 0.05 0.02 0.03 0.06 0.21 Net realized and unrealized gain (loss) 0.03 2.31 3.98 (4.89) (10.09) (1.68) ------------ ---------- ---------- ---------- ------------- ------------ Total income (loss) from investment operations 0.01 2.36 4.00 (4.86) (10.03) (1.47) ------------ ---------- ---------- ---------- ------------- ------------ Less dividends and distributions from: Net investment income -- (0.05) (0.03) (0.03) (0.10) (0.24) Net realized gain -- -- -- -- (6.89) (7.75) ------------ ---------- ---------- ---------- ------------- ------------ Total dividends and distributions -- (0.05) (0.03) (0.03) (6.99) (7.99) ------------ ---------- ---------- ---------- ------------- ------------ Net asset value, end of period $ 24.04 $ 24.03 $ 21.72 $ 17.75 $ 22.64 $ 39.66 ============ ========== ========== ========== ============= ============ TOTAL RETURN+ 0.04%(2) 10.86% 22.55% (21.45)% (27.07)% (3.99)%(2) RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.78%(3) 0.78% 0.77% 0.76% 0.76% 0.75%(3) Net investment income (loss) (0.17)%(3) 0.16% 0.13% 0.11% 0.30% 0.85%(3) SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 111,590 $ 115,471 $ 100,400 $ 64,829 $ 61,110 $ 31,903 Portfolio turnover rate 56%(2) 137% 210% 223% 329% 402%
- ---------- * FOR THE PERIOD JUNE 5, 2000 (ISSUED DATE) THROUGH DECEMBER 31, 2000. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 23 TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo CHAIRMAN OF THE BOARD Mitchell M. Merin PRESIDENT Ronald E. Robison EXECUTIVE VICE PRESIDENT AND PRINCIPAL EXECUTIVE OFFICER Joseph J. McAlinden VICE PRESIDENT Barry Fink VICE PRESIDENT Amy R. Doberman VICE PRESIDENT Carsten Otto CHIEF COMPLIANCE OFFICER Stefanie V. Chang VICE PRESIDENT Francis J. Smith TREASURER AND CHIEF FINANCIAL OFFICER Thomas F. Caloia VICE PRESIDENT Mary E. Mullin SECRETARY TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT 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 Portfolio 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 Portfolio. For more detailed information about the Portfolio, its fees and expenses and other pertinent information, please read its Prospectus. The Portfolio's Statement of Additional Information contains additional information about the Portfolio, 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 Portfolio 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) 2005 Morgan Stanley [MORGAN STANLEY LOGO] RA05-00682P-Y06/05 [GRAPHIC] MORGAN STANLEY FUNDS MORGAN STANLEY VARIABLE INVESTMENT SERIES -- EQUITY PORTFOLIO SEMIANNUAL REPORT JUNE 30, 2005 [MORGAN STANLEY LOGO] WELCOME, SHAREHOLDER: IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY VARIABLE INVESTMENT SERIES -- EUROPEAN EQUITY PORTFOLIO 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 PORTFOLIO'S FINANCIAL STATEMENTS AND A LIST OF PORTFOLIO INVESTMENTS. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE PORTFOLIO BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE PORTFOLIO WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE PORTFOLIO IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE PORTFOLIO WILL DECLINE AND, THEREFORE, THE VALUE OF THE PORTFOLIO'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS PORTFOLIO. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT For the six months ended June 30, 2005 TOTAL RETURN FOR THE 6 MONTHS ENDED JUNE 30, 2005
MSCI EUROPE CLASS X CLASS Y INDEX(1) -2.61% -2.81% -0.38%
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. SEE PERFORMANCE SUMMARY FOR PERFORMANCE INFORMATION AND INDEX DEFINITIONS. MARKET CONDITIONS Against a backdrop of mixed sentiment and exceptionally high oil prices, global equity markets slowed during the six month period ended June 30, 2005. While the leveling off of the United States economy was not surprising, given the good clip of growth in 2004 and the continued tightening in the federal funds target rate, the declines in Europe were more unsettling. Economies which had performed strongly, such as Sweden and the United Kingdom, lost ground. A strong euro (which can hurt exports) and high oil prices contributed to falling business confidence and a lack of momentum. Industrial production, consumer confidence and retail sales faltered significantly. Export activity, typically an area of strength in the European economy, also weakened due to slowing demand from China. In the United Kingdom, consumers retrenched markedly as protracted weakness in the housing market spilled over to the retailing sector. As these trends unfolded, speculation increased that the Bank of England and the European Central Bank would reduce rates to stimulate growth. Sweden's central bank, meanwhile, did move forward with a rate reduction. Within the Portfolio's benchmark, energy stocks performed with particular strength during the period, propelled from the high price of oil. Utilities benefited from rising energy costs as well as from investors' interest in stocks with yield potential and defensive characteristics. Telecommunications and retail stocks did not fare so well. Telecommunications retreated amid profit taking and the prospect of aggressive business strategies. Retailers struggled as the result of the pronounced decline in consumer spending. PERFORMANCE ANALYSIS The European Equity Portfolio underperformed the MSCI Europe Index for the six-month period ended June 30, 2005. An overweighted position in telecommunications stocks impeded performance; profit taking and merger-and-acquisition concerns were among the factors negatively impacting shares during the reporting period. Within financial services, Italian-domiciled banks performed well on merger-and-acquisition activity. The Portfolio's underweighting to these companies proved disadvantageous. Hindered by slowing consumer spending, U.K. bank exposure further tempered returns. Positions in capital goods stocks also detracted when operating performance fell short of market expectations. In contrast, the Portfolio benefited from strong stock selection within the materials sector due to a variety of company specific factors, including improving commodity trends and favorable operating results. Insurance company exposure also enhanced overall returns, again due to company-specific news. As of the end of the period, the Portfolio's long-term stock selection philosophy resulted in overweighting relative to the benchmark in telecommunications stocks and an underweighting in utilities. Positions in materials stocks were decreased to capture gains. Media exposure was pared, while technology, consumer staples and pharmaceutical stakes were increased. THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM WELL OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE PORTFOLIO IN THE FUTURE. 2 TOP 10 HOLDINGS Total S.A. 3.8% GlaxoSmithKline PLC 3.7 Novartis AG (Registered Shares) 3.6 BNP Paribas S.A. 3.3 BP PLC 3.3 Royal Dutch Petroleum Co. 3.2 Morrison (W.M.) Supermarkets PLC 3.2 Koninklijke (Royal) KPN NV 3.2 Banco Bilbao Vizcaya Argentaria, S.A. 3.2 Royal Bank of Scotland Group PLC 3.0
TOP FIVE COUNTRIES United Kingdom 32.1% Netherlands 15.8 France 15.4 Germany 9.3 Switzerland 8.7
DATA AS OF JUNE 30, 2005. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES FOR TOP TEN HOLDINGS AND TOP FIVE COUNTRIES ARE AS A PERCENTAGE OF NET ASSETS. 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. INVESTMENT STRATEGY THE PORTFOLIO WILL NORMALLY INVEST AT LEAST 80% OF ITS ASSETS IN EQUITY SECURITIES ISSUED BY ISSUERS LOCATED IN EUROPEAN COUNTRIES. A COMPANY IS CONSIDERED TO BE LOCATED IN EUROPE IF (i) IT IS ORGANIZED UNDER THE LAWS OF A EUROPEAN COUNTRY AND HAS A PRINCIPAL OFFICE IN A EUROPEAN COUNTRY; (ii) IT DERIVES AT LEAST 50% OF ITS TOTAL REVENUES FROM BUSINESSES IN EUROPE; OR (iii) ITS EQUITY SECURITIES ARE TRADED PRINCIPALLY ON A STOCK EXCHANGE IN EUROPE. THE PRINCIPAL COUNTRIES IN WHICH THE PORTFOLIO INVESTS ARE FRANCE, THE UNITED KINGDOM, GERMANY, THE NETHERLANDS, SPAIN, SWEDEN, SWITZERLAND AND ITALY. THE PORTFOLIO INVESTS IN AT LEAST THREE SEPARATE COUNTRIES. THE PORTFOLIO MAY ALSO INVEST UP TO 20% OF ITS ASSETS IN EQUITY SECURITIES OF NON-EUROPEAN ISSUERS. THE PORTFOLIO INVESTS PRINCIPALLY IN COMMON STOCKS AND OTHER EQUITY SECURITIES (WHICH MAY INCLUDE DEPOSITARY RECEIPTS OR CONVERTIBLE SECURITIES). FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY PORTFOLIO PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE PORTFOLIO'S SECOND AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY PORTFOLIO 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 3 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 PORTFOLIO'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 PORTFOLIO VOTED PROXIES RELATING TO PORTFOLIO SECURITIES DURING THE MOST RECENT TWELVE-MONTH PERIOD ENDED JUNE 30 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. 4 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED JUNE 30, 2005
CLASS X SHARES CLASS Y SHARES (SINCE 03/01/91) (SINCE 06/05/00) 1 YEAR 10.22%(2) 9.87%(2) 5 YEARS (2.75)(2) (2.99)(2) 10 YEARS 8.61(2) -- SINCE INCEPTION 10.64(2) (3.40)(2)
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 THE 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 PORTFOLIO SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. THE PERFORMANCE OF THE PORTFOLIO'S TWO SHARE CLASSES VARIES BECAUSE EACH HAS DIFFERENT EXPENSES. THE PORTFOLIO'S TOTAL RETURN FIGURES ASSUME THE REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE IMPACT OF ANY CHARGES BY YOUR INSURANCE COMPANY. SUCH COSTS WOULD LOWER PERFORMANCE. (1) THE MORGAN STANLEY CAPITAL INTERNATIONAL (MSCI) EUROPE INDEX MEASURES THE PERFORMANCE FOR A DIVERSE RANGE OF GLOBAL STOCK MARKETS WITHIN AUSTRIA, BELGIUM, DENMARK, FINLAND, FRANCE, GERMANY, ITALY, THE NETHERLANDS, NORWAY, SPAIN, SWEDEN, SWITZERLAND, IRELAND, PORTUGAL, AND THE UNITED KINGDOM. THE PERFORMANCE OF THE INDEX IS LISTED IN U.S. DOLLARS AND ASSUMES REINVESTMENT OF NET DIVIDENDS. "NET DIVIDENDS" REFLECTS A REDUCTION IN DIVIDENDS AFTER TAKING INTO ACCOUNT WITHHOLDING OF TAXES BY CERTAIN FOREIGN COUNTRIES REPRESENTED IN THE INDEX. 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) FIGURE ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS FOR THE UNDERLYING PORTFOLIO BASED ON NET ASSET VALUE (NAV). IT DOES NOT REFLECT THE DEDUCTION OF INSURANCE EXPENSES, AN ANNUAL CONTRACT MAINTENANCE FEE, OR SURRENDER CHARGES. 5 EXPENSE EXAMPLE As a shareholder of the Portfolio, you incur two types of costs: (1) insurance company charges; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Portfolio expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Portfolio 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 01/01/05 - 06/30/05. 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 Portfolio's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Portfolio'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 Portfolio 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 insurance company charges. 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 insurance company charges were included, your costs would have been higher.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD * ------------- ------------- --------------- 01/01/05 - 01/01/05 06/30/05 06/30/05 ------------- ------------- --------------- CLASS X Actual (-2.61% return) $ 1,000.00 $ 973.90 $ 5.14 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,019.59 $ 5.26 CLASS Y Actual (-2.81% return) $ 1,000.00 $ 971.90 $ 6.36 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,018.35 $ 6.51
- ---------- * EXPENSES ARE EQUAL TO THE PORTFOLIO'S ANNUALIZED EXPENSE RATIO OF 1.05% AND 1.30% 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 fixed income securities trading. The Board reviewed similar information and factors regarding the Sub-Adviser, to the extent applicable. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Portfolio's Administrator under the Administration Agreement, including accounting, clerical, bookkeeping, compliance, business management and planning, and the provision of supplies, office space and utilities. (The Investment Adviser, Sub-Adviser and the Administrator together are referred to as the "Adviser" and the Advisory, Sub-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 administrative and investment advisory services to the Portfolio. 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 Portfolio. 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 The Board reviewed the Portfolio's performance for the one-, three- and five-year periods ended November 30, 2004, as shown in reports (the "Lipper Reports") provided by Lipper compared to the performance of comparable funds selected by Lipper (the "performance peer group"), and noted that the Portfolio's performance was lower than its performance peer group average for all three periods. The Board discussed with the Adviser possible steps to improve performance. The Adviser informed the Board that, in order to try to improve performance, it had made a strategy change in managing the Portfolio's assets and was in the process of strengthening the research resources available to the Portfolio through hiring of key experienced research analysts, whose names and areas of research experience were provided to the Board. The Board concluded that the actions taken by the Adviser were reasonably designed to improve performance. FEES RELATIVE TO OTHER FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT STRATEGIES The Board reviewed the advisory and administrative fees (together, the "management fee") paid by the Portfolio under the Management Agreement. The Board noted that the rate was comparable to the management fee rates charged by the Adviser to any other funds it manages with investment strategies comparable to those of the Portfolio. 7 FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS The Board reviewed the management fee rate and the total expense ratio of the Portfolio. The Board noted that: (i) the Portfolio's management fee rate was higher than the average management fee rate for funds, selected by Lipper (the "expense peer group"), managed by other advisers with investment strategies comparable to those of the Portfolio, as shown in the Lipper Report for the Portfolio; and (ii) the Portfolio's total expense ratio was also higher than the average total expense ratio of the funds included in the Portfolio's expense peer group. The Adviser agreed to impose a cap of 1.00% on the Fund's total expenses, excluding 12b-1 fees and brokerage commissions but including the management fee. The Board concluded that, with the expense cap, the Portfolio's management fee and total expense ratio would be competitive with its expense peer group. BREAKPOINTS AND ECONOMIES OF SCALE The Board reviewed the structure of the Portfolio's management fee schedule under the Management Agreement and noted that it includes breakpoints. The Board also reviewed the level of the Portfolio's management fee and noted that the fee, as a percentage of the Portfolio's net assets, would decrease as net assets increase because the management fee includes breakpoints. The Board concluded that the Portfolio's management fee would reflect economies of scale as assets increase. PROFITABILITY OF ADVISER AND AFFILIATES The Board considered and reviewed information concerning the costs incurred and profits realized by the Adviser and its affiliates during the last two years from their relationship with the Portfolio and the Morgan Stanley Fund Complex and reviewed with the Controller of the Adviser the cost allocation methodology used to determine the Adviser's profitability. Based on their review of the information they received, the Board concluded that the profits earned by the Adviser and its affiliates were not excessive in light of the advisory, administrative and other services provided to the Portfolio. FALL-OUT BENEFITS The Board considered so-called "fall-out benefits" derived by the Adviser and its affiliates from their relationship with the Portfolio and the Morgan Stanley Fund Complex, such as "float" benefits derived from handling of checks for purchases and redemptions of Portfolio 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 Portfolio 12b-1 fees for distribution and shareholder services. The Board also considered that an affiliate of the Adviser, through a joint venture, receives revenue in connection with trading done on behalf of the Portfolio through an electronic trading system network ("ECN"). The Board concluded that the float benefits and the above-referenced ECN-related revenue were relatively small and that the 12b-1 fees were competitive with those of other broker-dealer affiliates of investment advisers of mutual funds. 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 Portfolio 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 Portfolio. The Adviser informed the Board that it does not use Portfolio 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 Portfolio and other funds in the Morgan Stanley Fund Complex. ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE PORTFOLIO'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 PORTFOLIO AND THE ADVISER The Board also reviewed and considered the historical relationship between the Portfolio and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Portfolio'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 Portfolio 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 Portfolio'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 Portfolio's business. GENERAL CONCLUSION After considering and weighing all of the above factors, the Board concluded it would be in the best interest of the Portfolio and its shareholders to approve renewal of the Management Agreement for another year. 9 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- EUROPEAN EQUITY PORTFOLIO PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ COMMON STOCKS (a) (98.0%) AUSTRIA (0.9%) MAJOR TELECOMMUNICATIONS 90,525 Telekom Austria AG $ 1,759,837 ------------- DENMARK (2.4%) BEVERAGES: ALCOHOLIC 49,764 Carlsberg A/S (Series B) 2,550,476 ------------- PHARMACEUTICALS: MAJOR 38,252 Novo Nordisk A/S (Series B) 1,947,213 ------------- TOTAL DENMARK 4,497,689 ------------- FINLAND (3.0%) MULTI-LINE INSURANCE 143,253 Sampo Oyj (A Shares) 2,232,520 ------------- TELECOMMUNICATION EQUIPMENT 198,737 Nokia Oyj 3,307,754 ------------- TOTAL FINLAND 5,540,274 ------------- FRANCE (15.4%) BROADCASTING 53,907 M6 Metropole Television 1,367,156 ------------- ELECTRICAL PRODUCTS 43,636 Schneider Electric S.A. 3,280,191 ------------- INTEGRATED OIL 30,480 Total S.A. 7,138,751 ------------- MAJOR BANKS 89,510 BNP Paribas S.A. 6,120,471 ------------- MAJOR TELECOMMUNICATIONS 184,039 France Telecom S.A. 5,347,333 ------------- MULTI-LINE INSURANCE 110,312 Axa 2,743,738 ------------- PHARMACEUTICALS: MAJOR 33,658 Sanofi-Aventis 2,755,875 ------------- TOTAL FRANCE 28,753,515 ------------- GERMANY (9.3%) INDUSTRIAL CONGLOMERATES 52,188 Siemens AG (Registered Shares) $ 3,794,414 ------------- MAJOR BANKS 43,137 Deutsche Bank AG (Registered Shares) 3,363,824 ------------- MEDICAL/NURSING SERVICES 24,620 Fresenius Medical Care AG 2,101,965 ------------- MOTOR VEHICLES 66,464 Bayerische Motoren Werke (BMW) AG 3,024,400 30,321 Volkswagen AG 1,383,428 ------------- 4,407,828 ------------- MULTI-LINE INSURANCE 33,008 Allianz AG (Registered Shares) 3,778,798 ------------- TOTAL GERMANY 17,446,829 ------------- ITALY (1.8%) INTEGRATED OIL 131,829 ENI SpA 3,384,957 ------------- NETHERLANDS (15.8%) AIR FREIGHT/COURIERS 110,705 TNT NV 2,803,498 ------------- ELECTRONIC PRODUCTION EQUIPMENT 225,461 ASML Holding NV* 3,524,885 ------------- FINANCIAL CONGLOMERATES 133,666 ING Groep NV (Share Certificates) 3,760,961 ------------- FOOD: SPECIALTY/CANDY 48,646 Royal Numico NV* 1,940,301 ------------- INTEGRATED OIL 91,884 Royal Dutch Petroleum Co. 5,980,814 -------------
SEE NOTES TO FINANCIAL STATEMENTS 10
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ MAJOR TELECOMMUNICATIONS 708,380 Koninklijke (Royal) KPN NV $ 5,933,984 ------------- PUBLISHING: BOOKS/MAGAZINES 68,737 VNU NV 1,911,552 193,956 Wolters Kluwer NV (Share Certificates) 3,699,698 ------------- 5,611,250 ------------- TOTAL NETHERLANDS 29,555,693 ------------- SPAIN (5.4%) MAJOR BANKS 384,731 Banco Bilbao Vizcaya Argentaria, S.A. 5,920,390 244,293 Banco Santander Central Hispano, S.A. 2,821,147 ------------- 8,741,537 ------------- TOBACCO 34,229 Altadis, S.A. 1,430,915 ------------- TOTAL SPAIN 10,172,452 ------------- SWEDEN (3.2%) INDUSTRIAL MACHINERY 74,322 Sandvik AB 2,747,510 ------------- MAJOR BANKS 144,017 ForeningsSparbanken AB 3,152,578 ------------- TOTAL SWEDEN 5,900,088 ------------- SWITZERLAND (8.7%) FINANCIAL CONGLOMERATES 24,071 UBS AG (Registered Shares) 1,873,434 ------------- FOOD: MAJOR DIVERSIFIED 12,475 Nestle S.A. (Registered Shares) 3,188,382 ------------- MAJOR BANKS 45,695 Credit Suisse Group 1,792,892 ------------- PHARMACEUTICALS: MAJOR 139,975 Novartis AG (Registered Shares) 6,648,904 22,130 Roche Holding AG (Switzerland) $ 2,791,020 ------------- 9,439,924 ------------- TOTAL SWITZERLAND 16,294,632 ------------- UNITED KINGDOM (32.1%) CHEMICALS: SPECIALTY 141,215 BOC Group PLC 2,530,062 ------------- ELECTRIC UTILITIES 797,507 International Power PLC 2,940,675 ------------- FOOD RETAIL 1,796,319 Morrison (W.M.) Supermarkets PLC 5,957,167 342,984 Tesco PLC 1,952,852 ------------- 7,910,019 ------------- FOOD: SPECIALTY/CANDY 313,467 Cadbury Schweppes PLC 2,982,847 ------------- HOTELS/RESORTS/CRUISELINES 37,547 Carnival PLC 2,131,623 ------------- HOUSEHOLD/PERSONAL CARE 64,131 Reckitt Benckiser PLC 1,883,550 ------------- INTEGRATED OIL 587,040 BP PLC 6,102,075 202,417 Shell Transport & Trading Co. PLC 1,960,095 ------------- 8,062,170 ------------- INVESTMENT MANAGERS 375,197 Amvescap PLC 2,224,701 ------------- LIFE/HEALTH INSURANCE 398,827 Prudential PLC 3,525,426 ------------- MAJOR BANKS 185,662 Royal Bank of Scotland Group PLC 5,588,829 47,707 Standard Chartered PLC 869,204 ------------- 6,458,033 ------------- MEDICAL SPECIALTIES 242,668 Smith & Nephew PLC 2,387,565 -------------
SEE NOTES TO FINANCIAL STATEMENTS 11
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ PHARMACEUTICALS: MAJOR 46,036 AstraZeneca PLC $ 1,901,612 286,555 GlaxoSmithKline PLC 6,911,193 ------------- 8,812,805 ------------- WIRELESS TELECOMMUNICATIONS 1,091,690 O2 PLC* 2,656,966 2,300,077 Vodafone Group PLC 5,586,777 ------------- 8,243,743 ------------- TOTAL UNITED KINGDOM 60,093,219 ------------- TOTAL COMMON STOCKS (COST $154,397,677) 183,399,185 ------------- PRINCIPAL AMOUNT IN THOUSANDS - ------------- SHORT-TERM INVESTMENT (b) (1.4%) U.S. GOVERNMENT AGENCY $ 2,550 Federal Home Loan Mortgage Corp. 2.60% due 07/01/05 (COST $2,550,000) 2,550,000 ------------- TOTAL INVESTMENTS (COST $156,947,677) (c) 99.3% 185,949,185 OTHER ASSETS IN EXCESS OF LIABILITIES 0.6 1,269,909 ----- ------------- NET ASSETS 100.0% $ 187,219,094 ===== =============
- ---------- * NON-INCOME PRODUCING SECURITY. (a) SECURITIES WITH TOTAL MARKET VALUE EQUAL TO $183,399,185 HAVE BEEN VALUED AT THEIR FAIR VALUE AS DETERMINED IN GOOD FAITH UNDER PROCEDURES ESTABLISHED BY AND UNDER THE GENERAL SUPERVISION OF THE PORTFOLIO'S TRUSTEES. (b) PURCHASED ON A DISCOUNT BASIS. THE INTEREST RATE SHOWN HAS BEEN ADJUSTED TO REFLECT A MONEY MARKET EQUIVALENT YIELD. (c) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES APPROXIMATES THE AGGREGATE COST FOR BOOK PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION IS $32,024,620 AND THE AGGREGATE GROSS UNREALIZED DEPRECIATION IS $3,023,112, RESULTING IN NET UNREALIZED APPRECIATION OF $29,001,508. SEE NOTES TO FINANCIAL STATEMENTS 12 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- EUROPEAN EQUITY PORTFOLIO SUMMARY OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
PERCENT OF INDUSTRY VALUE NET ASSETS - ------------------------------------------------------------------------ Major Banks $ 29,629,335 15.8% Integrated Oil 24,566,692 13.1 Pharmaceuticals: Major 22,955,817 12.3 Major Telecommunications 13,041,154 7.0 Multi-Line Insurance 8,755,056 4.7 Wireless Telecommunications 8,243,743 4.4 Food Retail 7,910,019 4.2 Financial Conglomerates 5,634,395 3.0 Publishing: Books/ Magazines 5,611,250 3.0 Food: Specialty/Candy 4,923,148 2.6 Motor Vehicles 4,407,828 2.3 Industrial Conglomerates 3,794,414 2.0 Life/Health Insurance 3,525,426 1.9 Electronic Production Equipment 3,524,885 1.9 Telecommunication Equipment 3,307,754 1.8 Electrical Products 3,280,191 1.7 Food: Major Diversified 3,188,382 1.7 Electric Utilities 2,940,675 1.6 Air Freight/Couriers 2,803,498 1.5 Industrial Machinery 2,747,510 1.5 Beverages: Alcoholic 2,550,476 1.4 U.S. Government Agencies & Obligations 2,550,000 1.4 Chemicals: Specialty 2,530,062 1.3 Medical Specialties 2,387,565 1.3 Investment Managers 2,224,701 1.2 Hotels/Resorts/Cruiselines 2,131,623 1.1 Medical/Nursing Services 2,101,965 1.1 Household/Personal Care 1,883,550 1.0 Tobacco 1,430,915 0.8 Broadcasting 1,367,156 0.7 --------------- ---- $ 185,949,185 99.3% =============== ====
SEE NOTES TO FINANCIAL STATEMENTS 13 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- EUROPEAN EQUITY PORTFOLIO FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 2005 (UNAUDITED) ASSETS: Investments in securities, at value (cost $156,947,677) $ 185,949,185 Cash (Including foreign currency valued at $730 with a cost of $742) 51,026 Receivable for: Investments sold 6,130,237 Dividends 270,928 Foreign withholding taxes reclaimed 206,069 Prepaid expenses and other assets 9,539 Receivable from affiliate 5,633 --------------- TOTAL ASSETS 192,622,617 --------------- LIABILITIES: Payable for: Investments purchased 5,163,763 Investment advisory fee 129,662 Administration fee 12,441 Distribution fee 7,920 Shares of beneficial interest redeemed 542 Accrued expenses and other payables 86,208 --------------- TOTAL LIABILITIES 5,400,536 --------------- NET ASSETS $ 187,222,081 --------------- COMPOSITION OF NET ASSETS: Paid-in-capital $ 204,078,145 Net unrealized appreciation 28,994,578 Accumulated undistributed net investment income 2,758,981 Accumulated net realized loss (48,609,623) --------------- NET ASSETS $ 187,222,081 =============== CLASS X SHARES: Net Assets $ 148,865,388 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 8,383,322 NET ASSET VALUE PER SHARE $ 17.76 =============== CLASS Y SHARES: Net Assets $ 38,356,693 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 2,170,061 NET ASSET VALUE PER SHARE $ 17.68 ===============
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2005 (UNAUDITED) NET INVESTMENT INCOME: INCOME Dividends (net of $478,925 foreign withholding tax) $ 3,848,071 Interest 24,361 --------------- TOTAL INCOME 3,872,432 --------------- EXPENSES Investment advisory fee 878,454 Administration fee 80,777 Custodian fees 58,032 Distribution fee (Class Y shares) 50,260 Professional fees 19,735 Shareholder reports and notices 17,900 Trustees' fees and expenses 1,413 Transfer agent fees and expenses 250 Other 10,396 --------------- TOTAL EXPENSES 1,117,217 --------------- Less: amounts waived (5,633) NET EXPENSES 1,111,584 --------------- NET INVESTMENT INCOME 2,760,848 --------------- NET REALIZED AND UNREALIZED GAIN (LOSS): NET REALIZED GAIN/LOSS ON: Investments 14,024,211 Foreign exchange transactions (40,473) --------------- NET REALIZED GAIN 13,983,738 --------------- NET CHANGE IN UNREALIZED APPRECIATION/ DEPRECIATION ON: Investments (22,170,379) Translation of forward foreign currency contracts, other assets and liabilities denominated in foreign currencies (49,852) --------------- NET DEPRECIATION (22,220,231) --------------- NET LOSS (8,236,493) --------------- NET DECREASE $ (5,475,645) ===============
SEE NOTES TO FINANCIAL STATEMENTS 14 STATEMENT OF CHANGES IN NET ASSETS
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 --------------- ----------------- (UNAUDITED) INCREASE (DECREASE) IN NET ASSETS: OPERATIONS: Net investment income $ 2,760,848 $ 2,609,184 Net realized gain 13,983,738 23,826,831 Net change in unrealized appreciation (22,220,231) (1,474,269) --------------- --------------- NET INCREASE (DECREASE) (5,475,645) 24,961,746 --------------- --------------- DIVIDENDS TO SHAREHOLDERS FROM NET INVESTMENT INCOME: Class X shares (1,892,105) (2,109,600) Class Y shares (395,805) (387,332) --------------- --------------- TOTAL DIVIDENDS (2,287,910) (2,496,932) --------------- --------------- Net decrease from transactions in shares of beneficial interest (26,030,370) (36,440,609) --------------- --------------- NET DECREASE (33,793,925) (13,975,795) NET ASSETS: Beginning of period 221,016,006 234,991,801 --------------- --------------- END OF PERIOD (INCLUDING ACCUMULATED UNDISTRIBUTED NET INVESTMENT INCOME OF $2,758,981 AND $2,286,043, RESPECTIVELY) $ 187,222,081 $ 221,016,006 =============== ===============
SEE NOTES TO FINANCIAL STATEMENTS 15 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- EUROPEAN EQUITY PORTFOLIO NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) 1. ORGANIZATION AND ACCOUNTING POLICIES Morgan Stanley Variable Investment Series (the "Fund") -- European Equity Portfolio (the "Portfolio"), one of 15 separate portfolios, is registered under the Investment Company Act of 1940, as amended (the "Act"), as a diversified, open-end management investment company. The Fund is offered exclusively to life insurance companies in connection with particular life insurance and/or annuity contracts they offer. The Portfolio's investment objective is to maximize capital appreciation of its investments. The Fund was organized as a Massachusetts business trust on February 25, 1983 and the Portfolio commenced operations on March 1, 1991. On June 5, 2000, the Portfolio commenced offering one additional class of shares (Class Y). The Portfolio offers Class X shares and Class Y shares. The two are identical except that Class Y shares incur distribution expenses. Class X shares are generally available to holders of contracts offered by Metropolitan Life Insurance Company (formerly Paragon Life Insurance Company) and other contracts offered before May 1, 2000. Class Y shares are available to holders of contracts offered on or after June 5, 2000. 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) when market quotations are not readily available or Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") or Morgan Stanley Investment Management Limited (the "Sub-Adviser"), an affiliate of the Investment Adviser, determines that the latest sale price, the bid price or the mean between the last reported bid and asked price do not reflect a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees. Occasionally, developments affecting the closing prices of securities and other assets may occur between the times at which valuations of such securities are determined (that is, close of the foreign market on which the securities trade) and the close of business on the NYSE. If developments occur during such periods that are expected to materially affect the value of such securities, such valuations may be adjusted to reflect 16 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; (6) certain portfolio securities may be valued by an outside pricing service approved by the Fund's Trustees; and (7) 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 except for certain dividends on foreign securities which are recorded as soon as the Fund is informed after 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 -- The Fund may 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. FOREIGN CURRENCY TRANSLATION AND FORWARD FOREIGN CURRENCY CONTRACTS -- The books and records of the Portfolio 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 Portfolio 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 Portfolio 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. 17 F. 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. G. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- Dividends and distributions to shareholders are recorded on the ex-dividend date. H. EXPENSES -- Direct expenses are charged to the Portfolio and general Fund expenses are allocated on the basis of relative net assets or equally among the Portfolios. I. 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 AND SUB-ADVISORY AGREEMENTS Pursuant to an Investment Advisory Agreement, the Portfolio pays the Investment Adviser an advisory fee, accrued daily and payable monthly, by applying the following annual rates to the net assets of the Portfolio determined at the close of each business day: 0.87% to the portion of net assets not exceeding $500 million; 0.82% to the portion of daily net assets exceeding $500 million but not exceeding $2 billion; 0.77% to the portion of daily net assets exceeding $2 billion but not exceeding $3 billion; and 0.745% to the portion of daily net assets in excess of $3 billion. Pursuant to an Administration Agreement with Morgan Stanley Services Company Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Portfolio pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.08% to the Portfolio's daily net assets. Under a Sub-Advisory Agreement between the Sub-Adviser and the Investment Adviser, the Sub-Adviser provides the Portfolio with investment advice and portfolio management relating to the Portfolio's investments in securities, subject to the overall supervision of the Investment Adviser. As compensation for its services provided pursuant to the Sub-Advisory Agreement, the Investment Adviser paid the Sub-Adviser compensation of $351,381 for the six months ended June 30, 2005. Effective June 1, 2005, the Investment Adviser, agreed to cap the Portfolio's operating expenses (except for brokerage and 12b-1 fees) by assuming the Portfolio's "other expenses" and/or waiving the Portfolio's advisory fees, and the Administrator, agreed to waive the Portfolio's administrative fees, to the extent such operating expenses exceed 1.00% of the average daily net assets of the Portfolio on an annualized basis. These voluntary assumptions/waivers may be discontinued at any time. 18 3. PLAN OF DISTRIBUTION Shares of the Fund are distributed by Morgan Stanley Distributors Inc. (the "Distributor"), an affiliate of the Investment Adviser, Administrator and Sub-Adviser. The Fund has adopted a Plan of Distribution (the "Plan") pursuant to Rule 12b-1 under the Act. The Plan provides that Class Y shares of the Portfolio will pay a distribution fee which is accrued daily and paid monthly at the annual rate of 0.25% of the average daily net assets of the class. 4. SECURITY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES The cost of purchases and the proceeds from sales of portfolio securities, excluding short-term investments, for the six months ended June 30, 2005 aggregated $57,410,279 and $84,860,232, respectively. Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator, Sub-Adviser and Distributor, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and compensation. Aggregate pension costs for the six months ended June 30, 2005 included in Trustees' fees and expenses in the Statement of Operations amounted to $185. At June 30, 2005, the Portfolio had an accrued pension liability of $1,703 which is included in accrued expenses in the Statement of Assets and Liabilities. On December 2, 2003, the Trustees voted to close the plan to new participants and eliminate the future benefits growth due to increases to compensation after July 31, 2003. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 19 5. SHARES OF BENEFICIAL INTEREST Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 ---------------------------------- ---------------------------------- (UNAUDITED) SHARES AMOUNT SHARES AMOUNT --------------- --------------- --------------- --------------- CLASS X SHARES Sold 420,481 $ 7,653,715 1,231,129 $ 20,601,080 Reinvestment of dividends 106,537 1,892,105 129,265 2,109,600 Redeemed (1,816,207) (33,133,218) (3,657,001) (60,650,325) --------------- --------------- --------------- --------------- Net decrease -- Class X (1,289,189) (23,587,398) (2,296,607) (37,939,645) --------------- --------------- --------------- --------------- CLASS Y SHARES Sold 100,259 1,821,541 723,533 12,050,890 Reinvestment of dividends 22,400 395,805 23,836 387,333 Redeemed (257,480) (4,660,318) (659,317) (10,939,187) --------------- --------------- --------------- --------------- Net increase (decrease) -- Class Y (134,821) (2,442,972) 88,052 1,499,036 --------------- --------------- --------------- --------------- Net decrease in Portfolio (1,424,010) $ (26,030,370) (2,208,555) $ (36,440,609) =============== =============== =============== ===============
6. PURPOSE OF AND RISKS RELATING TO CERTAIN FINANCIAL INSTRUMENTS The Portfolio may enter into forward contracts to facilitate settlement of foreign currency denominated portfolio transactions or to manage foreign currency exposure associated with foreign currency denominated securities. Forward contracts involve elements of market risk in excess of the amounts reflected in the Statement of Assets and Liabilities. The Portfolio bears the risk of an unfavorable change in the foreign exchange rates underlying the forward contracts. Risks may also arise upon entering into these contracts from the potential inability of the counterparties to meet the terms of their contracts. At June 30, 2005, investments in securities of issuers in the United Kingdom represented 32.1% of the Portfolio's net assets. These investments, as well as other non-U.S. investments, which involve risks and considerations not present with respect to U.S. securities, may be affected by economic or political developments in this region. At June 30, 2005 the Portfolio's cash balance consisted principally of interest bearing deposits with J.P. Morgan Chase Bank, the Portfolio's custodian. 20 7. 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 December 31, 2004, the Portfolio had a net capital loss carryforward of approximately $59,559,000 of which $24,131,000 will expire on December 31, 2009, $22,575,000 will expire on December 31, 2010, and $12,853,000 will expire on December 31, 2011 to offset future capital gains to the extent provided by regulations. As of December 31, 2004, the Portfolio had temporary book/tax differences primarily attributable to capital loss deferrals from wash sales and foreign tax credit pass through. 21 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- EUROPEAN EQUITY PORTFOLIO FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED -------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ---------- ---------- ---------- ---------- ---------- (UNAUDITED) CLASS X SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 18.47 $ 16.58 $ 12.97 $ 16.71 $ 25.37 $ 31.47 ---------- ---------- ---------- ---------- ---------- ---------- Income (loss) from investment operations: Net investment income++ 0.25 0.21 0.17 0.12 0.13 0.13 Net realized and unrealized gain (loss) (0.73) 1.88 3.57 (3.66) (4.47) (1.43) ---------- ---------- ---------- ---------- ---------- ---------- Total income (loss) from investment operations (0.48) 2.09 3.74 (3.54) (4.34) (1.30) ---------- ---------- ---------- ---------- ---------- ---------- Less dividends and distributions from: Net investment income (0.23) (0.20) (0.13) (0.20) (0.26) (0.18) Net realized gain - - - - (4.06) (4.62) ---------- ---------- ---------- ---------- ---------- ---------- Total dividends and distributions (0.23) (0.20) (0.13) (0.20) (4.32) (4.80) ---------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period $ 17.76 $ 18.47 $ 16.58 $ 12.97 $ 16.71 $ 25.37 ========== ========== ========== ========== ========== ========== TOTAL RETURN+ (2.61)%(2) 12.74% 29.03% (21.36)% (17.76)% (4.92)% RATIOS TO AVERAGE NET ASSETS(1): Expenses 1.05%(3) 1.04% 1.04% 1.05% 1.02% 1.00% Net investment income 2.79%(3) 1.24% 1.26% 0.82% 0.68% 0.46% SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 148,865 $ 178,683 $ 198,424 $ 193,153 $ 316,196 $ 508,366 Portfolio turnover rate 29%(2) 103% 95% 92% 82% 78%
- ---------- * PRIOR TO JUNE 5, 2000, THE PORTFOLIO ISSUED ONE CLASS OF SHARES. ALL SHARES OF THE PORTFOLIO HELD PRIOR TO MAY 1, 2000 HAVE BEEN DESIGNATED CLASS X SHARES. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 22
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED -------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ---------- ---------- ---------- ---------- ---------- (UNAUDITED) CLASS Y SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 18.37 $ 16.50 $ 12.91 $ 16.65 $ 25.33 $ 32.26 ---------- ---------- ---------- ---------- ---------- ---------- Income (loss) from investment operations: Net investment income (loss)++ 0.23 0.16 0.13 0.08 0.05 (0.03) Net realized and unrealized gain (loss) (0.74) 1.88 3.56 (3.63) (4.42) (2.10) ---------- ---------- ---------- ---------- ---------- ---------- Total income (loss) from investment operations (0.51) 2.04 3.69 (3.55) (4.37) (2.13) ---------- ---------- ---------- ---------- ---------- ---------- Less dividends and distributions from: Net investment income (0.18) (0.17) (0.10) (0.19) (0.25) (0.18) Net realized gain - - - - (4.06) (4.62) ---------- ---------- ---------- ---------- ---------- ---------- Total dividends and distributions (0.18) (0.17) (0.10) (0.19) (4.31) (4.80) ---------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period $ 17.68 $ 18.37 $ 16.50 $ 12.91 $ 16.65 $ 25.33 ========== ========== ========== ========== ========== ========== TOTAL RETURN+ (2.81)%(2) 12.48% 28.70% (21.53)% (17.92)% (7.39)%(2) RATIOS TO AVERAGE NET ASSETS(1): Expenses 1.30%(3) 1.29% 1.29% 1.30% 1.27% 1.25%(3) Net investment income (loss) 2.54%(3) 0.99% 1.01% 0.57% 0.43% (0.18)%(3) SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 38,357 $ 42,333 $ 36,568 $ 22,133 $ 20,858 $ 10,580 Portfolio turnover rate 29%(2) 103% 95% 92% 82% 78%(2)
- ---------- * FOR THE PERIOD JUNE 5, 2000 (ISSUED DATE) THROUGH DECEMBER 31, 2000. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 23 TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo CHAIRMAN OF THE BOARD Mitchell M. Merin PRESIDENT Ronald E. Robison EXECUTIVE VICE PRESIDENT and PRINCIPAL EXECUTIVE OFFICER Joseph J. McAlinden VICE PRESIDENT Barry Fink VICE PRESIDENT Amy R. Doberman VICE PRESIDENT Carsten Otto CHIEF COMPLIANCE OFFICER Stefanie V. Chang VICE PRESIDENT Francis J. Smith TREASURER and CHIEF FINANCIAL OFFICER Thomas F. Caloia VICE PRESIDENT Mary E. Mullin SECRETARY TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT ADVISER Morgan Stanley Investment Advisors Inc. 1221 Avenue of the Americas New York, New York 10020 SUB-ADVISOR Morgan Stanley Investment Management Limited 25 Cabot Square, Canary Wharf London, United Kingdom E14 4QA The financial statements included herein have been taken from the records of the Portfolio 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 Portfolio. For more detailed information about the Portfolio, its fees and expenses and other pertinent information, please read its Prospectus. The Portfolio's Statement of Additional Information contains additional information about the Portfolio, 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 Portfolio 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) 2005 Morgan Stanley [MORGAN STANLEY LOGO] RA05-00666P-Y06/05 [GRAPHIC] MORGAN STANLEY FUNDS MORGAN STANLEY VARIABLE INVESTMENT SERIES -- EUROPEAN EQUITY PORTFOLIO SEMIANNUAL REPORT JUNE 30, 2005 [MORGAN STANLEY LOGO] WELCOME, SHAREHOLDER: IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY VARIABLE INVESTMENT SERIES -- GLOBAL ADVANTAGE PORTFOLIO 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 PORTFOLIO'S FINANCIAL STATEMENTS AND A LIST OF PORTFOLIO INVESTMENTS. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE PORTFOLIO BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE PORTFOLIO WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE PORTFOLIO IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE PORTFOLIO WILL DECLINE AND, THEREFORE, THE VALUE OF THE PORTFOLIO'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS PORTFOLIO. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT For the six months ended June 30, 2005 TOTAL RETURN FOR THE 6 MONTHS ENDED JUNE 30, 2005
MSCI CLASS X CLASS Y WORLD INDEX(1) -2.65% -2.90% -0.70%
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. SEE PERFORMANCE SUMMARY FOR PERFORMANCE INFORMATION AND INDEX DEFINITIONS. MARKET CONDITIONS Against a backdrop of mixed sentiment and exceptionally high oil prices, global equity markets slowed during the six month period ended June 30, 2005. In the United States, the leveling off was not surprising, given the good clip of economic growth in 2004 and continued tightening in the federal funds target rate to curtail inflation. Additionally, many factors remained positive. For example, during the final months of the reporting period, the U.S. markets were buoyed by an upward revision of gross domestic product numbers, positive payroll and consumer confidence data and decreased inflationary concerns. The climate was less positive, in Europe, however. Economies which had performed strongly, such as Sweden and the United Kingdom, lost ground. A strong euro (which can hurt exports) and high oil prices contributed to falling business confidence and a lack of momentum. Industrial production, consumer confidence and retail sales faltered significantly. Export activity, typically an area of strength in the European economy, also weakened due to slowing demand from China. In the United Kingdom, consumers retrenched as protracted weakness in the housing market spilled over to the retailing sector. As these trends unfolded, speculation increased that the Bank of England and the European Central Bank would reduce rates to stimulate growth. Sweden's central bank, meanwhile, did move forward with a rate reduction. The market environment in Asia was varied. While the slowdown in China's growth rippled across the region, Japan more recently showed signs of improvement. Despite recent weakness in its consumer economy and its dependence on demand from China, Japan's gross domestic product data has been revised upwards while deflationary pressures continued to abate. Within the Portfolio's benchmark, energy stocks performed with particular strength, propelled by the high price of oil. Utilities benefited from rising energy costs as well as from investors' interest in stocks with yield potential and defensive characteristics. In contrast, auto and auto related stocks declined, as disappointing news from General Motors and Ford Motor raised concerns about the future profitability of the auto industry. Telecommunications stocks also retreated amid profit taking and the prospect of aggressive business strategies. Meanwhile, technology hardware companies were weighed down by concerns that increased energy costs would preclude corporations from pursuing capital spending initiatives. 2 PERFORMANCE ANALYSIS The Global Advantage Portfolio underperformed the MSCI World Index for the six- month period ended June 30, 2005. Materials stocks faltered due to company-specific factors such as increased operating costs and less favorable demand trends. Hindered by slowing consumer spending, U.K. bank exposure also tempered returns. Within the consumer services arena, positions in gaming related stocks detracted. Reflecting our view that many energy stocks were trading at unsustainably high prices, the Portfolio was underweighted in the energy sector relative to the MSCI World Index. This view proved out-of-step with the market's sentiment during the period as energy stocks continued to rise. Nonetheless, the Portfolio garnered good returns from other segments of its portfolio. Large-cap pharmaceutical and healthcare service companies were among those contributing gains. A number of the Portfolio's semiconductor stocks were rewarded by the market for their good earnings results. Within transportation, the Portfolio was well served by an underweighted in the struggling U.S. automobile sector. Exposure to the German auto market further enhanced returns. As of the end of the period, the Portfolio's long-term stock selection philosophy resulted in overweightings relative to the benchmark in consumer services, healthcare and telecommunications stocks, and underweightings in energy and consumer staples stocks. THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM WELL OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE PORTFOLIO IN THE FUTURE. TOP 10 HOLDINGS GlaxoSmithKline PLC 2.8% General Electric Co. 2.6 Citigroup, Inc. 2.5 Bank of America Corp. 1.9 Target Corp. 1.8 Total S.A. 1.8 Tyco International Ltd. (Bermuda) 1.8 Chevron Corp. 1.8 Royal Dutch Petroleum Co. 1.8 Genentech, Inc. 1.8
TOP FIVE COUNTRIES United States 53.7% United Kingdom 8.8 Japan 7.1 France 5.5 Netherlands 5.4
DATA AS OF JUNE 30, 2005. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES FOR TOP TEN HOLDINGS AND TOP FIVE COUNTRIES ARE AS A PERCENTAGE OF NET ASSETS. 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 PORTFOLIO WILL NORMALLY INVEST AT LEAST 65% OF ITS ASSETS IN EQUITY SECURITIES OF COMPANIES LOCATED THROUGHOUT THE WORLD (INCLUDING THE UNITED STATES). THE PORTFOLIO'S EQUITY SECURITIES MAY INCLUDE COMMON STOCK, PREFERRED STOCK, DEPOSITARY RECEIPTS AND/OR CONVERTIBLE SECURITIES. THE PORTFOLIO'S "INVESTMENT ADVISER," MORGAN STANLEY INVESTMENT ADVISORS INC., AND THE PORTFOLIO'S "SUB-ADVISER," MORGAN STANLEY INVESTMENT MANAGEMENT LIMITED, UTILIZE FUNDAMENTAL RESEARCH TO SEEK COMPANIES THAT THEY BELIEVE HAVE LONG-TERM GROWTH POTENTIAL AND/OR RELATIVELY ATTRACTIVE VALUATIONS. THE PORTFOLIO'S PORTFOLIO MANAGEMENT TEAM GENERALLY UTILIZES A BOTTOM-UP STOCK SELECTION PROCESS BASED ON FUNDAMENTAL RESEARCH PERFORMED BY THE SUB-ADVISER'S ANALYSTS THROUGHOUT THE WORLD, BUT ALSO CONSIDERS GLOBAL INDUSTRY TRENDS IN MAKING CERTAIN SECTOR ALLOCATIONS. FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY PORTFOLIO PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE PORTFOLIO'S SECOND AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY PORTFOLIO 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 PORTFOLIO'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 PORTFOLIO VOTED PROXIES RELATING TO PORTFOLIO SECURITIES DURING THE MOST RECENT TWELVE-MONTH PERIOD ENDED JUNE 30 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. 4 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED JUNE 30, 2005
CLASS X SHARES CLASS Y SHARES (SINCE 05/18/98) (SINCE 06/05/00) 1 YEAR 6.61%(2) 6.38%(2) 5 YEARS (5.82)(2) (6.06)(2) SINCE INCEPTION (1.52)(2) (6.00)(2)
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 THE 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 PORTFOLIO SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. THE PERFORMANCE OF THE PORTFOLIO'S TWO SHARE CLASSES VARIES BECAUSE EACH HAS DIFFERENT EXPENSES. THE PORTFOLIO'S TOTAL RETURN FIGURES ASSUME THE REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE IMPACT OF ANY CHARGES BY YOUR INSURANCE COMPANY. SUCH COSTS WOULD LOWER PERFORMANCE. (1) THE MORGAN STANLEY CAPITAL INTERNATIONAL (MSCI) WORLD INDEX MEASURES PERFORMANCE FROM A DIVERSE RANGE OF GLOBAL STOCK MARKETS INCLUDING THE U.S., CANADA, EUROPE, AUSTRALIA, NEW ZEALAND, AND THE FAR EAST. THE PERFORMANCE OF THE INDEX IS LISTED IN U.S. DOLLARS AND ASSUMES REINVESTMENT OF NET DIVIDENDS. "NET DIVIDENDS" REFLECTS A REDUCTION IN DIVIDENDS AFTER TAKING INTO ACCOUNT WITHHOLDING OF TAXES BY CERTAIN FOREIGN COUNTRIES REPRESENTED IN THE INDEX. 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) FIGURE ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS FOR THE UNDERLYING PORTFOLIO BASED ON NET ASSET VALUE (NAV). IT DOES NOT REFLECT THE DEDUCTION OF INSURANCE EXPENSES, AN ANNUAL CONTRACT MAINTENANCE FEE, OR SURRENDER CHARGES. 5 EXPENSE EXAMPLE As a shareholder of the Portfolio, you incur two types of costs: (1) insurance company charges; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Portfolio expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Portfolio 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 01/01/05 - 06/30/05. 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 Portfolio's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Portfolio'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 Portfolio 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 insurance company charges. 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 insurance company charges were included, your costs would have been higher.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD * ------------- ------------- --------------- 01/01/05 - 01/01/05 06/30/05 06/30/05 ------------- ------------- --------------- CLASS X Actual (-2.65% return) $ 1,000.00 $ 973.50 $ 4.11 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,020.63 $ 4.21 CLASS Y Actual (-2.90% return) $ 1,000.00 $ 971.00 $ 5.33 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,019.39 $ 5.46
- ---------- * EXPENSES ARE EQUAL TO THE PORTFOLIO'S ANNUALIZED EXPENSE RATIO OF 0.84% AND 1.09% 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 fixed income securities trading. The Board reviewed similar information and factors regarding the Sub-Adviser, to the extent applicable. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Portfolio's Administrator under the Administration Agreement, including accounting, clerical, bookkeeping, compliance, business management and planning, and the provision of supplies, office space and utilities. (The Investment Adviser, Sub-Adviser and Administrator together are referred to as the "Adviser" and the Advisory, Sub-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 administrative and investment advisory services to the Portfolio. 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 Portfolio. 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 The Board reviewed the Portfolio's performance for the one-, three- and five-year periods ended November 30, 2004, as shown in reports provided by Lipper (the "Lipper Reports"), compared to the performance of comparable funds selected by Lipper (the "performance peer group"), and noted that the Portfolio's performance was lower than its performance peer group average for all three periods. The Board discussed with the Adviser possible steps to improve performance. The Adviser informed the Board that, in order to try to improve performance, it made a strategy change in managing the Portfolio's assets, implemented a new collaborative portfolio management team approach and hired additional research analysts, whose names and areas of research experience were provided to the Board. The Board concluded that these changes were reasonably designed to improve performance. FEES RELATIVE TO OTHER FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT STRATEGIES The Board reviewed the advisory and administrative fees (together, the "management fee") paid by the Fund under the Management Agreement. The Board noted that the rate was comparable to the management fee rates charged by the Adviser to any other funds it manages with investment strategies comparable to those of the Portfolio. 7 FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS The Board reviewed the management fee rate and the total expense ratio of the Portfolio. The Board noted that: (i) the Portfolio's management fee rate was lower than the average management fee rate for funds, selected by Lipper (the "expense peer group"), managed by other advisers with investment strategies comparable to those of the Portfolio, as shown in the Lipper Report for the Portfolio; and (ii) the Portfolio's total expense ratio was also lower than the average total expense ratio of the funds included in the Portfolio's expense peer group. The Board concluded that the Portfolio's management fee 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 Portfolio's management fee schedule under the Management Agreement and noted that it includes a breakpoint. The Board also reviewed the level of the Portfolio's management fee and noted that the fee, as a percentage of the Portfolio's net assets, would decrease as net assets increase because the management fee includes a breakpoint. The Board concluded that the Portfolio's management fee would reflect economies of scale as assets increase. PROFITABILITY OF ADVISER AND AFFILIATES The Board considered and reviewed information concerning the costs incurred and profits realized by the Adviser and its affiliates during the last two years from their relationship with the Portfolio and the Morgan Stanley Fund Complex and reviewed with the Controller of the Adviser the cost allocation methodology used to determine the Adviser's profitability. Based on their review of the information they received, the Board concluded that the profits earned by the Adviser and its affiliates were not excessive in light of the advisory, administrative and other services provided to the Portfolio. FALL-OUT BENEFITS The Board considered so-called "fall-out benefits" derived by the Adviser and its affiliates from their relationship with the Portfolio and the Morgan Stanley Fund Complex, such as "float" benefits derived from handling of checks for purchases and redemptions of Portfolio 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 Portfolio 12b-1 fees for distribution and shareholder services. The Board also considered that an affiliate of the Adviser, through a joint venture, receives revenue in connection with trading done on behalf of the Portfolio through an electronic trading system network ("ECN"). The Board concluded that the float benefits and the above-referenced ECN-related revenue were relatively small and that the 12b-1 fees were competitive with those of other broker-dealer affiliates of investment advisers of mutual funds. 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 Portfolio 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 Portfolio. The Adviser informed the Board that it does not use Portfolio 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 Portfolio and other funds in the Morgan Stanley Fund Complex. ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE PORTFOLIO'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 PORTFOLIO AND THE ADVISER The Board also reviewed and considered the historical relationship between the Portfolio and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Portfolio'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 Portfolio 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 Portfolio'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 Portfolio's business. GENERAL CONCLUSION After considering and weighing all of the above factors, the Board concluded it would be in the best interest of the Portfolio and its shareholders to approve renewal of the Management Agreement for another year. 9 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- GLOBAL ADVANTAGE PORTFOLIO PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------------------------------- COMMON STOCKS (97.7%) BERMUDA (3.3%) INDUSTRIAL CONGLOMERATES 19,095 Tyco International Ltd. $ 557,574 ------------ SEMICONDUCTORS 11,503 Marvell Technology Group, Ltd.* 437,574 ------------ TOTAL BERMUDA 995,148 ------------ CAYMAN ISLANDS (0.8%) PROPERTY - CASUALTY INSURERS 5,427 ACE Ltd. 243,401 ------------ CHINA (0.5%) INTERNET SOFTWARE/SERVICES 2,833 Netease.com Inc. (ADR)* 161,793 ------------ FINLAND (a) (0.7%) TELECOMMUNICATION EQUIPMENT 12,212 Nokia Oyj 203,255 ------------ FRANCE (a) (5.5%) ELECTRICAL PRODUCTS 4,503 Schneider Electric S.A. 338,498 ------------ INTEGRATED OIL 2,383 Total S.A. 558,125 ------------ MAJOR BANKS 4,545 BNP Paribas S.A. 310,776 ------------ MAJOR TELECOMMUNICATIONS 16,839 France Telecom S.A. 489,264 ------------ TOTAL FRANCE 1,696,663 ------------ GERMANY (a) (2.1%) MOTOR VEHICLES 5,500 Bayerische Motoren Werke (BMW) AG 250,274 ------------ MULTI-LINE INSURANCE 3,444 Allianz AG (Registered Shares) 394,274 ------------ TOTAL GERMANY 644,548 ------------ HONG KONG (a) (1.1%) REAL ESTATE DEVELOPMENT 33,000 Sun Hung Kai Properties Ltd. $ 324,583 ------------ ITALY (a) (0.8%) INTEGRATED OIL 9,618 ENI SpA 246,960 ------------ JAPAN (a) (7.1%) CHEMICALS: SPECIALTY 5,700 JSR Corp. 119,449 7,100 Shin-Etsu Chemical Co., Ltd. 268,252 65,000 Sumitomo Chemical Co., Ltd. 297,468 ------------ 685,169 ------------ ELECTRIC UTILITIES 10,200 Tokyo Electric Power Co., Inc. 243,406 ------------ ELECTRONIC EQUIPMENT/ INSTRUMENTS 3,800 Canon, Inc. 198,987 ------------ MAJOR BANKS 24,000 Joyo Bank, Ltd. (The) 117,302 46,000 Sumitomo Trust & Banking Co., Ltd. (The) 278,687 ------------ 395,989 ------------ MOTOR VEHICLES 10,500 Toyota Motor Corp. 375,299 ------------ PHARMACEUTICALS: MAJOR 5,300 Takeda Pharmaceutical Co., Ltd. 261,972 ------------ TOTAL JAPAN 2,160,822 ------------ NETHERLANDS (a) (5.4%) AIR FREIGHT/COURIERS 12,811 TNT NV 324,426 ------------ FOOD: SPECIALTY/CANDY 7,628 Royal Numico NV* 304,252 ------------ INTEGRATED OIL 8,248 Royal Dutch Petroleum Co. 536,870 ------------
SEE NOTES TO FINANCIAL STATEMENTS 10
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------------------------------- MAJOR TELECOMMUNICATIONS 39,195 Koninklijke (Royal) KPN NV $ 328,330 ------------ PUBLISHING: BOOKS/MAGAZINES 8,515 Wolters Kluwer NV (Share Certificates) 162,423 ------------ TOTAL NETHERLANDS 1,656,301 ------------ SOUTH KOREA (1.3%) MAJOR BANKS 1,700 Kookmin Bank (ADR) 77,486 ------------ WIRELESS TELECOMMUNICATIONS 15,112 SK Telecom Co., Ltd. (ADR) 308,285 ------------ TOTAL SOUTH KOREA 385,771 ------------ SPAIN (a) (1.6%) MAJOR BANKS 17,096 Banco Bilbao Vizcaya Argentaria, S.A. 263,080 ------------ TOBACCO 5,154 Altadis, S.A. 215,459 ------------ TOTAL SPAIN 478,539 ------------ SWEDEN (a) (2.2%) INDUSTRIAL MACHINERY 10,898 Sandvik AB 402,874 ------------ MAJOR BANKS 11,841 ForeningsSparbanken AB 259,203 ------------ TOTAL SWEDEN 662,077 ------------ SWITZERLAND (a) (2.8%) FINANCIAL CONGLOMERATES 4,941 UBS AG (Registered Shares) 384,555 ------------ PHARMACEUTICALS: MAJOR 10,269 Novartis AG (Registered Shares) 487,784 ------------ TOTAL SWITZERLAND 872,339 ------------ UNITED KINGDOM (a) (8.8%) FOOD RETAIL 33,770 Morrison (W.M.) Supermarkets PLC $ 111,992 ------------ FOOD: SPECIALTY/CANDY 32,069 Cadbury Schweppes PLC 305,158 ------------ HOTELS/RESORTS/CRUISELINES 6,238 Carnival PLC 354,145 ------------ MAJOR BANKS 16,525 HSBC Holdings PLC 263,273 13,117 Royal Bank of Scotland Group PLC 394,850 ------------ 658,123 ------------ PHARMACEUTICALS: MAJOR 35,998 GlaxoSmithKline PLC 868,207 ------------ WIRELESS TELECOMMUNICATIONS 165,685 Vodafone Group PLC 402,441 ------------ TOTAL UNITED KINGDOM 2,700,066 ------------ UNITED STATES (53.7%) ALUMINUM 11,056 Alcoa, Inc. 288,893 ------------ BIOTECHNOLOGY 4,793 Amgen Inc.* 289,785 6,682 Genentech, Inc.* 536,431 ------------ 826,216 ------------ CASINO/GAMING 10,904 GTECH Holdings Corp. 318,833 13,773 International Game Technology 387,710 6,241 Las Vegas Sands Corp.* 223,116 ------------ 929,659 ------------ COMPUTER COMMUNICATIONS 12,206 Cisco Systems, Inc.* 233,257 ------------
SEE NOTES TO FINANCIAL STATEMENTS 11
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------------------------------- COMPUTER PROCESSING HARDWARE 4,103 Apple Computer, Inc.* $ 151,031 8,402 Dell, Inc.* 331,963 ------------ 482,994 ------------ CONTRACT DRILLING 3,684 GlobalSantaFe Corp. 150,307 ------------ DISCOUNT STORES 10,287 Target Corp. 559,716 ------------ ELECTRIC UTILITIES 11,614 American Electric Power Co., Inc. 428,208 ------------ ELECTRONIC EQUIPMENT/ INSTRUMENTS 14,436 Xerox Corp.* 199,072 ------------ FINANCE/RENTAL/LEASING 3,116 Capital One Financial Corp. 249,311 4,750 Freddie Mac 309,842 ------------ 559,153 ------------ FINANCIAL CONGLOMERATES 16,590 Citigroup, Inc. 766,956 5,472 State Street Corp. 264,024 ------------ 1,030,980 ------------ FOOD: MAJOR DIVERSIFIED 6,200 General Mills, Inc. 290,098 ------------ HOME IMPROVEMENT CHAINS 6,758 Lowe's Companies, Inc. 393,451 ------------ HOUSEHOLD/PERSONAL CARE 8,300 Avon Products, Inc. 314,155 ------------ INDUSTRIAL CONGLOMERATES 22,545 General Electric Co. 781,184 ------------ INSURANCE BROKERS/SERVICES 8,420 Marsh & McLennan Companies, Inc. 233,234 ------------ INTEGRATED OIL 9,779 Chevron Corp. 546,842 ------------ INVESTMENT BANKS/BROKERS 6,950 Merrill Lynch & Co., Inc. $ 382,319 22,149 Schwab (Charles) Corp. (The) 249,841 ------------ 632,160 ------------ INVESTMENT MANAGERS 2,508 Franklin Resources, Inc. 193,066 ------------ LIFE/HEALTH INSURANCE 6,900 MetLife, Inc. (Note 4) 310,086 ------------ MAJOR BANKS 12,701 Bank of America Corp. 579,293 ------------ MAJOR TELECOMMUNICATIONS 6,758 Sprint Corp. 169,558 2,230 Verizon Communications Inc. 77,046 ------------ 246,604 ------------ MANAGED HEALTH CARE 6,084 Aetna, Inc. 503,877 ------------ MEDIA CONGLOMERATES 24,355 News Corp Inc. (Class A) 394,064 ------------ MULTI-LINE INSURANCE 3,209 American International Group, Inc. 186,443 ------------ OIL REFINING/MARKETING 4,311 Marathon Oil Corp. 230,078 ------------ OILFIELD SERVICES/EQUIPMENT 4,213 BJ Services Co. 221,098 ------------ OTHER CONSUMER SERVICES 7,200 Coinstar, Inc.* 163,368 ------------ PACKAGED SOFTWARE 3,112 Mercury Interactive Corp.* 119,376 18,436 Microsoft Corp. 457,950 8,425 Symantec Corp.* 183,160 ------------ 760,486 ------------ PHARMACEUTICALS: MAJOR 4,829 Johnson & Johnson 313,885 5,978 Lilly (Eli) & Co. 333,034 12,541 Pfizer, Inc. 345,881 21,642 Schering-Plough Corp. 412,497 ------------ 1,405,297 ------------
SEE NOTES TO FINANCIAL STATEMENTS 12
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------------------------------- PULP & PAPER 7,333 Georgia-Pacific Corp. $ 233,189 ------------ REGIONAL BANKS 10,655 U.S. Bancorp 311,126 ------------ RESTAURANTS 5,452 Outback Steakhouse, Inc. 246,648 ------------ SEMICONDUCTORS 13,580 Intel Corp. 353,895 ------------ SPECIALTY STORES 8,639 PETsMART, Inc. 262,194 ------------ TELECOMMUNICATION EQUIPMENT 12,115 Corning, Inc.* 201,351 10,184 QUALCOMM Inc. 336,174 ------------ 537,525 ------------ TOBACCO 6,227 Altria Group, Inc. 402,638 ------------ TOTAL UNITED STATES 16,420,554 ------------ TOTAL INVESTMENTS (COST $28,593,038) (b) (c) 97.7% 29,852,820 OTHER ASSETS IN EXCESS OF LIABILITIES 2.3 703,271 ----- ------------ NET ASSETS 100.0% $ 30,556,091 ===== ============
- ---------- ADR AMERICAN DEPOSITARY RECEIPT. * NON-INCOME PRODUCING SECURITY. (a) SECURITIES WITH TOTAL MARKET VALUE EQUAL TO $11,646,153 HAVE BEEN VALUED AT THEIR FAIR VALUE AS DETERMINED IN GOOD FAITH UNDER PROCEDURES ESTABLISHED BY AND UNDER GENERAL SUPERVISION OF THE FUND'S TRUSTEES. (b) SECURITIES HAVE BEEN DESIGNATED AS COLLATERAL IN AN AMOUNT EQUAL TO $3,269,124 IN CONNECTION WITH OPEN FORWARD FOREIGN CURRENCY CONTRACTS. (c) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES APPROXIMATES THE AGGREGATE COST FOR BOOK PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION IS $2,579,792 AND THE AGGREGATE GROSS UNREALIZED DEPRECIATION IS $1,320,010, RESULTING IN NET UNREALIZED APPRECIATION OF $1,259,782. FORWARD FOREIGN CURRENCY CONTRACTS OPEN AT JUNE 30, 2005:
UNREALIZED CONTRACTS IN EXCHANGE DELIVERY APPRECIATION TO DELIVER FOR DATE (DEPRECIATION) - -------------------------------------------------------------- $ 622,104 AUD 800,000 08/04/05 $ (15,157) EUR 100,000 AUD 157,563 08/04/05 (1,636) $ 922,287 CAD 1,150,000 08/04/05 16,080 EUR 243,412 JPY 33,000,000 08/04/05 3,490 $ 618,816 GBP 325,000 08/04/05 (37,510) SEK 2,100,000 GBP 157,307 08/04/05 12,248 $ 469,623 JPY 49,000,000 08/04/05 (26,472) ---------- Net unrealized depreciation $ (48,957) ==========
CURRENCY ABBREVIATIONS: AUD Australian Dollar. GBP British Pound. CAD Canadian Dollar. EUR Euro. JPY Japanese Yen. SEK Swedish Krona. SEE NOTES TO FINANCIAL STATEMENTS 13 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- GLOBAL ADVANTAGE PORTFOLIO SUMMARY OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
PERCENT OF INDUSTRY VALUE NET ASSETS - --------------------------------------------------------------- Pharmaceuticals: Major $ 3,023,260 9.9% Major Banks 2,543,950 8.3 Integrated Oil 1,888,797 6.2 Financial Conglomerates 1,415,535 4.6 Industrial Conglomerates 1,338,758 4.4 Major Telecommunications 1,064,198 3.5 Casino/Gaming 929,659 3.0 Biotechnology 826,216 2.7 Semiconductors 791,469 2.6 Packaged Software 760,486 2.5 Telecommunication Equipment 740,780 2.4 Wireless Telecommunications 710,726 2.3 Chemicals: Specialty 685,169 2.2 Electric Utilities 671,614 2.2 Investment Banks/Brokers 632,160 2.1 Motor Vehicles 625,573 2.0 Tobacco 618,097 2.0 Food: Specialty/Candy 609,410 2.0 Multi-Line Insurance 580,717 1.9 Discount Stores 559,716 1.8 Finance/Rental/Leasing 559,153 1.8 Managed Health Care 503,877 1.7 Computer Processing Hardware 482,994 1.6 Industrial Machinery 402,874 1.3 Electronic Equipment/ Instruments 398,059 1.3 Media Conglomerates 394,064 1.3 Home Improvement Chains 393,451 1.3 Hotels/Resorts/Cruiselines 354,145 1.2 Electrical Products 338,498 1.1 Real Estate Development 324,583 1.1 Air Freight/Couriers 324,426 1.1 Household/Personal Care 314,155 1.0 Regional Banks 311,126 1.0 Life/Health Insurance 310,086 1.0 Food: Major Diversified 290,098 1.0 Aluminum 288,893 0.9 Specialty Stores 262,194 0.9 Restaurants $ 246,648 0.8% Property-Casualty Insurers 243,401 0.8 Computer Communications 233,257 0.8 Insurance Brokers/Services 233,234 0.8 Pulp & Paper 233,189 0.8 Oil Refining/Marketing 230,078 0.8 Oilfield Services/Equipment 221,098 0.7 Investment Managers 193,066 0.6 Other Consumer Services 163,368 0.5 Publishing: Books/Magazines 162,423 0.5 Internet Software/Services 161,793 0.5 Contract Drilling 150,307 0.5 Food Retail 111,992 0.4 ------------- ------------- $ 29,852,820* 97.7% ============= =============
- ---------- * DOES NOT INCLUDE OPEN FORWARD FOREIGN CURRENCY CONTRACTS WITH NET UNREALIZED DEPRECIATION OF $48,957. SEE NOTES TO FINANCIAL STATEMENTS 14 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- GLOBAL ADVANTAGE PORTFOLIO FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 2005 (UNAUDITED) ASSETS: Investments in securities, at value (cost $28,593,038) $ 29,542,734 Investment in affiliate (cost $314,746) 310,086 Foreign cash (cost $194,384) 191,099 Receivable for: Investments sold 1,602,470 Dividends 37,943 Foreign withholding taxes reclaimed 15,969 Prepaid expenses and other assets 5,783 -------------- TOTAL ASSETS 31,706,084 -------------- LIABILITIES: Unrealized depreciation on open forward foreign currency contracts 48,957 Payable for: Investments purchased 878,971 Investment advisory fee 14,583 Distribution fee 2,140 Administration fee 2,047 Shares of beneficial interest redeemed 160 Payable to bank 180,632 Accrued expenses and other payables 22,503 -------------- TOTAL LIABILITIES 1,149,993 -------------- NET ASSETS $ 30,556,091 ============== COMPOSITION OF NET ASSETS: Paid-in-capital $ 52,709,634 Net unrealized appreciation 1,208,320 Accumulated undistributed net investment income 247,331 Accumulated net realized loss (23,609,194) -------------- NET ASSETS $ 30,556,091 ============== CLASS X SHARES: Net Assets $ 20,246,177 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 2,550,578 NET ASSET VALUE PER SHARE $ 7.94 ============== CLASS Y SHARES: Net Assets $ 10,309,914 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 1,304,323 NET ASSET VALUE PER SHARE $ 7.90 ==============
SEE NOTES TO FINANCIAL STATEMENTS 15 STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2005 (UNAUDITED) NET INVESTMENT INCOME: INCOME Dividends (net of $28,226 foreign withholding tax) $ 385,552 Dividends from affiliates 3,616 Interest 3,723 -------------- TOTAL INCOME 392,891 -------------- EXPENSES Investment advisory fee 91,479 Distribution fee (Class Y shares) 13,146 Administration fee 12,839 Professional fees 10,469 Custodian fees 10,277 Shareholder reports and notices 3,839 Transfer agent fees and expenses 250 Trustees' fees and expenses 187 Other 5,753 -------------- TOTAL EXPENSES 148,239 -------------- NET INVESTMENT INCOME 244,652 -------------- NET REALIZED AND UNREALIZED GAIN (LOSS): NET REALIZED GAIN/LOSS ON: Investments 974,499 Foreign exchange transactions (51,312) -------------- NET REALIZED GAIN 923,187 -------------- NET CHANGE IN UNREALIZED APPRECIATION/DEPRECIATION ON: Investments (2,170,006) Translation of forward foreign currency contracts, other assets and liabilities denominated in foreign currencies 64,133 -------------- NET DEPRECIATION (2,105,873) -------------- NET LOSS (1,182,686) -------------- NET DECREASE $ (938,034) ==============
SEE NOTES TO FINANCIAL STATEMENTS 16 STATEMENT OF CHANGES IN NET ASSETS
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 -------------- ----------------- (UNAUDITED) INCREASE (DECREASE) IN NET ASSETS: OPERATIONS: Net investment income $ 244,652 $ 247,195 Net realized gain 923,187 3,329,807 Net change in unrealized appreciation (2,105,873) 317,208 -------------- ----------------- NET INCREASE (DECREASE) (938,034) 3,894,210 -------------- ----------------- DIVIDENDS TO SHAREHOLDERS FROM NET INVESTMENT INCOME: Class X shares (59,993) (106,256) Class Y shares (5,014) (30,070) -------------- ----------------- TOTAL DIVIDENDS (65,007) (136,326) -------------- ----------------- Net decrease from transactions in shares of beneficial interest (3,093,077) (4,011,668) -------------- ----------------- NET DECREASE (4,096,118) (253,784) NET ASSETS: Beginning of period 34,652,209 34,905,993 -------------- ----------------- END OF PERIOD (INCLUDING ACCUMULATED UNDISTRIBUTED NET INVESTMENT INCOME OF $247,331 AND $67,686, RESPECTIVELY) $ 30,556,091 $ 34,652,209 ============== =================
SEE NOTES TO FINANCIAL STATEMENTS 17 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- GLOBAL ADVANTAGE PORTFOLIO NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) 1. ORGANIZATION AND ACCOUNTING POLICIES Morgan Stanley Variable Investment Series (the "Fund") -- Global Advantage Portfolio (the "Portfolio"), one of 15 separate portfolios, is registered under the Investment Company Act of 1940, as amended (The "Act"), as a diversified, open-end management investment company. The Fund is offered exclusively to life insurance companies in connection with particular life insurance and/or annuity contracts they offer. The Portfolio's investment objective is long-term capital growth. The Fund was organized as a Massachusetts business trust on February 25, 1983 and the Portfolio commenced operations on May 18, 1998. On June 5, 2000, the Portfolio commenced offering one additional class of shares (Class Y). The Portfolio offers Class X shares and Class Y shares. The two are identical except that Class Y shares incur distribution expenses. Class X shares are generally available to holders of contracts offered by Metropolitan Life Insurance Company (formerly Paragon Life Insurance Company) and other contracts offered before May 1, 2000. Class Y shares are available to holders of contracts offered on or after June 5, 2000. 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) when market quotations are not readily available or Morgan Stanley Investment Advisors Inc. (the "Investment Adviser"), or Morgan Stanley Investment Management Limited (the "Sub-Adviser"), an affiliate of the Investment Adviser, determines that the latest sale price, the bid price or the mean between the last reported bid and asked price do not reflect a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees. Occasionally, developments affecting the closing prices of securities and other assets may occur between the times at which valuations of such securities are determined (that is, close of the foreign market on which the securities trade) and the close of business on the NYSE. If developments occur during such periods that are expected to materially affect the value of such securities, such valuations may be adjusted to reflect the 18 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; (6) certain portfolio securities may be valued by an outside pricing service approved by the Fund's Trustees; and (7) 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 except for certain dividends on foreign securities which are recorded as soon as the Fund is informed after 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 AGREEMENT -- The Fund may 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. FOREIGN CURRENCY TRANSLATION AND FORWARD FOREIGN CURRENCY CONTRACTS -- The books and records of the Portfolio 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 Portfolio 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 Portfolio 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. 19 F. 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. G. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- Dividends and distributions to shareholders are recorded on the ex-dividend date. H. EXPENSES -- Direct expenses are charged to the Portfolio and general Fund expenses are allocated on the basis of relative net assets or equally among the Portfolios. I. 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 AND SUB-ADVISORY AGREEMENTS Pursuant to an Investment Advisory Agreement with the Investment Adviser, the Portfolio pays an advisory fee, accrued daily and payable monthly, by applying the following annual rates to the net assets of the Portfolio determined as of the close of each business day: 0.57% to the portion of the daily net assets not exceeding $1.5 billion and 0.545% to the portion of the daily net assets in excess of $1.5 billion. Pursuant to an administration Agreement with Morgan Stanley Services Company Inc. (the Administrator"), an affiliate of the Investment Adviser, the Portfolio pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.08% to the Portfolio's daily net assets. Under a Sub-Advisory Agreement between the Sub-Adviser and the Investment Adviser, the Sub-Adviser provides the Portfolio with investment advice and portfolio management relating to the Portfolio's investments in securities, subject to the overall supervision of the Investment Adviser. As compensation for its services provided pursuant to the Sub-Advisory Agreement, the Investment Adviser paid the Sub-Adviser compensation of $36,592 for the six months ended June 30, 2005. 3. PLAN OF DISTRIBUTION Shares of the Fund are distributed by Morgan Stanley Distributors Inc. (the "Distributor"), an affiliate of the Investment Adviser, Administrator and Sub-Adviser. The Fund has adopted a Plan of Distribution (the "Plan") pursuant to Rule 12b-1 under the Act. Under the plan, Class Y shares of the Portfolio will pay a distribution fee which is accrued daily and paid monthly at the annual rate of 0.25% of the average daily net assets of the class. 20 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 June 30, 2005 were $12,935,569, and $16,388,821, respectively. Included in the aforementioned are purchases of $180,544 with other Morgan Stanley funds. The Portfolio also had the following transactions with affiliates:
NET REALIZED ISSUER PURCHASES SALES GAIN/LOSS INCOME VALUE - ------ --------- --------- ------------ ------- --------- Allstate Corp $ 307,986 $ 341,615 $ 33,629 $ 3,616 -- MetLife, Inc 314,746 -- -- -- $ 310,086
For the six months ended June 30, 2005, the Portfolio incurred brokerage commissions of $113 with Morgan Stanley & Co., Inc., an affiliate of the Investment Adviser, Administrator, Distributor and Sub-Adviser, for transactions executed on behalf of the Portfolio. At June 30, 2005, the Portfolio's receivable for investments sold and payable for investments purchased included unsettled trades with Morgan Stanley & Co., Inc. of $171,708 and $47,414 respectively. Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator, Sub-Adviser and Distributor, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and compensation. At June 30, 2005, the Portfolio had an accrued pension liability of $501 which is included in accrued expenses in the Statement of Assets and Liabilities. On December 2, 2003, the Trustees voted to close the plan to new participants and eliminate the future benefits growth due to increases to compensation after July 31, 2003. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 21 5. SHARES OF BENEFICIAL INTEREST Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 -------------------------------- -------------------------------- (UNAUDITED) SHARES AMOUNT SHARES AMOUNT -------------- -------------- -------------- -------------- CLASS X SHARES Sold 103,278 $ 822,180 738,226 $ 5,510,451 Reinvestment of dividends 7,556 59,993 14,224 106,256 Redeemed (447,275) (3,568,014) (1,371,181) (10,203,963) -------------- -------------- -------------- -------------- Net decrease -- Class X (336,441) (2,685,841) (618,731) (4,587,256) -------------- -------------- -------------- -------------- CLASS Y SHARES Sold 55,920 444,694 320,294 2,383,553 Reinvestment of dividends 635 5,014 4,047 30,070 Redeemed (107,968) (856,944) (248,938) (1,838,035) -------------- -------------- -------------- -------------- Net increase (decrease) -- Class Y (51,413) (407,236) 75,403 575,588 -------------- -------------- -------------- -------------- Net decrease in Portfolio (387,854) $ (3,093,077) (543,328) $ (4,011,668) ============== ============== ============== ==============
6. PURPOSES OF AND RISKS RELATING TO CERTAIN FINANCIAL INSTRUMENTS The Portfolio may enter into forward contracts to facilitate settlement of foreign currency denominated portfolio transactions or to manage foreign currency exposure associated with foreign currency denominated securities. Forward contracts involve elements of market risk in excess of the amounts reflected in the Statement of Assets and Liabilities. The Portfolio bears the risk of an unfavorable change in the foreign exchange rates underlying the forward contracts. Risks may also arise upon entering into these contracts from the potential inability of the counterparties to meet the terms of their contracts. 7. 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. 22 As of December 31, 2004, the Portfolio had a net capital loss carryforward of approximately $24,520,000 of which $10,348,000 will expire on December 31, 2009 and $14,172,000 will expire on December 31, 2010 to offset future capital gains to the extent provided by regulations. As of December 31, 2004, the Portfolio had temporary book/tax differences primarily attributable to post October losses (foreign currency losses incurred after October 31 within the taxable year which are deemed to arise on the first business day of the Portfolio's next taxable year), capital loss deferrals on wash sales, foreign tax credit pass through and loss from the mark-to-market of forward foreign currency contracts. 23 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- GLOBAL ADVANTAGE PORTFOLIO FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ------------------------------------------------------------------ JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ---------- ---------- ---------- ---------- ---------- (UNAUDITED) CLASS X SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 8.18 $ 7.30 $ 5.63 $ 7.17 $ 10.18 $ 12.37 ------------- ---------- ---------- ---------- ---------- ---------- Income (loss) from investment operations: Net investment income++ 0.06 0.06 0.05 0.05 0.05 0.06 Net realized and unrealized gain (loss) (0.28) 0.85 1.69 (1.53) (2.36) (2.20) ------------- ---------- ---------- ---------- ---------- ---------- Total income (loss) from investment operations (0.22) 0.91 1.74 (1.48) (2.31) (2.14) ------------- ---------- ---------- ---------- ---------- ---------- Less dividends and distributions from: Net investment income (0.02) (0.03) (0.07) (0.06) (0.06) (0.05) Net realized gain - - - - (0.64) - ------------- ---------- ---------- ---------- ---------- ---------- Total dividends and distributions (0.02) (0.03) (0.07) (0.06) (0.70) (0.05) ------------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period $ 7.94 $ 8.18 $ 7.30 $ 5.63 $ 7.17 $ 10.18 ============= ========== ========== ========== ========== ========== TOTAL RETURN+ (2.65)%(2) 12.54% 31.12% (20.81)% (23.33)% (17.39)% RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.84%(3) 0.84% 0.93% 0.80% 0.75% 0.71% Net investment income 1.61%(3) 0.79% 0.87% 0.72% 0.55% 0.50% SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 20,246 $ 23,620 $ 25,598 $ 22,866 $ 40,084 $ 69,882 Portfolio turnover rate 41%(2) 111% 98% 119% 47% 70%
- ---------- * PRIOR TO JUNE 5, 2000, THE PORTFOLIO ISSUED ONE CLASS OF SHARES. ALL SHARES OF THE PORTFOLIO HELD PRIOR TO MAY 1, 2000 HAVE BEEN DESIGNATED CLASS X SHARES. ++ 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) REFELECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 24
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED -------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- --------- --------- --------- --------- ---------- (UNAUDITED) CLASS Y SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 8.14 $ 7.27 $ 5.61 $ 7.14 $ 10.16 $ 12.03 ------------- --------- --------- --------- --------- ---------- Income (loss) from investment operations: Net investment income++ 0.05 0.04 0.04 0.03 0.02 - Net realized and unrealized gain (loss) (0.29) 0.85 1.68 (1.52) (2.35) (1.82) ------------- --------- --------- --------- --------- ---------- Total income (loss) from investment operations (0.24) 0.89 1.71 (1.49) (2.33) (1.82) ------------- --------- --------- --------- --------- ---------- Less dividends and distributions from: Net investment income - (0.02) (0.05) (0.04) (0.05) (0.05) Net realized gain - - - - (0.64) - ------------- --------- --------- --------- --------- ---------- Total dividends and distributions 0.00 (0.02) (0.05) (0.04) (0.69) (0.05) ------------- --------- --------- --------- --------- ---------- Net asset value, end of period $ 7.90 $ 8.14 $ 7.27 $ 5.61 $ 7.14 $ 10.16 ============= ========= ========= ========= ========= ========== TOTAL RETURN+ (2.90)%(2) 12.29% 30.75% (20.94)% (23.53)% (15.22)%(2) RATIOS TO AVERAGE NET ASSETS(1): Expenses 1.09%(3) 1.09% 1.18% 1.05% 1.00% 0.96%(3) Net investment income 1.36%(3) 0.54% 0.62% 0.47% 0.30% 0.06%(3) SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 10,310 $ 11,032 $ 9,308 $ 5,229 $ 5,869 $ 4,666 Portfolio turnover rate 41%(2) 111% 98% 119% 47% 70%
- ---------- * FOR THE PERIOD JUNE 5, 2000 (ISSUED DATE) THROUGH DECEMBER 31, 2000. ++ 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) REFELECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 25 TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo CHAIRMAN OF THE BOARD Mitchell M. Merin PRESIDENT Ronald E. Robison EXECUTIVE VICE PRESIDENT AND PRINCIPAL EXECUTIVE OFFICER Joseph J. McAlinden VICE PRESIDENT Barry Fink VICE PRESIDENT Amy R. Doberman VICE PRESIDENT Carsten Otto CHIEF COMPLIANCE OFFICER Stefanie V. Chang VICE PRESIDENT Francis J. Smith TREASURER AND CHIEF FINANCIAL OFFICER Thomas F. Caloia VICE PRESIDENT Mary E. Mullin SECRETARY TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT ADVISER Morgan Stanley Investment Advisors Inc. 1221 Avenue of the Americas New York, New York 10020 SUB-ADVISOR Morgan Stanley Investment Management Limited 25 Cabot Square, Canary Wharf London, United Kingdom E144QA The financial statements included herein have been taken from the records of the Portfolio 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 Portfolio. For more detailed information about the Portfolio, its fees and expenses and other pertinent information, please read its Prospectus. The Portfolio's Statement of Additional Information contains additional information about the Portfolio, 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 Portfolio 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) 2005 Morgan Stanley [MORGAN STANLEY LOGO] RA05-00657P-Y06/05 [GRAPHIC] MORGAN STANLEY FUNDS MORGAN STANLEY VARIABLE INVESTMENT SERIES -- GLOBAL ADVANTAGE PORTFOLIO SEMIANNUAL REPORT JUNE 30, 2005 [MORGAN STANLEY LOGO] WELCOME, SHAREHOLDER: IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY VARIABLE INVESTMENT SERIES -- GLOBAL DIVIDEND GROWTH PORTFOLIO 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 PORTFOLIO'S FINANCIAL STATEMENTS AND A LIST OF PORTFOLIO INVESTMENTS. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE PORTFOLIO BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE PORTFOLIO WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE PORTFOLIO IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE PORTFOLIO WILL DECLINE AND, THEREFORE, THE VALUE OF THE PORTFOLIO'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS PORTFOLIO. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT For the six-months ended June 30, 2005 TOTAL RETURN FOR THE 6 MONTHS ENDED JUNE 30, 2005
CLASS X CLASS Y MSCI WORLD INDEX(1) -1.12% -1.19% -0.70%
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. SEE PERFORMANCE SUMMARY FOR PERFORMANCE INFORMATION AND INDEX DEFINITIONS. MARKET CONDITIONS As investor sentiment wavered and oil prices continued to soar, global equity markets slowed during the six-month period ended June 30, 2005. Performance was particularly lackluster in the first portion of 2005, but showed signs of renewed strength in the final months of the period. In the United States, the Federal Open Market Committee continued raising the federal funds target rate to curtail inflation. Economic growth slowed, but given the strong pace of growth in 2004 and the Fed's actions, this tempered pace was not surprising. Many factors remained positive. For example, during the final months of the reporting period, encouraging retail sales and payroll data, strengthening consumer confidence, decreased inflationary concerns, and an upward revision of first-quarter gross domestic product numbers combined to boost investor sentiment. The slowdown seen in Europe was more significant. Strong performing economies (including the United Kingdom) retreated. A strong euro and weakening demand from China slowed export activity, typically a cornerstone of the European economy. These factors, as well as high oil prices, contributed to falling business confidence. Industrial production, consumer confidence and retail sales also declined. In the United Kingdom, consumers retrenched as protracted weakness in the housing market spilled over to the retailing sector. While the slowdown in China's growth rippled across the region, Japan more recently showed signs of improvement. Despite recent weakness in its consumer economy and its dependence on China's demand for its exports, Japan's gross domestic product data was revised upward while deflationary pressures continued to abate. Against this backdrop, energy stocks led, propelled by the high price of oil. Utilities stocks were also robust performers, benefiting from rising energy costs and investors' quest for yield-oriented, defensive stocks. In contrast, telecommunications stocks retreated. After earning strong performance in 2004, the sector felt the pressures of profit taking and concerns about future growth prospects. Auto and auto related stocks were notable laggards. Negative news from General Motors and Ford Motor brought into doubt the near and long-term profitability of the auto industry. Within the technology sector, hardware companies fared poorly. The market was concerned that rising energy costs -- and by extension, production costs -- would increase corporations' reluctance to move forward with capital spending initiatives. PERFORMANCE ANALYSIS The Global Dividend Growth Portfolio underperformed the Morgan Stanley Capital International (MSCI) World Index, for the six-month period ended June 30, 2005. The largest detractor from relative performance came from the energy sector. While the Portfolio's holdings performed strongly in absolute terms, its investment strategy precluded its participation in some of the top-performing stocks that were trading at prices that we 2 believed to be expensive. Additionally, as the result of individual stock-selection decisions, the Portfolio was underweighted in the energy sector overall versus the benchmark index. As crude oil prices soared and the market continued to reward energy stocks, this positioning proved disadvantageous. An overweighting in the telecommunications service sector -- the weakest performing sector for both the Portfolio and the index -- also dampened gains. Telecommunications stocks fared poorly, hurt by increased competition and the prospect for aggressive business strategies. Positions within the healthcare sector hindered performance, due to stock-specific events. In contrast, the Portfolio was boosted by stock selection in the consumer staples sector. Exposure to the beverage sector helped due to company-specific events. Tobacco stocks further enhanced returns, amid improving sentiment surrounding potential litigation risks. Industrial stocks, specifically, those involved in aerospace and defense, contributed gains. Relative to the index, the Portfolio held a smaller weighting in financials stocks; this helped performance as many financials felt the pressure of rising short-term rates, among other factors. Moreover, the Portfolio's financial services stake included a number of insurance stocks which posted strong returns. THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM WELL OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE PORTFOLIO IN THE FUTURE. TOP 10 HOLDINGS Citigroup, Inc. 3.5% Boeing Co. 2.8 GlaxoSmithKline PLC 2.7 Royal Dutch Petroleum Co. (Netherlands) 2.6 Tyco International Ltd. (Bermuda) 2.6 Wyeth 2.2 Altria Group, Inc. 2.1 Nestle S.A. (Registered Shares) 1.9 IBM Corp. 1.9 ENI SpA 1.9
TOP FIVE COUNTRIES United States 35.1% United Kingdom 19.0 Japan 9.2 France 5.7 Switzerland 5.3
DATA AS OF JUNE 30, 2005. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES FOR TOP TEN HOLDINGS AND TOP FIVE COUNTRIES ARE AS A PERCENTAGE OF NET ASSETS. 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 PORTFOLIO WILL NORMALLY INVEST AT LEAST 80% OF ITS ASSETS IN DIVIDEND PAYING EQUITY SECURITIES ISSUED BY ISSUERS LOCATED IN VARIOUS COUNTRIES AROUND THE WORLD. THE PORTFOLIO'S "SUB-ADVISER," MORGAN STANLEY INVESTMENT MANAGEMENT LIMITED, SEEKS INVESTMENTS PRIMARILY IN COMMON STOCKS (INCLUDING DEPOSITARY RECEIPTS) OF COMPANIES WITH A RECORD OF PAYING DIVIDENDS AND POTENTIAL FOR INCREASING DIVIDENDS. THE PORTFOLIO INVESTS IN AT LEAST THREE SEPARATE COUNTRIES. THE PERCENTAGE OF THE PORTFOLIO'S ASSETS INVESTED IN PARTICULAR GEOGRAPHIC SECTORS WILL SHIFT FROM TIME TO TIME IN ACCORDANCE WITH THE JUDGMENT OF THE SUB-ADVISER. FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY PORTFOLIO PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE PORTFOLIO'S SECOND AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY PORTFOLIO 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 PORTFOLIO'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 PORTFOLIO VOTED PROXIES RELATING TO PORTFOLIO SECURITIES DURING THE MOST RECENT TWELVE-MONTH PERIOD ENDED JUNE 30 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. 4 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS -- PERIOD ENDED JUNE 30, 2005
CLASS X SHARES CLASS Y SHARES (SINCE 02/23/94) (SINCE 06/05/00) 1 YEAR 8.32%(2) 8.08%(2) 5 YEARS 4.93(2) 4.67(2) 10 YEARS 8.42(2) -- SINCE INCEPTION 8.40(2) 3.98(2)
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 THE 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 PORTFOLIO SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. THE PERFORMANCE OF THE PORTFOLIO'S TWO SHARE CLASSES VARIES BECAUSE EACH HAS DIFFERENT EXPENSES. THE PORTFOLIO'S TOTAL RETURN FIGURES ASSUME THE REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE IMPACT OF ANY CHARGES BY YOUR INSURANCE COMPANY. SUCH COSTS WOULD LOWER PERFORMANCE. (1) THE MORGAN STANLEY CAPITAL INTERNATIONAL (MSCI) WORLD INDEX MEASURES PERFORMANCE FROM A DIVERSE RANGE OF GLOBAL STOCK MARKETS INCLUDING THE U.S., CANADA, EUROPE, AUSTRALIA, NEW ZEALAND, AND THE FAR EAST. THE PERFORMANCE OF THE INDEX IS LISTED IN U.S. DOLLARS AND ASSUMES REINVESTMENT OF NET DIVIDENDS. "NET DIVIDENDS" REFLECTS A REDUCTION IN DIVIDENDS AFTER TAKING INTO ACCOUNT WITHHOLDING OF TAXES BY CERTAIN FOREIGN COUNTRIES REPRESENTED IN THE INDEX. 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) FIGURE ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS FOR THE UNDERLYING PORTFOLIO BASED ON NET ASSET VALUE (NAV). IT DOES NOT REFLECT THE DEDUCTION OF INSURANCE EXPENSES, AN ANNUAL CONTRACT MAINTENANCE FEE, OR SURRENDER CHARGES. 5 EXPENSE EXAMPLE As a shareholder of the Portfolio, you incur two types of costs: (1) insurance company charges; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Portfolio expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Portfolio 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 01/01/05 - 06/30/05. 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 Portfolio's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Portfolio'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 Portfolio 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 insurance company charges. 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 insurance company charges were included, your costs would have been higher.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD * -------------- -------------- --------------- 01/01/05 - 01/01/05 06/30/05 06/30/05 -------------- -------------- --------------- CLASS X Actual (-1.12% return) $ 1,000.00 $ 988.80 $ 3.99 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,020.78 $ 4.06 CLASS Y Actual (-1.19% return) $ 1,000.00 $ 988.10 $ 5.23 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,019.54 $ 5.31
- ---------- * EXPENSES ARE EQUAL TO THE PORTFOLIO'S ANNUALIZED EXPENSE RATIO OF 0.81% AND 1.06% 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 fixed income securities trading. The Board reviewed similar information and factors regarding the Sub-Adviser, to the extent applicable. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Portfolio's Administrator under the Administration Agreement, including accounting, clerical, bookkeeping, compliance, business management and planning, and the provision of supplies, office space and utilities. (The Investment Adviser, Sub-Adviser and the Administrator together are referred to as the "Adviser" and the Advisory, Sub-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 administrative and investment advisory services to the Portfolio. 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 Portfolio. 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 The Board reviewed the Portfolio's performance for the one-, three- and five-year periods ended November 30, 2004, as shown in reports provided by Lipper (the "Lipper Reports"), compared to the performance of comparable funds selected by Lipper (the "performance peer group"), and noted that the Portfolio's performance was lower than its performance peer group average for the one-, three- and five-year periods. The Board discussed with the Adviser possible steps to improve performance. The Adviser informed the Board that, in order to try to improve performance, it was strengthening its research resources. The Board concluded that this action was reasonably designed to improve performance. FEES RELATIVE TO OTHER FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT STRATEGIES The Board reviewed the advisory and administrative fees (together, the "management fee") paid by the Fund under the Management Agreement. The Board noted that the rate was comparable to the management fee rates charged by the Adviser to any other funds it manages with investment strategies comparable to those of the Portfolio. 7 FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS The Board reviewed the management fee rate and the total expense ratio of the Portfolio. The Board noted that: (i) the Portfolio's management fee rate was lower than the average management fee rate for funds, selected by Lipper (the "expense peer group"), managed by other advisers with investment strategies comparable to those of the Portfolio, as shown in the Lipper Report for the Portfolio; and (ii) the Portfolio's total expense ratio was also lower than the average total expense ratio of the funds included in the Portfolio's expense peer group. The Board concluded that the Portfolio's management fee 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 Portfolio's management fee schedule under the Management Agreement and noted that it includes breakpoints. The Board also reviewed the level of the Portfolio's management fee and noted that the fee, as a percentage of the Portfolio's net assets, would decrease as net assets increase because the management fee includes breakpoints. The Board concluded that the Portfolio's management fee would reflect economies of scale as assets increase. PROFITABILITY OF ADVISER AND AFFILIATES The Board considered and reviewed information concerning the costs incurred and profits realized by the Adviser and its affiliates during the last two years from their relationship with the Portfolio and the Morgan Stanley Fund Complex and reviewed with the Controller of the Adviser the cost allocation methodology used to determine the Adviser's profitability. Based on their review of the information they received, the Board concluded that the profits earned by the Adviser and its affiliates were not excessive in light of the advisory, administrative and other services provided to the Portfolio. FALL-OUT BENEFITS The Board considered so-called "fall-out benefits" derived by the Adviser and its affiliates from their relationship with the Portfolio and the Morgan Stanley Fund Complex, such as "float" benefits derived from handling of checks for purchases and redemptions of Portfolio 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 Portfolio 12b-1 fees for distribution and shareholder services. The Board also considered that an affiliate of the Adviser, through a joint venture, receives revenue in connection with trading done on behalf of the Portfolio through an electronic trading system network ("ECN"). The Board concluded that the float benefits and the above-referenced ECN-related revenue were relatively small and that the 12b-1 fees were competitive with those of other broker-dealer affiliates of investment advisers of mutual funds. 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 Portfolio 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 Portfolio. The Adviser informed the Board that it does not use Portfolio 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 Portfolio and other funds in the Morgan Stanley Fund Complex. ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE PORTFOLIO'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 PORTFOLIO AND THE ADVISER The Board also reviewed and considered the historical relationship between the Portfolio and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Portfolio'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 Portfolio 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 Portfolio'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 Portfolio's business. GENERAL CONCLUSION After considering and weighing all of the above factors, the Board concluded it would be in the best interest of the Portfolio and its shareholders to approve renewal of the Management Agreement for another year. 9 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- GLOBAL DIVIDEND GROWTH PORTFOLIO PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------------------- COMMON STOCKS (96.6%) AUSTRALIA (a) (2.1%) BEVERAGES: ALCOHOLIC 389,108 Foster's Group Ltd. $ 1,570,471 --------------- CONSTRUCTION MATERIALS 272,973 Boral Ltd. 1,339,257 --------------- MAJOR BANKS 108,403 National Australia Bank Ltd. 2,528,910 --------------- TOTAL AUSTRALIA 5,438,638 --------------- BERMUDA (2.6%) INDUSTRIAL CONGLOMERATES 231,889 Tyco International Ltd. 6,771,159 --------------- CAYMAN ISLANDS (1.0%) PROPERTY - CASUALTY INSURERS 33,820 XL Capital Ltd. (Class A) 2,516,884 --------------- FRANCE (a) (5.7%) CONSTRUCTION MATERIALS 34,732 Lafarge S.A. 3,152,181 --------------- INTEGRATED OIL 19,527 Total S.A. 4,573,438 --------------- MAJOR BANKS 49,035 BNP Paribas S.A. 3,352,891 --------------- PHARMACEUTICALS: MAJOR 47,478 Sanofi-Aventis 3,887,440 --------------- TOTAL FRANCE 14,965,950 --------------- GERMANY (a) (1.8%) CHEMICALS: MAJOR DIVERSIFIED 39,536 BASF AG 2,620,770 --------------- MOTOR VEHICLES 46,964 Bayerische Motoren Werke (BMW) AG 2,137,066 --------------- TOTAL GERMANY 4,757,836 --------------- HONG KONG (a) (0.6%) ELECTRIC UTILITIES 318,500 Hong Kong Electric Holdings Ltd. $ 1,452,116 --------------- IRELAND (a) (2.2%) FOOD: SPECIALTY/CANDY 96,622 Kerry Group PLC (A Shares) 2,385,661 --------------- MAJOR BANKS 213,756 Bank of Ireland 3,464,440 --------------- TOTAL IRELAND 5,850,101 --------------- ITALY (a) (3.4%) INTEGRATED OIL 190,734 ENI SpA 4,897,453 --------------- MAJOR TELECOMMUNICATIONS 1,501,584 Telecom Italia SpA - RNC 3,887,103 --------------- TOTAL ITALY 8,784,556 --------------- JAPAN (a) (9.2%) ELECTRICAL PRODUCTS 213,000 Sumitomo Electric Industries, Ltd. 2,162,468 --------------- ELECTRONIC EQUIPMENT/INSTRUMENTS 65,100 Canon, Inc. 3,408,969 --------------- ELECTRONICS/APPLIANCES 104,000 Fuji Photo Film Co., Ltd. 3,382,497 --------------- HOME BUILDING 202,000 Sekisui House, Ltd. 2,032,130 --------------- HOUSEHOLD/PERSONAL CARE 126,000 Kao Corp. 2,967,863 --------------- MOTOR VEHICLES 61,400 Toyota Motor Corp. 2,194,604 --------------- PHARMACEUTICALS: MAJOR 83,700 Takeda Pharmaceutical Co., Ltd. 4,137,175 ---------------
SEE NOTES TO FINANCIAL STATEMENTS 10
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------------------- PHARMACEUTICALS: OTHER 75,800 Astellas Pharma Inc. $ 2,586,077 --------------- PROPERTY - CASUALTY INSURERS 143,000 Mitsui Sumitomo Insurance Co., Ltd. 1,281,510 --------------- TOTAL JAPAN 24,153,293 --------------- NETHERLANDS (a) (4.7%) FOOD: MAJOR DIVERSIFIED 37,784 Unilever NV (Share Certificates) 2,446,306 INDUSTRIAL CONGLOMERATES 42,405 Koninklijke (Royal) Philips Electronics NV 1,066,460 --------------- INTEGRATED OIL 106,140 Royal Dutch Petroleum Co. (NY Registered Shares) 6,888,486 --------------- PUBLISHING: BOOKS/ MAGAZINES 102,913 Wolters Kluwer NV (Share Certificates) 1,963,059 --------------- TOTAL NETHERLANDS 12,364,311 --------------- NEW ZEALAND (a) (1.0%) MAJOR TELECOMMUNICATIONS 623,174 Telecom Corporation of New Zealand Ltd. 2,599,766 --------------- SOUTH KOREA (0.8%) WIRELESS TELECOMMUNICATIONS 104,752 SK Telecom Co., Ltd. (ADR) 2,136,941 --------------- SPAIN (a) (2.1%) MAJOR BANKS 157,433 Banco Bilbao Vizcaya Argentaria, S.A. 2,422,640 --------------- MAJOR TELECOMMUNICATIONS 187,519 Telefonica S.A. 3,062,145 --------------- TOTAL SPAIN 5,484,785 --------------- SWITZERLAND (a) (5.3%) CHEMICALS: AGRICULTURAL 25,711 Syngenta AG* $ 2,633,687 --------------- FINANCIAL CONGLOMERATES 34,571 UBS AG (Registered Shares) 2,690,643 --------------- FOOD: MAJOR DIVERSIFIED 19,556 Nestle S.A. (Registered Shares) 4,998,156 --------------- PHARMACEUTICALS: MAJOR 73,080 Novartis AG (Registered Shares) 3,471,348 --------------- TOTAL SWITZERLAND 13,793,834 --------------- UNITED KINGDOM (a) (19.0%) ADVERTISING/MARKETING SERVICES 142,112 WPP Group PLC 1,457,275 --------------- AEROSPACE & DEFENSE 665,066 Rolls-Royce Group PLC* 3,408,463 35,210,850 Rolls-Royce Group PLC (B Shares) 61,801 --------------- 3,470,264 --------------- BEVERAGES: ALCOHOLIC 117,893 Allied Domecq PLC 1,426,619 240,095 Diageo PLC 3,526,657 --------------- 4,953,276 --------------- FOOD RETAIL 563,777 Morrison (W.M.) Supermarkets PLC 1,869,665 --------------- FOOD: SPECIALTY/CANDY 477,068 Cadbury Schweppes PLC 4,539,619 --------------- INVESTMENT MANAGERS 205,014 Amvescap PLC 1,215,614 --------------- MAJOR BANKS 339,800 Barclays PLC 3,370,303 145,783 Royal Bank of Scotland Group PLC 4,388,384 --------------- 7,758,687 ---------------
SEE NOTES TO FINANCIAL STATEMENTS 11
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------------------- MISCELLANEOUS COMMERCIAL SERVICES 396,634 Rentokil Initial PLC $ 1,128,872 --------------- OTHER TRANSPORTATION 179,953 BAA PLC 1,994,601 --------------- PHARMACEUTICALS: MAJOR 297,781 GlaxoSmithKline PLC 7,181,944 --------------- PUBLISHING: BOOKS/MAGAZINES 497,423 Reed Elsevier PLC 4,747,231 --------------- TOBACCO 166,734 Imperial Tobacco Group PLC 4,476,086 --------------- WIRELESS TELECOMMUNICATIONS 1,974,319 Vodafone Group PLC 4,795,526 --------------- TOTAL UNITED KINGDOM 49,588,660 --------------- UNITED STATES (35.1%) AEROSPACE & DEFENSE 111,808 Boeing Co. 7,379,328 26,844 General Dynamics Corp. 2,940,492 40,315 Northrop Grumman Corp. 2,227,404 --------------- 12,547,224 --------------- ALUMINUM 75,513 Alcoa, Inc. 1,973,155 --------------- APPAREL/FOOTWEAR RETAIL 61,034 Gap, Inc. (The) 1,205,422 --------------- COMPUTER PROCESSING HARDWARE 142,020 Hewlett-Packard Co. 3,338,890 --------------- DATA PROCESSING SERVICES 69,403 First Data Corp. 2,785,836 --------------- ELECTRIC UTILITIES 72,711 American Electric Power Co., Inc. 2,680,855 --------------- FINANCE/RENTAL/LEASING 19,957 Freddie Mac 1,301,795 --------------- FINANCIAL CONGLOMERATES 199,517 Citigroup, Inc. $ 9,223,671 25,605 Prudential Financial, Inc. 1,681,224 --------------- 10,904,895 --------------- INFORMATION TECHNOLOGY SERVICES 67,147 International Business Machines Corp. 4,982,307 --------------- INTEGRATED OIL 59,029 Chevron Corp. 3,300,902 21,769 Exxon Mobil Corp. 1,251,064 --------------- 4,551,966 --------------- INVESTMENT BANKS/BROKERS 46,483 Merrill Lynch & Co., Inc. 2,557,030 --------------- INVESTMENT MANAGERS 101,984 Mellon Financial Corp. 2,925,921 --------------- MAJOR TELECOMMUNICATIONS 130,112 SBC Communications, Inc. 3,090,160 102,497 Verizon Communications Inc. 3,541,271 --------------- 6,631,431 --------------- MULTI-LINE INSURANCE 24,565 American International Group, Inc. 1,427,227 --------------- PACKAGED SOFTWARE 506 Computer Associates International, Inc. 13,905 --------------- PHARMACEUTICALS: MAJOR 134,887 Bristol-Myers Squibb Co. 3,369,477 129,901 Pfizer, Inc. 3,582,670 83,509 Schering-Plough Corp. 1,591,682 131,694 Wyeth 5,860,383 --------------- 14,404,212 --------------- PROPERTY - CASUALTY INSURERS 83,005 St. Paul Travelers Companies, Inc. (The) 3,281,188 ---------------
SEE NOTES TO FINANCIAL STATEMENTS 12
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------------------- PUBLISHING: NEWSPAPERS 65,590 New York Times Co. (The) (Class A) $ 2,043,129 --------------- PULP & PAPER 51,431 Georgia-Pacific Corp. 1,635,506 --------------- RESTAURANTS 100,571 McDonald's Corp. 2,790,845 --------------- SPECIALTY INSURANCE 16,873 MBIA Inc. 1,000,738 --------------- TOBACCO 84,942 Altria Group, Inc. 5,492,350 36,233 Loews Corp.- Carolina Group 1,207,284 --------------- 6,699,634 --------------- TOTAL UNITED STATES 91,683,111 --------------- TOTAL COMMON STOCKS (COST $205,289,370) 252,341,941 ---------------
PRINCIPAL AMOUNT IN THOUSANDS - ---------- SHORT-TERM INVESTMENT (b) (3.1%) U.S. GOVERNMENT AGENCY $ 8,100 Federal Home Loan Mortgage Corp. 2.60% due 07/01/05 (COST $8,100,000) 8,100,000 --------------- TOTAL INVESTMENTS (COST $213,389,370) (c) 99.7% 260,441,941 OTHER ASSETS IN EXCESS OF LIABILITIES 0.3 759,876 ----- --------------- Net Assets 100.0% $ 261,201,817 ===== ===============
- ---------- ADR AMERICAN DEPOSITARY RECEIPT. * NON-INCOME PRODUCING SECURITY. (a) SECURITIES WITH TOTAL MARKET VALUE EQUAL TO $142,345,360 HAVE BEEN VALUED AT THEIR FAIR VALUE AS DETERMINED IN GOOD FAITH UNDER PROCEDURES ESTABLISHED BY AND UNDER THE GENERAL SUPERVISION OF THE PORTFOLIO'S TRUSTEES. (b) PURCHASED ON A DISCOUNT BASIS. THE INTEREST RATE SHOWN HAS BEEN ADJUSTED TO REFLECT A MONEY MARKET EQUIVALENT YIELD. (c) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES APPROXIMATES THE AGGREGATE COST FOR BOOK PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION IS $53,300,623 AND THE AGGREGATE GROSS UNREALIZED DEPRECIATION IS $6,248,052, RESULTING IN NET UNREALIZED APPRECIATION OF $47,052,571. SEE NOTES TO FINANCIAL STATEMENTS 13 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- GLOBAL DIVIDEND GROWTH PORTFOLIO SUMMARY OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
PERCENT OF INDUSTRY VALUE NET ASSETS - ------------------------------------------------------------------------------------ Pharmaceuticals: Major $ 33,082,119 12.7% Integrated Oil 20,911,343 8.0 Major Banks 19,527,568 7.5 Major Telecommunications 16,180,445 6.2 Aerospace & Defense 16,017,488 6.1 Financial Conglomerates 13,595,538 5.2 Tobacco 11,175,720 4.3 U.S. Government Agency 8,100,000 3.1 Industrial Conglomerates 7,837,619 3.0 Food: Major Diversified 7,444,462 2.8 Property - Casualty Insurers 7,079,582 2.7 Wireless Telecommunications 6,932,467 2.6 Food: Specialty/Candy 6,925,280 2.6 Publishing: Books/Magazines 6,710,290 2.6 Beverages: Alcoholic 6,523,747 2.5 Information Technology Services 4,982,307 1.9 Construction Materials 4,491,438 1.7 Motor Vehicles 4,331,670 1.7 Investment Managers 4,141,535 1.6 Electric Utilities 4,132,971 1.6 Electronic Equipment/Instruments 3,408,969 1.3 Electronics/Appliances 3,382,497 1.3 Computer Processing Hardware 3,338,890 1.3 Household/Personal Care 2,967,863 1.1 Restaurants 2,790,845 1.1 Data Processing Services 2,785,836 1.1 Chemicals: Agricultural 2,633,687 1.0 Chemicals: Major Diversified 2,620,770 1.0 Pharmaceuticals: Other 2,586,077 1.0 Investment Banks/Brokers 2,557,030 1.0 Electrical Products 2,162,468 0.8 Publishing: Newspapers 2,043,129 0.8 Home Building 2,032,130 0.8 Other Transportation 1,994,601 0.8 Aluminum 1,973,155 0.8 Food Retail 1,869,665 0.7 Pulp & Paper 1,635,506 0.6 Advertising/Marketing Services 1,457,275 0.6 Multi-Line Insurance 1,427,227 0.5 Finance/Rental/Leasing 1,301,795 0.5 Apparel/Footwear Retail 1,205,422 0.4 Miscellaneous Commercial Services 1,128,872 0.4 Specialty Insurance 1,000,738 0.4 Packaged Software 13,905 0.0 -------------- -------- $ 260,441,941 99.7% ============== ========
SEE NOTES TO FINANCIAL STATEMENTS 14 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- GLOBAL DIVIDEND GROWTH PORTFOLIO FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 2005 (UNAUDITED) ASSETS: Investments in securities, at value (cost $204,004,339) $ 251,218,270 Investment in affiliates (cost $9,385,032) 9,223,671 Cash (Including foreign currency value at $98 with a cost of $100) 175,126 Receivable for: Dividends 607,632 Foreign withholding taxes reclaimed 202,216 Prepaid expenses and other assets 10,158 -------------- TOTAL ASSETS 261,437,073 -------------- LIABILITIES: Payable for: Investment advisory fee 145,902 Administration fee 17,421 Distribution fee 14,219 Shares of beneficial interest redeemed 733 Accrued expenses and other payables 56,981 -------------- TOTAL LIABILITIES 235,256 -------------- NET ASSETS $ 261,201,817 ============== COMPOSITION OF NET ASSETS: Paid-in-capital $ 216,311,546 Net unrealized appreciation 47,044,296 Accumulated undistributed net investment income 3,172,005 Accumulated net realized loss (5,326,030) -------------- NET ASSETS $ 261,201,817 ============== CLASS X SHARES: Net Assets $ 192,404,160 Shares Outstanding (UNLIMITED AUTHORIZED SHARES OF $.01 PAR VALUE) 13,686,535 NET ASSET VALUE PER SHARE $ 14.06 ============== CLASS Y SHARES: Net Assets $ 68,797,657 Shares Outstanding (UNLIMITED AUTHORIZED SHARES OF $.01 PAR VALUE) 4,929,171 NET ASSET VALUE PER SHARE $ 13.96 ==============
SEE NOTES TO FINANCIAL STATEMENTS 15 STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2005 (UNAUDITED) NET INVESTMENT INCOME: INCOME Dividends (net of $288,543 foreign withholding tax) $ 4,092,115 Dividends from affiliates 148,672 Interest 106,130 -------------- TOTAL INCOME 4,346,917 -------------- EXPENSES Investment advisory fee 901,874 Administration fee 107,687 Distribution fee (Class Y shares) 84,346 Custodian fees 23,889 Professional fees 18,998 Shareholder reports and notices 17,493 Trustees' fees and expenses 1,812 Transfer agent fees and expenses 250 Other 15,088 -------------- TOTAL EXPENSES 1,171,437 -------------- NET INVESTMENT INCOME 3,175,480 -------------- NET REALIZED AND UNREALIZED GAIN (LOSS): NET REALIZED GAIN/(LOSS) ON: Investments 8,105,287 Foreign exchange transactions (62,492) -------------- NET REALIZED GAIN 8,042,795 -------------- NET CHANGE IN UNREALIZED APPRECIATION/DEPRECIATION ON: Investments (14,349,153) Translation of forward foreign currency contracts, other assets and liabilities denominated in foreign currencies (33,276) -------------- NET DEPRECIATION (14,382,429) -------------- NET LOSS (6,339,634) -------------- NET DECREASE $ (3,164,154) ==============
SEE NOTES TO FINANCIAL STATEMENTS 16 STATEMENT OF CHANGES IN NET ASSETS
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 ---------------- ------------------ (UNAUDITED) INCREASE (DECREASE) IN NET ASSETS: OPERATIONS: Net investment income $ 3,175,480 $ 4,157,479 Net realized gain 8,042,795 18,814,334 Net change in unrealized appreciation (14,382,429) 14,496,215 ---------------- ------------------ NET INCREASE (DECREASE) (3,164,154) 37,468,028 ---------------- ------------------ DIVIDENDS TO SHAREHOLDERS FROM NET INVESTMENT INCOME: Class X shares (3,212,516) (3,177,112) Class Y shares (1,016,465) (789,377) ---------------- ------------------ TOTAL DIVIDENDS (4,228,981) (3,966,489) ---------------- ------------------ Net decrease from transactions in shares of beneficial interest (12,762,474) (21,638,972) ---------------- ------------------ NET INCREASE (DECREASE) (20,155,609) 11,862,567 NET ASSETS: Beginning of period 281,357,426 269,494,859 ---------------- ------------------ END OF PERIOD (INCLUDING ACCUMULATED UNDISTRIBUTED NET INVESTMENT INCOME OF $3,172,005 AND $4,225,506, RESPECTIVELY) $ 261,201,817 $ 281,357,426 ================ ==================
SEE NOTES TO FINANCIAL STATEMENTS 17 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- GLOBAL DIVIDEND GROWTH PORTFOLIO NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) 1. ORGANIZATION AND ACCOUNTING POLICIES Morgan Stanley Variable Investment Series (the "Fund") -- Global Dividend Growth Portfolio (the "Portfolio"), one of 15 separate portfolios, is registered under the Investment Company Act of 1940, as amended (the "Act"), as a diversified, open-end management investment company. The Fund is offered exclusively to life insurance companies in connection with particular life insurance and/or annuity contracts they offer. The Portfolio's investment objective is to provide reasonable current income and long-term growth of income and capital. The Fund was organized as a Massachusetts business trust on February 25, 1983 and the Portfolio commenced operations on February 23, 1994. On June 5, 2000, the Portfolio commenced offering one additional class of shares (Class Y). The Portfolio offers Class X and Class Y shares. The two are identical except that Class Y shares incurs distribution expenses. Class X shares are generally available to holders of contracts offered by Metropolitan Life Insurance Company (formerly Paragon Life Insurance Company) and other contracts offered before May 1, 2000. Class Y shares are available to holders of contracts offered on or after June 5, 2000. 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) when market quotations are not readily available or Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") or Morgan Stanley Investment Management Limited (the "Sub-Adviser"), an affiliate of the Investment Adviser determines that the latest sale price, the bid price or the mean between the last reported bid and asked price do not reflect a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees. Occasionally, developments affecting the closing prices of securities and other assets may occur between the times at which valuations of such securities are determined (that is, close of the foreign market on which the securities trade) and the close of business on the NYSE. If developments occur during such periods that are expected to materially affect the value of such securities, such valuations may be adjusted to reflect 18 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; (6) certain portfolio securities may be valued by an outside pricing service approved by the Fund's Trustees; and (7) 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 except for certain dividends on foreign securities which are recorded as soon as the Fund is informed after 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 -- The Fund may 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. FOREIGN CURRENCY TRANSLATION AND FORWARD FOREIGN CURRENCY CONTRACTS -- The books and records of the Portfolio 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 Portfolio 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 Portfolio 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. 19 F. 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. G. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- Dividends and distributions to shareholders are recorded on the ex-dividend date. H. EXPENSES -- Direct expenses are charged to the Portfolio and general Fund expenses are allocated on the basis of relative net assets or equally among the Portfolios. I. 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 AND SUB-ADVISORY AGREEMENTS Pursuant to an Investment Advisory Agreement, the Portfolio pays the Investment Adviser an advisory fee, accrued daily and payable monthly, by applying the following annual rates to the net assets of the Portfolio determined as of the close of each business day: 0.67% to the portion of daily net assets not exceeding $1 billion; 0.645% to the portion of daily net assets exceeding $1 billion but not exceeding $1.5 billion; 0.62% to the portion of daily net assets exceeding $1.5 billion but not exceeding $2.5 billion; 0.595% to the portion of daily net assets exceeding $2.5 billion but not exceeding $3.5 billion; 0.57% to the portion of daily net assets exceeding $3.5 billion but not exceeding $4.5 billion; and 0.545% to the portion of daily net assets in excess of $4.5 billion. Pursuant to an Administration Agreement with Morgan Stanley Services Company Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Portfolio pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.08% to the Portfolio's daily net assets. Under a Sub-Advisory Agreement between the Investment Adviser and Sub-Adviser, the Sub-Adviser provides the Portfolio with investment advice and portfolio management relating to the Portfolio's investments in securities, subject to the overall supervision of the Investment Adviser. As compensation for its services provided pursuant to the Sub-Advisory Agreement, the Investment Adviser paid the Sub-Adviser compensation of $360,750 for the six months ended June 30, 2005. 3. PLAN OF DISTRIBUTION Shares of the Fund are distributed by Morgan Stanley Distributors Inc. (the "Distributor"), an affiliate of the Investment Adviser, Administrator and Sub-Adviser. The Fund has adopted a Plan of Distribution (the "Plan") pursuant to Rule 12b-1 under the Act. The Plan provides that Class Y shares of the Portfolio will 20 pay a distribution fee which is accrued daily and paid monthly at the annual rate of 0.25% of the average daily net assets of the class. 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 June 30, 2005 aggregated $32,680,281 and $49,647,777, respectively. Included in the aforementioned transactions are purchases and sales with Citigroup Inc., an affiliate of the Fund, for $656,937 and $3,941,506, respectively, including a realized loss of $31,031, income of $148,672, and a value of $9,223,671. Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator, Distributor and Sub-Adviser, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and compensation. Aggregate pension costs for the six months ended June 30, 2005 included in Trustees' fees and expenses in the Statement of Operations amounted to $226. At June 30, 2005, the Portfolio had an accrued pension liability of $1,442 which is included in accrued expenses in the Statement of Assets and Liabilities. On December 2, 2003, the Trustees voted to close the plan to new participants and eliminate the future benefits growth due to increases to compensation after July 31, 2003. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 21 5. SHARES OF BENEFICIAL INTEREST Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 -------------------------------- -------------------------------- (UNAUDITED) SHARES AMOUNT SHARES AMOUNT -------------- -------------- -------------- -------------- CLASS X SHARES Sold 782,971 $ 11,225,481 2,247,506 $ 29,630,871 Reinvestment of dividends 228,486 3,212,516 240,690 3,177,112 Redeemed (2,116,783) (30,329,277) (5,084,949) (66,984,704) -------------- -------------- -------------- -------------- Net decrease -- Class X (1,105,326) (15,891,280) (2,596,753) (34,176,721) -------------- -------------- -------------- -------------- CLASS Y SHARES Sold 564,703 8,025,809 1,501,824 19,677,928 Reinvestment of dividends 72,813 1,016,465 60,212 789,377 Redeemed (416,153) (5,913,468) (601,676) (7,929,556) -------------- -------------- -------------- -------------- Net increase -- Class Y 221,363 3,128,806 960,360 12,537,749 -------------- -------------- -------------- -------------- Net decrease in the Portfolio (883,963) $ (12,762,474) (1,636,393) $ (21,638,972) ============== ============== ============== ==============
6. 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 December 31, 2004, the Portfolio had a net capital loss carryforward of approximately $13,005,000 which will expire on December 31, 2011 to offset future capital gains to the extent provided by regulations. As of December 31, 2004, the Portfolio had temporary book/tax differences primarily attributable to capital loss deferrals on wash sales and foreign tax credit pass-through. 22 7. PURPOSES OF AND RISKS RELATING TO CERTAIN FINANCIAL INSTRUMENTS The Portfolio may enter into forward contracts to facilitate settlement of foreign currency denominated portfolio transactions or to manage foreign currency exposure associated with foreign currency denominated securities. Forward contracts involve elements of market risk in excess of the amounts reflected in the Statement of Assets and Liabilities. The Portfolio bears the risk of an unfavorable change in the foreign exchange rates underlying the forward contracts. Risks may also arise upon entering into these contracts from the potential inability of the counterparties to meet the terms of their contracts. At June 30, 2005, the Portfolio's cash balance consisted principally of interest bearing deposits with J.P. Morgan Chase Bank, the custodian of the Portfolio. 23 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- GLOBAL DIVIDEND GROWTH PORTFOLIO FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED -------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ---------- ---------- ---------- ---------- ---------- (UNAUDITED) CLASS X SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 14.46 $ 12.77 $ 9.87 $ 11.47 $ 12.73 $ 14.44 ------------- ---------- ---------- ---------- ---------- ---------- Income (loss) from investment operations: Net investment income++ 0.17 0.21 0.18 0.21 0.21 0.24 Net realized and unrealized gain (loss) (0.33) 1.68 2.94 (1.62) (1.00) (0.64) ------------- ---------- ---------- ---------- ---------- ---------- Total income (loss) from investment operations (0.16) 1.89 3.12 (1.41) (0.79) (0.40) ------------- ---------- ---------- ---------- ---------- ---------- Less dividends and distributions from: Net investment income (0.24) (0.20) (0.22) (0.19) (0.33) (0.09) Net realized gain - - - - (0.14) (1.22) ------------- ---------- ---------- ---------- ---------- ---------- Total dividends and distributions (0.24) (0.20) (0.22) (0.19) (0.47) (1.31) ------------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period $ 14.06 $ 14.46 $ 12.77 $ 9.87 $ 11.47 $ 12.73 ============= ========== ========== ========== ========== ========== TOTAL RETURN+ (1.12)%(2) 14.93% 32.07% (12.52)% (6.25)% (2.50)% RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.81%(3) 0.81% 0.82% 0.81% 0.80% 0.80% Net investment income 2.42%(3) 1.58% 1.73% 1.96% 1.76% 1.88% SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 192,404 $ 213,836 $ 221,971 $ 201,022 $ 285,158 $ 373,770 Portfolio turnover rate 12%(2) 21% 103% 17% 9% 40%
- ---------- * PRIOR TO JUNE 5, 2000, THE PORTFOLIO ISSUED ONE CLASS OF SHARES. ALL SHARES OF THE PORTFOLIO HELD PRIOR TO MAY 1, 2000 HAVE BEEN DESIGNATED CLASS X SHARES. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 24
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED -------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ---------- ---------- ---------- ---------- ---------- (UNAUDITED) CLASS Y SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 14.34 $ 12.68 $ 9.82 $ 11.43 $ 12.71 $ 13.96 ------------- ---------- ---------- ---------- ---------- ---------- Income (loss) from investment operations: Net investment income++ 0.16 0.18 0.15 0.18 0.15 0.08 Net realized and unrealized gain (loss) (0.33) 1.66 2.91 (1.61) (0.96) (0.11) ------------- ---------- ---------- ---------- ---------- ---------- Total income (loss) from investment operations (0.17) 1.84 3.06 (1.43) (0.81) (0.03) ------------- ---------- ---------- ---------- ---------- ---------- Less dividends and distributions from: Net investment income (0.21) (0.18) (0.20) (0.18) (0.33) - Net realized gain - - - - (0.14) (1.22) ------------- ---------- ---------- ---------- ---------- ---------- Total dividends and distributions (0.21) (0.18) (0.20) (0.18) (0.47) (1.22) ------------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period $ 13.96 $ 14.34 $ 12.68 $ 9.82 $ 11.43 $ 12.71 ============= ========== ========== ========== ========== ========== TOTAL RETURN+ (1.19)%(2) 14.65% 31.64% (12.72)% (6.44)% 0.07%(2) RATIOS TO AVERAGE NET ASSETS(1): Expenses 1.06%(3) 1.05% 1.07% 1.06% 1.05% 1.05%(3) Net investment income 2.17%(3) 1.34% 1.48% 1.71% 1.51% 1.14%(3) SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 68,798 $ 67,522 $ 47,524 $ 20,981 $ 10,494 $ 2,211 Portfolio turnover rate 12%(2) 21% 103% 17% 9% 40%
- ---------- * FOR THE PERIOD JUNE 5, 2000 (ISSUED DATE) THROUGH DECEMBER 31, 2000. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 25 TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo CHAIRMAN OF THE BOARD Mitchell M. Merin PRESIDENT Ronald E. Robison EXECUTIVE VICE PRESIDENT and PRINCIPAL EXECUTIVE OFFICER Joseph J. McAlinden VICE PRESIDENT Barry Fink VICE PRESIDENT Amy R. Doberman VICE PRESIDENT Carsten Otto CHIEF COMPLIANCE OFFICER Stefanie V. Chang VICE PRESIDENT Francis J. Smith TREASURER and CHIEF FINANCIAL OFFICER Thomas F. Caloia VICE PRESIDENT Mary E. Mullin SECRETARY TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT ADVISER Morgan Stanley Investment Advisors Inc. 1221 Avenue of the Americas New York, New York 10020 SUB-ADVISOR Morgan Stanley Investment Management Limited 25 Cabot Square, Canary Wharf London, United Kingdom E14 4QA The financial statements included herein have been taken from the records of the Portfolio 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 Portfolio. For more detailed information about the Portfolio, its fees and expenses and other pertinent information, please read its Prospectus. The Portfolio's Statement of Additional Information contains additional information about the Portfolio, including its tustees. It is available, without charge, by calling (800) 869-NEWS. This report is not authorized for distribution to prospective investors in the Portfolio 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) 2005 Morgan Stanley [MORGAN STANLEY LOGO] RA05-00683P-Y06/05 [GRAPHIC] MORGAN STANLEY FUNDS MORGAN STANLEY VARIABLE INVESTMENT SERIES -- GLOBAL DIVIDEND GROWTH PORTFOLIO SEMIANNUAL REPORT JUNE 30, 2005 [MORGAN STANLEY LOGO] WELCOME, SHAREHOLDER: IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY VARIABLE INVESTMENT SERIES -- HIGH YIELD PORTFOLIO 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 PORTFOLIO'S FINANCIAL STATEMENTS AND A LIST OF PORTFOLIO INVESTMENTS. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE PORTFOLIO BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE PORTFOLIO WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE PORTFOLIO IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE PORTFOLIO WILL DECLINE AND, THEREFORE, THE VALUE OF THE PORTFOLIO'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS PORTFOLIO. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT For the six months ended June 30, 2005 TOTAL RETURN FOR THE 6 MONTHS ENDED JUNE 30, 2005
CSFB LEHMAN BROTHERS HIGH YIELD HIGH YIELD CLASS X CLASS Y INDEX(1) INDEX(2) 0.38% 0.25% 0.77% 1.11%
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. SEE PERFORMANCE SUMMARY FOR PERFORMANCE INFORMATION AND INDEX DEFINITIONS. MARKET CONDITIONS After performing at an extremely brisk clip in 2003 and 2004, the high yield market generated more muted gains for the six-month period ending June 30, 2005. Despite good economic growth, strong underlying company fundamentals, reasonable corporate earnings, low default rates and improving credit qualities, the market encountered considerable volatility. In January, heavy new issuance created a less favorable supply-and-demand relationship, and gave investors pause. Of greater consequence, however, was General Motors' mid-March announcement of production cuts and poor earnings for the next quarter. The realization that such a bellwether company was struggling so significantly exacerbated the woes of the auto industry and cast a grim shadow across the market overall. Moreover, high yield markets were unsettled by the prospect that General Motors would move from the high grade to the high yield universe. Such a move, it was feared, could trigger a sell-off of other high yield bonds, as investors moved to purchase General Motors debt. Against this backdrop, the market declined through April. The reporting period finished on a brighter note, however. The market became more comfortable with the inclusion of General Motors and Ford Motor in the high yield arena, while new issuance slowed. Investors returned their attention to company fundamentals and favorable economic and corporate data. Overall, the higher rated segment of the high yield universe greatly outperformed issues rated CCC and lower. From an industry perspective, wireless communications, telecommunications and food/tobacco fared the best, while transportation, aerospace and forest products lagged most significantly. PERFORMANCE ANALYSIS The High Yield Portfolio underperformed the CSFB High Yield Index and the Lehman Brothers High Yield Index for the six-month period ended June 30, 2005. During the period, the Portfolio benefited from its underweighting in transportation securities relative to the CSFB High Yield Index. Moreover, among the transportation securities the Portfolio did hold, our investment discipline had led us to de-emphasize auto and auto related companies; this positioning proved advantageous as these securities were penalized by the market with added force. Security selection in wireless communications also enhanced performance. The sector performed well overall, and several of the Portfolio's positions were particularly rewarded for their strong fundamentals. In contrast, forest products, housing and manufacturing securities slowed the Portfolio's pace. Within housing, exposure to highly leveraged building product companies hindered performance as investors worried about a potential decline in home construction. Forest 2 and manufacturing securities detracted from overall returns due to company-specific reasons. At the close of the reporting period, chemicals, housing, energy and manufacturing represented the largest overweightings in the Portfolio relative to the CSFB High Yield Index. Utilities, broadcasting, information, technology, telecommunications and gaming/leisure were the most significantly underweighted exposures. We note, however, that the overall sector weightings of the Portfolio are the result of our conviction in individual securities, not reflection of a sector-driven strategy. The overall credit quality of the Portfolio was B at the close of the period, in line with that of the index. THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM WELL OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE PORTFOLIO IN THE FUTURE. TOP FIVE INDUSTRIES Chemicals: Specialty 6.9% Electric Utilities 6.5 Cable/Satellite Tv 4.2 Casinos/Gaming 4.0 Specialty Telecommunications 3.6
LONG-TERM CREDIT ANALYSIS A/A and above 4.5% Baa/BBB 1.0 BB 19.5 B/B 50.4 CCC or Below 22.5 NR 2.1
DATA AS OF JUNE 30, 2005. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES FOR TOP FIVE INDUSTRIES ARE AS A PERCENTAGE OF NET ASSETS AND ALL PERCENTAGES FOR LONG-TERM CREDIT ANALYSIS ARE AS A PERCENTAGE OF TOTAL LONG-TERM 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 PORTFOLIO WILL NORMALLY INVEST AT LEAST 80% OF ITS ASSETS IN FIXED-INCOME SECURITIES (INCLUDING ZERO COUPON SECURITIES) RATED BELOW BAA BY MOODY'S INVESTORS SERVICE, INC. ("MOODY'S") OR BELOW BBB BY STANDARD & POOR'S RATINGS GROUP, A DIVISION OF THE MCGRAW HILL COMPANIES, INC. ("S&P") OR IN NON-RATED SECURITIES CONSIDERED BY THE PORTFOLIO'S INVESTMENT ADVISER TO BE APPROPRIATE INVESTMENTS FOR THE PORTFOLIO. SUCH SECURITIES MAY ALSO INCLUDE "RULE 144A" SECURITIES, WHICH ARE SUBJECT TO RESALE RESTRICTIONS. SHAREHOLDERS OF THE PORTFOLIO WILL RECEIVE AT LEAST 60 DAYS PRIOR NOTICE OF ANY CHANGES IN THIS POLICY. SECURITIES RATED BELOW BAA OR BBB ARE COMMONLY KNOWN AS "JUNK BONDS." THERE ARE NO MINIMUM QUALITY RATINGS FOR INVESTMENTS, AND AS SUCH THE PORTFOLIO MAY INVEST IN SECURITIES WHICH NO LONGER MAKE PAYMENTS OF INTEREST OR PRINCIPAL. FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY PORTFOLIO PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE PORTFOLIO'S SECOND AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY PORTFOLIO 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 PORTFOLIO'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 PORTFOLIO VOTED PROXIES RELATING TO PORTFOLIO SECURITIES DURING THE MOST RECENT TWELVE-MONTH PERIOD ENDED JUNE 30 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. 4 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED JUNE 30, 2005
CLASS X SHARES CLASS Y SHARES (SINCE 03/09/84) (SINCE 06/05/00) 1 YEAR 8.81%(3) 8.53%(3) 5 YEARS (9.51)(3) (9.78)(3) 10 YEARS (3.31)(3) -- SINCE INCEPTION 3.53(3) (9.60)(3)
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 THE 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 PORTFOLIO SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. THE PERFORMANCE OF THE PORTFOLIO'S TWO SHARE CLASSES VARIES BECAUSE EACH HAS DIFFERENT EXPENSES. THE PORTFOLIO'S TOTAL RETURN FIGURES ASSUME THE REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE IMPACT OF ANY CHARGES BY YOUR INSURANCE COMPANY. SUCH COSTS WOULD LOWER PERFORMANCE. (1) THE CREDIT SUISSE FIRST BOSTON (CSFB) HIGH YIELD INDEX IS DESIGNED TO MIRROR THE INVESTIBLE UNIVERSE OF THE $US-DENOMINATED HIGH YIELD DEBT MARKET. 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. THE PORTFOLIO'S BENCHMARK WAS CHANGED FROM THE LEHMAN BROTHERS U.S. CORPORATE HIGH YIELD INDEX TO THE CSFB HIGH YIELD INDEX TO MORE ACCURATELY REFLECT THE PORTFOLIO'S INVESTIBLE UNIVERSE. (2) THE LEHMAN BROTHERS U.S. CORPORATE HIGH YIELD INDEX TRACKS THE PERFORMANCE OF ALL BELOW INVESTMENT-GRADE SECURITIES WHICH HAVE AT LEAST $100 MILLION IN OUTSTANDING ISSUANCE, A MATURITY GREATER THAN ONE YEAR, AND ARE ISSUED IN FIXED-RATE U.S. DOLLAR DENOMINATIONS. 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) FIGURE ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS FOR THE UNDERLYING PORTFOLIO BASED ON NET ASSET VALUE (NAV). IT DOES NOT REFLECT THE DEDUCTION OF INSURANCE EXPENSES, AN ANNUAL CONTRACT MAINTENANCE FEE, OR SURRENDER CHARGES. 5 EXPENSE EXAMPLE As a shareholder of the Portfolio, you incur two types of costs: (1) insurance company charges; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Portfolio expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Portfolio 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 01/01/05 - 06/30/05. 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 Portfolio's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Portfolio'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 costs of investing in the Portfolio 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 insurance company charges. 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 insurance company charges were included, your costs would have been higher.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD* ------------- ------------- -------------- 01/01/05- 01/01/05 06/30/05 06/30/05 ------------- ------------- -------------- CLASS X Actual (0.38% return) $ 1,000.00 $ 1,003.80 $ 3.97 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,020.83 $ 4.01 CLASS Y Actual (0.25% return) $ 1,000.00 $ 1,002.50 $ 5.21 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,019.59 $ 5.26
- ---------- * EXPENSES ARE EQUAL TO THE PORTFOLIO'S ANNUALIZED EXPENSE RATIO OF 0.80% AND 1.05% 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 fixed income securities trading. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Portfolio's Administrator under the Administration Agreement, including accounting, clerical, bookkeeping, compliance, business management and planning, and the provision of supplies, office space and utilities. (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 administrative and investment advisory services to the Portfolio. 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 Portfolio. 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 The Board reviewed the Portfolio's performance for the one-, three- and five-year periods ended November 30, 2004, as shown in reports provided by Lipper (the "Lipper Reports"), compared to the performance of comparable funds selected by Lipper (the "performance peer group"), and noted that the Portfolio's performance was lower than its performance peer group average for all three periods. The Board discussed with the Adviser possible steps to improve performance. The Adviser informed the Board that, in an effort to try to improve performance, the Adviser appointed a new co-head of the Portfolio's investment team in early 2004, has tightened the investment process and implemented additional risk controls. The Board considered that relative performance had improved in the most recent one-year period and concluded that the actions taken by the Adviser were reasonably designed to improve performance. FEES RELATIVE TO OTHER FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT STRATEGIES The Board reviewed the advisory and administrative fees (together, the "management fee") paid by the Portfolio under the Management Agreement. The Board noted that the rate was comparable to the management fee rates charged by the Adviser to any other funds it manages with investment strategies comparable to those of the Portfolio. 7 FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS The Board reviewed the management fee rate and the total expense ratio of the Portfolio. The Board noted that: (i) the Portfolio's management fee rate was lower than the average management fee rate for funds, selected by Lipper (the "expense peer group"), managed by other advisers with investment strategies comparable to those of the Portfolio, as shown in the Lipper Report for the Portfolio; and (ii) the Portfolio's total expense ratio was also lower than the average total expense ratio of the funds included in the Portfolio's expense peer group. The Board concluded that the Portfolio's management fee 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 Portfolio's management fee schedule under the Management Agreement and noted that it includes breakpoints. The Board also reviewed the level of the Portfolio's management fee and noted that the fee, as a percentage of the Portfolio's net assets, would decrease as net assets increase because the management fee includes breakpoints. The Board concluded that the Portfolio's management fee would reflect economies of scale as assets increase. PROFITABILITY OF ADVISER AND AFFILIATES The Board considered and reviewed information concerning the costs incurred and profits realized by the Adviser and its affiliates during the last two years from their relationship with the Portfolio and the Morgan Stanley Fund Complex and reviewed with the Controller of the Adviser the cost allocation methodology used to determine the Adviser's profitability. Based on their review of the information they received, the Board concluded that the profits earned by the Adviser and its affiliates were not excessive in light of the advisory, administrative and other services provided to the Portfolio. FALL-OUT BENEFITS The Board considered so-called "fall-out benefits" derived by the Adviser and its affiliates from their relationship with the Portfolio and the Morgan Stanley Fund Complex, such as "float" benefits derived from handling of checks for purchases and redemptions of Portfolio shares through a broker-dealer affiliate of the Adviser. The Board also considered that a broker-dealer affiliate of the Adviser receives from the Portfolio 12b-1 fees for distribution and shareholder services. The Board concluded that the float benefits were relatively small and that the 12b-1 fees were competitive with those of other broker-dealer affiliates of investment advisers. 8 SOFT DOLLAR BENEFITS The Board considered whether the Adviser realizes any benefits from commissions paid to brokers who execute securities transactions for the Portfolio ("soft dollars"). The Board noted that the Portfolio invests only in fixed income securities, which do not generate soft dollars. ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE PORTFOLIO'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 PORTFOLIO AND THE ADVISER The Board also reviewed and considered the historical relationship between the Portfolio and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Portfolio'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 Portfolio 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 Portfolio'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 Portfolio's business. GENERAL CONCLUSION After considering and weighing all of the above factors, the Board concluded it would be in the best interest of the Portfolio and its shareholders to approve renewal of the Management Agreement for another year. 9 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- HIGH YIELD PORTFOLIO PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------------------------ CORPORATE BONDS (89.9%) ADVERTISING/MARKETING SERVICES (0.4%) $ 130 Interpublic Group of Companies, Inc. (The) 5.40% 11/15/09 $ 124,285 180 Interpublic Group of Companies, Inc. (The) 6.25 11/15/14 168,987 --------------- 293,272 --------------- AEROSPACE & DEFENSE (0.9%) 650 K&F Acquisition Inc. - 144A* 7.75 11/15/14 667,875 --------------- ALTERNATIVE POWER GENERATION (0.8%) 628 Ormat Funding Corp. 8.25 12/30/20 637,654 --------------- ALUMINUM (0.9%) 665 Novelis, Inc. - 144A* 7.25 02/15/15 670,819 --------------- APPAREL/FOOTWEAR (1.1%) 740 Levi Strauss & Co. 7.73 04/01/12 703,000 180 Oxford Industries, Inc. 8.875 06/01/11 193,500 --------------- 896,500 --------------- APPAREL/FOOTWEAR RETAIL (0.4%) 330 Brown Shoe Co., Inc. - 144A* 8.75 05/01/12 345,675 --------------- AUTO PARTS: O.E.M. (1.4%) 180 ArvinMeritor, Inc. 8.75 03/01/12 188,550 185 Lear Corp. (Series B) 8.11 05/15/09 191,455 220 Meritor Automotive Inc. 6.80 02/15/09 218,900 470 TRW Automotive, Inc. 9.375 02/15/13 522,875 --------------- 1,121,780 --------------- BROADCASTING (0.9%) 671 Canwest Media Inc. 8.00 09/15/12 709,584 --------------- BUILDING PRODUCTS (2.3%) 115 Interface Inc. 7.30 04/01/08 117,875 455 Interface Inc. 9.50 02/01/14 466,375 145 Interface Inc. 10.375 02/01/10 160,225 600 Nortek Inc. 8.50 09/01/14 561,000 590 NTK Holdings Inc. - 144A* 10.75## 03/01/14 280,250 235 PLY Gem Industries, Inc. 9.00 02/15/12 199,750 --------------- 1,785,475 --------------- CABLE/SATELLITE TV (4.2%) 270 Cablevision Systems Corp. (Series B) 7.89** 04/01/09 272,025 225 Charter Communications Holdings LLC 9.625 11/15/09 169,312 245 Charter Communications Holdings LLC 10.75 10/01/09 190,488
SEE NOTES TO FINANCIAL STATEMENTS 10
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------------------------ $ 325 Charter Communications Holdings/ Charter Capital 11.75##% 05/15/11 $ 216,937 245 Echostar DBS Corp. 6.375 10/01/11 244,081 330 Intelsat Bermuda Ltd. - 144A* 7.805** 01/15/12 337,425 45 Intelsat Bermuda Ltd. - 144A* 8.25 01/15/13 46,687 440 Intelsat Bermuda Ltd. - 144A* 8.625 01/15/15 466,400 715 Kabel Deutschland - 144A* (Germany) 10.625 07/01/14 779,350 170 Renaissance Media Group LLC 10.00 04/15/08 169,150 535 Telenet Group Holding NV - 144A* (Belgium) 11.50## 06/15/14 418,638 --------------- 3,310,493 --------------- CASINO/GAMING (4.0%) 4,485 Aladdin Gaming Holdings/Capital Corp. LLC (Series B) (a) (b) (f) 13.50 03/01/10 0 600 Harrah's Operating Co., Inc. 7.875 12/15/05 610,500 605 Isle of Capri Casinos 7.00 03/01/14 611,050 1,225 MGM Mirage Inc. 6.00 10/01/09 1,237,250 7,210 Resort At Summerlin LP/Ras Co. (Series B) (a) (b) (f) 13.00# 12/15/07 0 700 Station Casinos, Inc. 6.00 04/01/12 714,000 --------------- 3,172,800 --------------- CHEMICALS: AGRICULTURAL (0.0%) 8 IMC Global Inc. (Series B) 10.875 06/01/08 9,040 --------------- CHEMICALS: MAJOR DIVERSIFIED (0.8%) 175 Huntsman Advanced Materials Corp. - 144A* 11.00 07/15/10 198,625 437 Huntsman ICI Chemicals 10.125 07/01/09 451,749 --------------- 650,374 --------------- CHEMICALS: SPECIALTY (6.9%) 490 Equistar Chemical Funding 10.125 09/01/08 532,875 185 Equistar Chemical Funding 10.625 05/01/11 205,119 410 Innophos Inc. - 144A* 8.875 08/15/14 420,250 209 Innophos Inc. - 144A* 10.771 02/15/15 193,743 200 ISP Chemco 10.25 07/01/11 219,000 750 ISP Holdings Inc. (Series B) 10.625 12/15/09 810,000 135 Koppers Industry Inc. 9.875 10/15/13 146,475 375 Lyondell Chemical Co. 10.50 06/01/13 430,781 180 Millennium America, Inc. 7.00 11/15/06 184,950 318 Millennium America, Inc. 9.25 06/15/08 345,825
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PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------------------------ $ 165 Nalco Co. 7.75% 11/15/11 $ 176,550 625 Nalco Co. 8.875 11/15/13 673,437 430 Rhodia SA (France) 8.875 06/01/11 416,025 600 Rockwood Specialties, Inc. 10.625 05/15/11 664,500 --------------- 5,419,530 --------------- COAL (0.2%) 140 Foundation PA Coal Co. 7.25 08/01/14 147,700 --------------- CONSTRUCTION MATERIALS (0.5%) 435 RMCC Acquisition Co. - 144A* 9.50 11/01/12 417,600 --------------- CONSUMER SUNDRIES (0.3%) 280 Amscan Holdings, Inc. 8.75 05/01/14 257,600 --------------- CONTAINERS/PACKAGING (3.0%) 215 Graham Packaging Company Inc. - 144A* 8.50 10/15/12 218,225 415 Graham Packaging Company Inc. - 144A* 9.875 10/15/14 418,112 555 Graphic Packaging International Corp. 9.50 08/15/13 561,937 400 Owens-Brockway Glass Containers Corp. 8.75 11/15/12 443,000 60 Owens-Illinois Inc. 7.35 05/15/08 62,550 285 Owens-Illinois Inc. 7.50 05/15/10 300,675 135 Pliant Corp. (Issued 04/10/02) 13.00 06/01/10 110,025 290 Pliant Corp. (Issued 08/29/00) 13.00 06/01/10 236,350 --------------- 2,350,874 --------------- DRUGSTORE CHAINS (1.4%) 150 Jean Coutu Group PJC Inc. (Canada) 7.625 08/01/12 155,625 635 Jean Coutu Group PJC Inc. (Canada) 8.50 08/01/14 630,237 305 Rite Aid Corp. 8.125 05/01/10 315,675 --------------- 1,101,537 --------------- ELECTRIC UTILITIES (5.8%) 370 AES Corp. (The) 7.75 03/01/14 403,300 42 AES Corp. (The) 8.875 02/15/11 47,040 54 AES Corp. (The) 9.375 09/15/10 61,425 150 AES Corp. (The) - 144A* 9.00 05/15/15 169,125 300 Allegheny Energy, Inc. 7.75 08/01/05 301,050 50 CMS Energy Corp. 7.50 01/15/09 52,875 510 CMS Energy Corp. 8.50 04/15/11 571,200 115 IPALCO Enterprises, Inc. 8.625 11/14/11 129,950 365 Monongahela Power Co. 5.00 10/01/06 368,064 415 MSW Energy Holdings/Finance 7.375 09/01/10 427,450 80 MSW Energy Holdings/Finance 8.50 09/01/10 85,000
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PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------------------------ $ 290 Nevada Power Co. 8.25% 06/01/11 $ 328,425 405 Nevada Power Co. 9.00 08/15/13 457,650 25 PSEG Energy Holdings Inc. 7.75 04/16/07 25,938 320 PSEG Energy Holdings Inc. 8.625 02/15/08 341,600 470 Reliant Energy, Inc. 6.75 12/15/14 461,775 325 TNP Enterprises, Inc. 10.25 04/01/10 343,038 --------------- 4,574,905 --------------- ELECTRICAL PRODUCTS (1.0%) 610 Rayovac Corp. 8.50 10/01/13 640,500 135 Rayovac Corp. - 144A* 7.375 02/01/15 131,288 --------------- 771,788 --------------- ELECTRONIC COMPONENTS (0.6%) 525 Sanmina-SCI Corp. - 144A* 6.75 03/01/13 504,000 --------------- ENVIRONMENTAL SERVICES (1.3%) 190 Allied Waste North America, Inc. 6.375 04/15/11 183,350 355 Allied Waste North America, Inc. 7.875 04/15/13 364,762 55 Allied Waste North America, Inc. 8.50 12/01/08 57,956 9 Allied Waste North America, Inc. 9.25 09/01/12 9,765 280 Allied Waste North America, Inc. - 144A* 7.25 03/15/15 272,300 95 Allied Waste North America, Inc. (Series B) 8.875 04/01/08 100,225 --------------- 988,358 --------------- FINANCIAL CONGLOMERATES (0.8%) 75 General Motors Acceptance Corp. 6.875 09/15/11 69,316 585 General Motors Acceptance Corp. 6.875 08/28/12 536,251 --------------- 605,567 --------------- FOOD RETAIL (0.8%) 218 CA FM Lease Trust - 144A* 8.50 07/15/17 249,511 350 Delhaize America, Inc. 8.125 04/15/11 394,304 --------------- 643,815 --------------- FOOD: MAJOR DIVERSIFIED (0.0%) 1 Dole Food Company, Inc. 8.875 03/15/11 1,072 --------------- FOOD: MEAT/FISH/DAIRY (2.8%) 325 Michael Foods Inc. (Series B) 8.00 11/15/13 332,312 710 Pilgrim's Pride Corp. 9.625 09/15/11 779,225 265 PPC Escrow Corp. 9.25 11/15/13 295,475 130 Smithfield Foods Inc. 7.00 08/01/11 137,475 75 Smithfield Foods Inc. 7.75 05/15/13 82,125
SEE NOTES TO FINANCIAL STATEMENTS 13
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------------------------ $ 535 Smithfield Foods Inc. (Series B) 8.00% 10/15/09 $ 580,475 --------------- 2,207,087 --------------- FOREST PRODUCTS (0.9%) EUR 200 Crown Euro Holdings SA (France) 6.25 09/01/11 255,978 $ 70 Tembec Industries Inc. (Canada) 7.75 03/15/12 51,800 475 Tembec Industries Inc. (Canada) 8.50 02/01/11 369,313 --------------- 677,091 --------------- GAS DISTRIBUTORS (1.1%) 380 Dynegy Holdings, Inc. 6.875 04/01/11 377,150 425 Dynegy Holdings, Inc. - 144A* 9.875 07/15/10 471,750 45 Northwest Pipeline Corp. 8.125 03/01/10 49,050 --------------- 897,950 --------------- HOME BUILDING (1.0%) 80 Tech Olympic USA, Inc. 7.50 01/15/15 72,400 300 Tech Olympic USA, Inc. 10.375 07/01/12 315,000 355 Tech Olympic USA, Inc. (Issued 02/03/03) 9.00 07/01/10 366,981 70 Tech Olympic USA, Inc. (Issued 11/27/02) 9.00 07/01/10 72,363 --------------- 826,744 --------------- HOME FURNISHINGS (0.2%) 165 Tempur-Pedic Inc. 10.25 08/15/10 182,325 --------------- HOSPITAL/NURSING MANAGEMENT (1.5%) 335 Community Health System Inc. 6.50 12/15/12 342,537 405 Medcath Holdings Corp. 9.875 07/15/12 454,612 125 Tenet Healthcare Corp. 7.375 02/01/13 124,063 210 Tenet Healthcare Corp. 9.875 07/01/14 226,275 --------------- 1,147,487 --------------- HOTELS/RESORTS/CRUISELINES (0.3%) 190 Starwood Hotels & Resorts Worldwide, Inc. 7.875 05/01/12 215,175 --------------- HOUSEHOLD/PERSONAL CARE (0.2%) 175 Del Laboratories, Inc. 8.00 02/01/12 151,375 --------------- INDUSTRIAL MACHINERY (1.0%) 120 Flowserve Corp. 12.25 08/15/10 130,200 140 Goodman Global Holding Company, Inc. - 144A* 6.41** 06/15/12 138,600 580 Goodman Global Holding Company, Inc. - 144A* 7.875 12/15/12 539,400 --------------- 808,200 ---------------
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PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------------------------ INDUSTRIAL SPECIALTIES (1.3%) $ 560 Johnsondiversy, Inc. 9.625% 05/15/12 $ 571,200 405 UCAR Finance, Inc. 10.25 02/15/12 428,288 --------------- 999,488 --------------- INVESTMENT BANKS/BROKERS (0.9%) 670 Refco Finance Holdings 9.00 08/01/12 713,550 --------------- INVESTMENT MANAGERS (0.4%) 315 JSG Funding PLC (Ireland) 9.625 10/01/12 316,575 --------------- MEDICAL DISTRIBUTORS (0.5%) 95 AmerisourceBergen Corp. 7.25 11/15/12 105,094 290 AmerisourceBergen Corp. 8.125 09/01/08 316,100 --------------- 421,194 --------------- MEDICAL SPECIALTIES (0.4%) 155 Fisher Scientific International, Inc. 6.75 08/15/14 162,750 180 Fisher Scientific International, Inc. - 144A* 6.125 07/01/15 181,125 --------------- 343,875 --------------- MEDICAL/NURSING SERVICES (1.3%) 330 DaVita Inc. - 144A* 6.625 03/15/13 342,375 570 Fresenius Medical Care Capital Trust 7.875 06/15/11 615,600 80 National Nephrology Assoc. Inc. - 144A* 9.00 11/01/11 90,200 --------------- 1,048,175 --------------- METAL FABRICATIONS (1.4%) 215 General Cable Corp. 9.50 11/15/10 231,125 380 Hexcell Corp. 6.75 02/01/15 381,900 580 Trimas Corp. 9.875 06/15/12 490,100 --------------- 1,103,125 --------------- MISCELLANEOUS COMMERCIAL SERVICES (2.1%) 75 Advanstar Communications, Inc. 10.75 08/15/10 82,312 501 Advanstar Communications, Inc. 10.768** 08/15/08 537,653 295 Iron Mountain Inc. 7.75 01/15/15 297,950 585 Iron Mountain Inc. 8.625 04/01/13 608,400 215 Vertis Inc. - 144A* 13.50 12/07/09 161,519 --------------- 1,687,834 --------------- MISCELLANEOUS MANUFACTURING (1.4%) 1,225 Associated Materials Inc. 11.25## 03/01/14 784,000 330 Propex Fabrics Inc. 10.00 12/01/12 315,150 --------------- 1,099,150 ---------------
SEE NOTES TO FINANCIAL STATEMENTS 15
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------------------------ MOVIES/ENTERTAINMENT (0.4%) $ 285 AMC Entertainment Inc. 7.518% 08/15/10 $ 296,044 --------------- OIL & GAS PIPELINES (3.2%) 950 El Paso Production Holdings 7.75 06/01/13 1,018,875 375 Pacific Energy Partners/Finance 7.125 06/15/14 392,344 155 Southern Natural Gas 8.875 03/15/10 170,799 835 Williams Companies, Inc. (The) 7.875 09/01/21 953,988 --------------- 2,536,006 --------------- OIL & GAS PRODUCTION (3.0%) 570 Chesapeake Energy Corp. 7.50 09/15/13 619,875 28 Chesapeake Energy Corp. 7.75 01/15/15 30,380 185 Chesapeake Energy Corp. - 144A* 6.625 01/15/16 191,937 575 Hilcorp Energy/Finance - 144A* 10.50 09/01/10 638,250 140 Magnum Hunter Resources, Inc. 9.60 03/15/12 156,100 275 Plains E & P Corp. 7.125 06/15/14 295,625 385 Vintage Petroleum, Inc. 7.875 05/15/11 408,100 --------------- 2,340,267 --------------- OIL REFINING/MARKETING (1.3%) 390 CITGO Petroleum Corp. 6.00 10/15/11 390,975 345 Husky Oil Ltd. 8.90 08/15/28 383,230 255 Tesoro Petroleum Corp. 9.625 04/01/12 283,369 --------------- 1,057,574 --------------- OILFIELD SERVICES/EQUIPMENT (1.3%) 175 CIE Generale de Geophysique SA - 144A* 7.50 05/15/15 183,312 135 Hanover Compressor Co. 8.625 12/15/10 143,437 185 Hanover Compressor Co. 9.00 06/01/14 197,950 300 Hanover Equipment Trust 2001 A (Series A) 8.50 09/01/08 313,500 210 Hanover Equipment Trust 2001 B (Series B) 8.75 09/01/11 224,175 --------------- 1,062,374 --------------- OTHER METALS/MINERALS (0.0%) 355 Murrin Holdings Property Ltd. (Australia)(b)(f) 9.375 08/31/07 0 --------------- OTHER TRANSPORTATION (1.0%) 470 CHC Helicopter Corp. 7.375 05/01/14 471,175 330 CHC Helicopter Corp. - 144A* 7.375 05/01/14 330,825 --------------- 802,000 ---------------
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PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------------------------ PHARMACEUTICALS: MAJOR (1.1%) $ 200 VWR International Inc. 6.875% 04/15/12 $ 198,000 250 VWR International Inc. 8.00 04/15/14 239,375 400 Warner Chilcott Corp. - 144A* 8.75 02/01/15 391,000 --------------- 828,375 --------------- PUBLISHING: BOOKS/MAGAZINES (2.7%) 206 Dex Media East/Finance 12.125 11/15/12 247,715 327 Dex Media West/Finance 9.875 08/15/13 374,415 60 Houghton Mifflin Co. 8.25 02/01/11 62,550 515 Houghton Mifflin Co. 9.875 02/01/13 552,337 290 Houghton Mifflin Co. 11.50## 10/15/13 213,150 640 PRIMEDIA, Inc. 8.875 05/15/11 673,600 --------------- 2,123,767 --------------- PULP & PAPER (1.8%) 315 Abitibi-Consolidated Inc. (Canada) 6.00 06/20/13 291,375 215 Abitibi-Consolidated Inc. (Canada) 7.75 06/15/11 217,150 830 Georgia-Pacific Corp. 8.875 02/01/10 946,200 --------------- 1,454,725 --------------- REAL ESTATE INVESTMENT TRUSTS (0.8%) 57 HMH Properties, Inc. (Series B) 7.875 08/01/08 58,140 540 Host Marriott LP - 144A* 6.375 03/15/15 537,300 --------------- 595,440 --------------- SPECIALTY STORES (2.2%) 130 Autonation, Inc. 9.00 08/01/08 142,675 480 General Nutrition Centers Inc. 8.50 12/01/10 386,400 580 Petro Stopping Centers LP/Petro Financial Corp. 9.00 02/15/12 585,800 635 Sonic Automotive, Inc. 8.625 08/15/13 644,525 --------------- 1,759,400 --------------- SPECIALTY TELECOMMUNICATIONS (3.6%) 320 American Tower Corp. 7.125 10/15/12 340,000 310 American Tower Corp. 7.50 05/01/12 332,475 98 Panamsat Corp. 9.00 08/15/14 107,433 735 Panamsat Holding Corp. 10.375## 11/01/14 508,988 445 Qwest Communications International 6.768 02/15/09 439,438 745 Qwest Services Corp. 13.50 12/15/10 864,200 145 Qwest Services Corp. 14.00 12/15/14 176,538
SEE NOTES TO FINANCIAL STATEMENTS 17
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------------------------ $ 100 U.S. West Communications Corp. 5.625% 11/15/08 $ 98,750 --------------- 2,867,822 --------------- STEEL (1.4%) 605 Amsted Industries Inc. - 144A* 10.25 10/15/11 656,425 415 United States Steel Corp. 9.75 05/15/10 450,275 --------------- 1,106,700 --------------- TELECOMMUNICATION EQUIPMENT (0.6%) 450 Nortel Networks Ltd. 6.125 02/15/06 455,063 --------------- TELECOMMUNICATIONS (0.8%) 550 Axtel SA (Mexico) 11.00 12/15/13 602,250 623 Exodus Communications, Inc. (a) (b) (f) 11.625 07/15/10 0 4,679 Rhythms Netconnections, Inc. (a) (b) (f) 12.75 04/15/09 0 --------------- 602,250 --------------- TRUCKS/CONSTRUCTION/FARM MACHINERY (1.4%) 110 Commercial Vehicle Group Inc. - 144A* 8.00 07/01/13 112,337 347 Manitowoc Inc. (The) 10.50 08/01/12 393,845 520 NMHG Holding Co. 10.00 05/15/09 548,600 --------------- 1,054,782 --------------- WHOLESALE DISTRIBUTORS (1.4%) 510 Buhrmann US, Inc. 8.25 07/01/14 512,550 160 Buhrmann US, Inc. - 144A* 7.875 03/01/15 156,800 425 Nebraska Book Company, Inc. 8.625 03/15/12 398,438 --------------- 1,067,788 --------------- WIRELESS TELECOMMUNICATIONS (2.5%) 280 Rogers Wireless Communications Inc. 7.50 03/15/15 305,900 430 Rural Cellular Corp. 7.91** 03/15/10 445,050 305 SBA Communications Corp. 8.50 12/01/12 330,163 473 SBA Communications Corp. 9.75## 12/15/11 437,525 415 Ubiquitel Operating Co. 9.875 03/01/11 457,538 --------------- 1,976,176 --------------- TOTAL CORPORATE BONDS (COST $86,397,094) 70,888,640 ---------------
SEE NOTES TO FINANCIAL STATEMENTS 18
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS (d) (1.5%) APPAREL/FOOTWEAR RETAIL (0.0%) 1,310,596 County Seat Stores Corp. (c) (f) $ 0 --------------- CASINO/GAMING (0.0%) 2,000 Fitzgeralds Gaming Corp.+ (f) 0 FOOD: SPECIALTY/CANDY (0.0%) 2,375 SFAC New Holdings Inc. (c) ++ (f) 0 436 SFAC New Holdings Inc. (c) (f) 0 120,000 Specialty Foods Acquisition Corp. - 144A* (f) 0 --------------- 0 --------------- HOTELS/RESORTS/CRUISELINES (0.0%) 444,351 Premier Holdings Inc. (c) +++ (f) 0 --------------- MEDICAL/NURSING SERVICES (0.0%) 418,663 Raintree Healthcare Corp. (c) (f) 0 --------------- OIL & GAS PRODUCTION (0.2%) 7,568 Chesapeake Energy Corp. (c) 172,550 --------------- RESTAURANTS (0.3%) 37,167 American Restaurant Group Holdings, Inc.(c) (f) 0 4,366 American Restaurant Group Holdings, Inc. (f) 0 7,750 American Restaurant Group Holdings, Inc. - 144A* (f) 0 92,158 Catalina Restaurant Group (c) (f) 223,944 --------------- 223,944 --------------- SPECIALTY TELECOMMUNICATIONS (0.0%) 12,688 Birch Telecom Inc. (c) (f) 127 131,683 PFB Telecom NV (Series B) (c) (f) 0 --------------- 127 --------------- TELECOMMUNICATIONS (0.0%) 2,251 Viatel Holdings Bermuda Ltd. (c) 158 --------------- TEXTILES (0.0%) 298,461 U.S. Leather, Inc. (c) (f) 0 --------------- WIRELESS TELECOMMUNICATIONS (1.0%) 11,692 NII Holdings, Inc. (Class B)* (c) 747,586 521 USA Mobility, Inc. (c) 15,297 38,444 Vast Solutions, Inc. (Class B1) (c) (f) 0 38,444 Vast Solutions, Inc. (Class B2) (c) (f) 0 38,444 Vast Solutions, Inc. (Class B3) (c) (f) 0 --------------- 762,883 --------------- TOTAL COMMON STOCK (COST $63,679,794) 1,159,662 ---------------
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PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------------------------ CONVERTIBLE BONDS (0.5%) HOTELS/RESORTS/CRUISELINES (0.0%) $ 742 Premier Cruises Ltd. - 144A* (a) (b) (f) 10.00#% 08/15/05 $ 0 --------------- TELECOMMUNICATION EQUIPMENT (0.5%) 450 Nortel Networks Corp. (Canada) 4.25 09/01/08 421,875 --------------- TOTAL CONVERTIBLE BONDS (COST $1,174,539) 421,875 --------------- NUMBER OF SHARES - ------------ NON-CONVERTIBLE PREFERRED STOCKS (1.0%) BROADCASTING (0.1%) 14 Paxson Communications Corp.# 92,916 --------------- ELECTRIC UTILITIES (0.7%) 466 TNP Enterprises, Inc. (Series D) # 528,910 --------------- RESTAURANTS (0.2%) 187 Catalina Restaurant Group (Units)^ (f) 167,921 --------------- TOTAL CONVERTIBLE PREFERRED STOCKS (COST $796,970) 789,747 --------------- EXPIRATION DATE --------------- WARRANTS (d) (0.0%) CASINO/GAMING (0.0%) 83,500 Aladdin Gaming Enterprises, Inc. - 144A* (f) 03/01/10 0 6,000 Resort At Summerlin LP - 144A* (f) 12/15/07 0 --------------- 0 --------------- PERSONNEL SERVICES (0.0%) 42,250 Comforce Corp. - 144A* (f) 12/01/09 0 --------------- RESTAURANTS (0.0%) 1,500 American Restaurant Group Holdings, Inc. - 144A* (f) 08/15/08 0 39,250 Catalina Restaurant Group (c) (f) 07/10/12 0 --------------- 0 --------------- TOTAL WARRANTS (COST $127,660) 0 ---------------
SEE NOTES TO FINANCIAL STATEMENTS 20
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------------------------ SHORT-TERM INVESTMENTS (4.4%) REPURCHASE AGREEMENT $ 3,441 The Bank of New York (dated 06/30/05; proceeds $3,441,227) (e) (COST $3,440,928) 3.125% 07/01/05 $ 3,440,928 --------------- TOTAL INVESTMENTS (COST $155,616,985)(g) 97.3% 76,700,852 OTHER ASSETS IN EXCESS OF LIABILITIES 2.7 2,161,467 --------------- --------------- NET ASSETS 100.0% $ 78,862,319 =============== ===============
- ---------- * RESALE IS RESTRICTED TO QUALIFIED INSTITUTIONAL INVESTORS. ** FLOATING RATE SECURITY. RATE SHOWN IS THE RATE IN EFFECT AT JUNE 30, 2005. + RESALE IS RESTRICTED; ACQUIRED (12/22/98) AT A COST BASIS OF $9,020. ++ RESALE IS RESTRICTED; ACQUIRED (06/10/99) AT A COST BASIS OF $24. +++ RESALE IS RESTRICTED; ACQUIRED (BETWEEN 03/06/98 AND 07/12/99) AT A COST BASIS OF $5,493,079. # PAYMENT-IN-KIND SECURITY. ## CURRENTLY A ZERO COUPON BOND AND IS SCHEDULED TO PAY INTEREST AT THE RATE SHOWN AT A FUTURE SPECIFIED DATE. ^ CONSISTS OF ONE OR MORE CLASS OF SECURITIES TRADED TOGETHER AS A UNIT; PREFERRED STOCKS WITH ATTACHED WARRANTS. (a) ISSUER IN BANKRUPTCY. (b) NON-INCOME PRODUCING SECURITY; BOND IN DEFAULT. (c) ACQUIRED THROUGH EXCHANGE OFFER. (d) NON-INCOME PRODUCING SECURITIES. (e) COLLATERALIZED BY FEDERAL NATIONAL MORTGAGE ASSOCIATION 4.126% DUE 07/01/18 VALUED AT $3,509,747. (f) SECURITIES WITH TOTAL MARKET VALUE EQUAL TO $391,865 HAVE BEEN VALUED AT THEIR FAIR VALUE AS DETERMINED IN GOOD FAITH UNDER PROCEDURES ESTABLISHED BY AND UNDER THE GENERAL SUPERVISION OF THE PORTFOLIO'S TRUSTEES. (g) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES APPROXIMATES THE AGGREGATE COST FOR BOOK PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION IS $3,202,350 AND THE AGGREGATE GROSS UNREALIZED DEPRECIATION IS $82,118,483, RESULTING IN NET UNREALIZED DEPRECIATION OF $78,916,133. FORWARD FOREIGN CURRENCY CONTRACT OPEN AT JUNE 30, 2005:
CONTRACTS TO DELIVERY UNREALIZED DELIVER IN EXCHANGE FOR DATE APPRECIATION - ------------------------------------------------------------------------------------------------------------ EUR 220,000 $ 266,495 7/26/2005 $ 21,994
CURRENCY ABBREVIATION: EUR EURO. SEE NOTES TO FINANCIAL STATEMENTS 21 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- HIGH YIELD PORTFOLIO FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 2005 (UNAUDITED) ASSETS: Investments in securities, at value (cost $155,616,985) $ 76,700,852 Unrealized appreciation on open forward foreign currency contracts 21,994 Receivable for: Interest 1,420,213 Investments sold 1,272,657 Prepaid expenses and other assets 25,138 --------------- TOTAL ASSETS 79,440,854 --------------- LIABILITIES: Payable for: Investments purchased 493,845 Investment advisory fee 27,102 Distribution fee 7,788 Administration fee 5,162 Shares of beneficial interest redeemed 47 Accrued expenses and other payables 44,591 --------------- TOTAL LIABILITIES 578,535 --------------- NET ASSETS $ 78,862,319 =============== COMPOSITION OF NET ASSETS: Paid-in-capital $ 395,899,543 Net unrealized depreciation (78,894,409) Accumulated net investment loss (60,884) Accumulated net realized loss (238,081,931) --------------- NET ASSETS $ 78,862,319 =============== CLASS X SHARES: Net Assets $ 40,865,855 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 35,221,955 NET ASSET VALUE PER SHARE $ 1.16 =============== CLASS Y SHARES: Net Assets $ 37,996,464 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 32,712,503 NET ASSET VALUE PER SHARE $ 1.16 ===============
SEE NOTES TO FINANCIAL STATEMENTS 22 STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2005 (UNAUDITED) NET INVESTMENT INCOME: INCOME Interest $ 2,963,856 Dividends 71,557 --------------- TOTAL INCOME 3,035,413 --------------- EXPENSES Investment advisory fee 171,951 Professional fees 93,846 Distribution fee (Class Y shares) 47,966 Administration fee 32,752 Shareholder reports and notices 9,670 Custodian fees 6,804 Trustees' fees and expenses 559 Transfer agent fees and expenses 250 Other 9,927 --------------- TOTAL EXPENSES 373,725 --------------- NET INVESTMENT INCOME 2,661,688 --------------- NET REALIZED AND UNREALIZED GAIN (LOSS): NET REALIZED LOSS ON: Investments (706,441) Foreign exchange transactions (706) --------------- Net Realized Loss (707,147) --------------- NET CHANGE IN UNREALIZED APPRECIATION/DEPRECIATION ON: Investments (2,014,381) Translation of forward foreign currency contracts, other assets and liabilities denominated in foreign currencies 21,724 --------------- NET DEPRECIATION (1,992,657) --------------- NET LOSS (2,699,804) --------------- NET DECREASE $ (38,116) ===============
SEE NOTES TO FINANCIAL STATEMENTS 23 STATEMENT OF CHANGES IN NET ASSETS
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 --------------- ----------------- (UNAUDITED) INCREASE (DECREASE) IN NET ASSETS: OPERATIONS: Net investment income $ 2,661,688 $ 6,650,548 Net realized loss (707,147) (23,213,309) Net change in unrealized appreciation (1,992,657) 25,141,012 --------------- ----------------- NET INCREASE (DECREASE) (38,116) 8,578,251 --------------- ----------------- DIVIDENDS TO SHAREHOLDERS FROM NET INVESTMENT INCOME Class X shares (1,626,950) (3,915,838) Class Y shares (1,397,549) (2,808,283) --------------- ----------------- TOTAL DIVIDENDS (3,024,499) (6,724,121) --------------- ----------------- Net decrease from transactions in shares of beneficial interest (6,611,806) (4,785,721) --------------- ----------------- NET DECREASE (9,674,421) (2,931,591) NET ASSETS: Beginning of period 88,536,740 91,468,331 --------------- ----------------- END OF PERIOD (INCLUDING AN ACCUMULATED NET INVESTMENT LOSS OF $60,884 AND ACCUMULATED UNDISTRIBUTED INVESTMENT INCOME OF $301,927, RESPECTIVELY) $ 78,862,319 $ 88,536,740 =============== ===============
SEE NOTES TO FINANCIAL STATEMENTS 24 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- HIGH YIELD PORTFOLIO NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) 1. ORGANIZATION AND ACCOUNTING POLICIES Morgan Stanley Variable Investment Series (the "Fund") -- High Yield Portfolio (the "Portfolio"), one of 15 separate portfolios, is registered under the Investment Company Act of 1940, as amended (the "Act"), as a diversified, open-end management investment company. The Fund is offered exclusively to life insurance companies in connection with particular life insurance and/or annuity contracts they offer. The Portfolio's primary investment objective is to earn a high level of current income and, as a secondary objective, capital appreciation, but only when consistent with its primary objective. The Fund was organized as a Massachusetts business trust on February 25, 1983 and the Portfolio commenced operations on March 9, 1984. On June 5, 2000, the Portfolio commenced offering one additional class of shares (Class Y). The Portfolio offers Class X shares and Class Y shares. The two are identical except that Class Y shares incur distribution expenses. Class X shares are generally available to holders of contracts offered by Metropolitan Life Insurance Company (formerly Paragon Life Insurance Company) and other contracts offered before May 1, 2000. Class Y shares are available to holders of contracts offered on or after June 5, 2000. 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) when market quotations are not readily available or Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") determines that the latest sale price, the bid price or the mean between the last reported bid and asked price do not reflect a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees. Occasionally, developments affecting the closing prices of securities and other assets may occur between the times at which valuations of such securities are determined (that is, close of the foreign market on which the securities trade) and the close of business on the NYSE. If developments occur during such periods that are expected to materially affect the value of such securities, such valuations may be adjusted to reflect 25 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; (6) certain portfolio securities may be valued by an outside pricing service approved by the Fund's Trustees; and (7) 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 except where collection is not expected. C. REPURCHASE AGREEMENTS -- The Fund may 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. FOREIGN CURRENCY TRANSLATION AND FORWARD FOREIGN CURRENCY CONTRACTS -- The books and records of the Portfolio 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 Portfolio 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 Portfolio 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. 26 F. 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. G. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS-- Dividends and distributions to shareholders are recorded on the ex-dividend date. H. EXPENSES -- Direct expenses are charged to the Portfolio and general Fund expenses are allocated on the basis of relative net assets or equally among the Portfolios. I. 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, the Portfolio pays the Investment Adviser an advisory fee, accrued daily and payable monthly, by applying the following annual rates to the net assets of the Portfolio determined at the close of each business day: 0.42% to the portion of daily net assets not exceeding $500 million; 0.345% to the portion of daily net assets exceeding $500 million but not exceeding $750 million; 0.295% to the portion of daily net assets exceeding $750 million but not exceeding $1 billion; 0.27% to the portion of daily net assets exceeding $1 billion but not exceeding $2 billion; 0.245% to the portion of daily net assets exceeding $2 billion but not exceeding $3 billion; and 0.22% to the portion of daily net assets in excess of $3 billion. Pursuant to an Administration Agreement with Morgan Stanley Services Company Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Portfolio pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.08% to the Portfolio'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. Under the Plan, Class Y shares of the Portfolio will pay a distribution fee which is accrued daily and paid monthly at the annual rate of 0.25% of the average daily net assets of the class. 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 June 30, 2005, aggregated $19,442,511 and $27,235,276, respectively. 27 Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and Distributor, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and compensation. Aggregate pension costs for the six months ended June 30, 2005 included in Trustees' fees and expenses in the Statement of Operations amounted to $74. At June 30, 2005, the Portfolio had an accrued pension liability of $3,874 which is included in accrued expenses in the Statement of Assets and Liabilities. On December 2, 2003, the Trustees voted to close the plan to new participants and eliminate the future benefits growth due to increases to compensation after July 31, 2003. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 5. SHARES OF BENEFICIAL INTEREST Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 ---------------------------------- ---------------------------------- (UNAUDITED) SHARES AMOUNT SHARES AMOUNT --------------- --------------- --------------- --------------- CLASS X SHARES Sold 6,089,039 $ 7,168,315 20,351,555 $ 24,061,769 Reinvestment of dividends 1,392,986 1,626,950 3,326,755 3,915,838 Redeemed (12,969,977) (15,283,678) (30,636,027) (36,202,065) --------------- --------------- --------------- --------------- Net decrease -- Class X (5,487,952) (6,488,413) (6,957,717) (8,224,458) --------------- --------------- --------------- --------------- CLASS Y SHARES Sold 2,227,313 2,643,227 10,578,269 12,518,844 Reinvestment of dividends 1,196,152 1,397,549 2,383,798 2,808,283 Redeemed (3,536,249) (4,164,169) (10,092,725) (11,888,390) --------------- --------------- --------------- --------------- Net increase (decrease) -- Class Y (112,784) (123,393) 2,869,342 3,438,737 --------------- --------------- --------------- --------------- Net decrease in Portfolio (5,600,736) $ (6,611,806) (4,088,375) $ (4,785,721) =============== =============== =============== ===============
28 6. 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 December 31, 2004, the Portfolio had a net capital loss carryforward of approximately $237,376,000 of which $2,735,000 will expire on December 31, 2006, $10,786,000 will expire on December 31, 2007, $7,524,000 will expire on December 31, 2008, $47,273,000 will expire on December 31, 2009, $63,495,000 will expire on December 31, 2010, $81,458,000 will expire on December 31, 2011 and $24,105,000 will expire on December 31, 2012 to offset future capital gains to the extent provided by regulations. As of December 31, 2004, the Portfolio had temporary book/tax differences primarily attributable to capital loss deferrals on wash sales, book amortization of discounts on debt securities and income on bonds in default. 7. PURPOSES OF AND RISKS RELATING TO CERTAIN FINANCIAL INSTRUMENTS The Portfolio may enter into forward contracts to facilitate settlement of foreign currency denominated portfolio transactions or to manage foreign currency exposure associated with foreign currency denominated securities. Forward contracts involve elements of market risk in excess of the amounts reflected in the Statement of Assets and Liabilities. The Portfolio bears the risk of an unfavorable change in the foreign exchange rates underlying the forward contracts. Risks may also arise upon entering into these contracts from the potential inability of the counterparties to meet the terms of their contracts. 29 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- HIGH YIELD PORTFOLIO FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ----------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- --------- --------- --------- --------- --------- (UNAUDITED) CLASS X SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 1.20 $ 1.18 $ 1.03 $ 1.33 $ 2.43 $ 4.33 --------- --------- --------- --------- --------- --------- Income (loss) from investment operations: Net investment income^ 0.04 0.09 0.16 0.26 0.33 0.66 Net realized and unrealized gain (loss) (0.04) 0.02 0.10 (0.34) (1.09) (1.90) --------- --------- --------- --------- --------- --------- Total income (loss) from investment operations 0.00 0.11 0.26 (0.08) (0.76) (1.24) --------- --------- --------- --------- --------- --------- Less dividends and distributions from: Net investment income (0.04) (0.09) (0.11) (0.22) (0.34) (0.66) Net realized gain - - - - - - --------- --------- --------- --------- --------- --------- Total dividends and distributions (0.04) (0.09) (0.11) (0.22) (0.34) (0.66) --------- --------- --------- --------- --------- --------- Net asset value, end of period $ 1.16 $ 1.20 $ 1.18 $ 1.03 $ 1.33 $ 2.43 ========= ========= ========= ========= ========= ========= TOTAL RETURN# 0.38%(2) 9.84% 27.73% (7.14)% (33.75)% (32.22)% RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.80%(3) 0.66% 0.70% 0.73 % 0.59 % 0.54% Net investment income 6.61%(3) 7.60% 14.09% 21.71 % 17.33 % 17.40% SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 40,866 $ 48,990 $ 56,162 $ 45,503 $ 64,470 $ 128,646 Portfolio turnover rate 25%(2) 55% 59% 48% 81% 9%
- ---------- * PRIOR TO JUNE 5, 2000, THE PORTFOLIO ISSUED ONE CLASS OF SHARES. ALL SHARES OF THE PORTFOLIO HELD PRIOR TO MAY 1, 2000 HAVE BEEN DESIGNATED CLASS X SHARES. ^ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. # CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 30
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ----------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- --------- --------- --------- --------- --------- (UNAUDITED) CLASS Y SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 1.20 $ 1.18 $ 1.03 $ 1.33 $ 2.43 $ 3.92 --------- --------- --------- --------- --------- --------- Income (loss) from investment operations: Net investment income^ 0.04 0.09 0.15 0.24 0.32 0.37 Net realized and unrealized gain (loss) (0.04) 0.02 0.11 (0.32) (1.08) (1.48) --------- --------- --------- --------- --------- --------- Total income (loss) from investment operations 0.00 0.11 0.26 (0.08) (0.76) (1.11) --------- --------- --------- --------- --------- --------- Less dividends and distributions from: Net investment income (0.04) (0.09) (0.11) (0.22) (0.34) (0.38) Net realized gain - - - - - - --------- --------- --------- --------- --------- --------- Total dividends and distributions (0.04) (0.09) (0.11) (0.22) (0.34) (0.38) --------- --------- --------- --------- --------- --------- Net asset value, end of period $ 1.16 $ 1.20 $ 1.18 $ 1.03 $ 1.33 $ 2.43 ========= ========= ========= ========= ========= ========= TOTAL RETURN# 0.25%(2) 9.56% 27.43% (7.36)% (33.92)% (30.02)%(2) RATIOS TO AVERAGE NET ASSETS(1): Expenses 1.05%(3) 0.91% 0.95% 0.98% 0.84% 0.79%(3) Net investment income 6.36%(3) 7.35% 13.84% 21.46% 17.08% 20.95%(3) SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 37,996 $ 39,547 $ 35,306 $ 10,797 $ 6,163 $ 1,947 Portfolio turnover rate 25%(2) 55% 59% 48% 81% 9%
- ---------- * FOR THE PERIOD JUNE 5, 2000 (ISSUED DATE) THROUGH DECEMBER 31, 2000. ^ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. # CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 31 TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo CHAIRMAN OF THE BOARD Mitchell M. Merin PRESIDENT Ronald E. Robison EXECUTIVE VICE PRESIDENT AND PRINCIPAL EXECUTIVE OFFICER Joseph J. McAlinden VICE PRESIDENT Barry Fink VICE PRESIDENT Amy R. Doberman VICE PRESIDENT Carsten Otto CHIEF COMPLIANCE OFFICER Stefanie V. Chang VICE PRESIDENT Francis J. Smith TREASURER AND CHIEF FINANCIAL OFFICER Thomas F. Caloia VICE PRESIDENT Mary E. Mullin SECRETARY TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT 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 Portfolio 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 Portfolio. For more detailed information about the Portfolio, its fees and expenses and other pertinent information, please read its Prospectus. The Portfolio's Statement of Additional Information contains additional information about the Portfolio, 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 Portfolio 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) 2005 Morgan Stanley [MORGAN STANLEY LOGO] RA05-00643P-Y06/05 [GRAPHIC] MORGAN STANLEY FUNDS MORGAN STANLEY VARIABLE INVESTMENT SERIES -- HIGH YIELD PORTFOLIO SEMIANNUAL REPORT JUNE 30, 2005 [MORGAN STANLEY LOGO] WELCOME, SHAREHOLDER: IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INCOME BUILDER PORTFOLIO 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 PORTFOLIO'S FINANCIAL STATEMENTS AND A LIST OF PORTFOLIO INVESTMENTS. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE PORTFOLIO BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE PORTFOLIO WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE PORTFOLIO IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE PORTFOLIO WILL DECLINE AND, THEREFORE, THE VALUE OF THE PORTFOLIO'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS PORTFOLIO. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT For the six-months ended June 30, 2005 TOTAL RETURN FOR THE 6 MONTHS ENDED JUNE 30, 2005
LEHMAN BROTHERS RUSSELL 1000(R) U.S. GOVERNMENT/ CLASS X CLASS Y VALUE INDEX(1) CREDIT INDEX(2) 1.55% 1.43% 1.76% 2.75%
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. SEE PERFORMANCE SUMMARY FOR PERFORMANCE INFORMATION AND INDEX DEFINITIONS. MARKET CONDITIONS Stock market performance was generally flat during the six-month period ended June 30, 2005. The strong equity rally of the fourth quarter of 2004 met a headwind in 2005 as investors rushed to lock in gains. This profit taking was not surprising, but few expected the downdraft to persist for most of the year's first quarter. High oil prices and rising interest rates also threatened to stifle future economic growth. Yet, a moderately growing economy, strengthening consumer confidence, as well as corporate earnings growth and strong balance sheets helped buoy the market as the reporting period progressed. Inflation appeared to be contained. Sentiment improved as investors began to speculate that the Federal Reserve was nearing the end of its increases to the federal funds target rate. In this environment, value stocks, in which the Portfolio invests, produced better results than growth stocks. Bonds generally outperformed stocks during the period, but like stocks, the bond market's gains were muted on an absolute basis. Investors preferred government issues and higher quality corporate bonds over lower quality names. PERFORMANCE ANALYSIS The Income Builder Portfolio underperformed the Russell 1000(R) Value Index and the Lehman Brothers U.S. Government/Credit Index for the six-month period ending June 30, 2005. Energy holdings added the most to the Portfolio's overall return. Refining companies led the group, driven by the wider profit margins gained from the high price of crude oil. These companies' budgets were structured based on oil prices estimated in the $25 to $30 per barrel range. As crude climbed north of $50 per barrel, the refiners were able to capture significantly higher than expected operating margins. Exposure to health care equipment and services stocks generated particularly strong performance among the Portfolio's health care holdings, due to company specific positive events. Utilities stocks performed well for the Portfolio, as these companies successfully passed higher fuel costs onto their customers. The market also rewarded utilities companies for their defensive traits and yield potential. Weakness in the Portfolio came from the consumer discretionary sector, primarily media-related holdings. Radio companies continued to struggle with generating advertising revenues -- typically a mainstay of their earnings -- as the radio industry contended with alternative formats, such as satellite radio and the Apple iPod and its imitators. Industrials and telecommunication services also detracted from the Portfolio's performance. Unlike utilities companies, industrial companies have been unable to transfer their higher raw material costs to their customers. Telecommunication services have 2 continued to languish under the industry's overcapacity, and face a new threat from cable phone service. The Portfolio's fixed income position was slightly additive to performance. The portfolio included investment-grade corporate bonds and Treasury securities. This emphasis on credit quality served the Portfolio well, as the market favored these sectors over more risky high-yield issuers. During the six month period, the Portfolio's stock, bond, and convertible securities proportions remained fairly constant. As of the end of the reporting period, the Portfolio held 57.8 percent in stocks, 16.3 percent in bonds and 22.4 percent in convertible securities. THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM WELL OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE PORTFOLIO IN THE FUTURE. TOP 10 HOLDINGS Clear Channel Communications, Inc. 2.6% Starwood Hotels & Resorts Worldwide, Inc. 2.5 Lehman Brothers Holdings Inc. 2.1 Disney (Walt) Co. (The) 2.1 Schering-Plough Corp. 2.0 Corn Products International Inc. 1.7 Bristol-Myers Squibb Co. 1.7 J.P. Morgan Chase & Co. 1.6 American Standard Companies, Inc. 1.5 Bayer AG (ADR) (Germany) 1.5
PORTFOLIO COMPOSTION Common Stocks 57.8% Corporate Notes/Bonds 16.3 Convertible Corp Notes/Bonds 15.8 Convertible Preferred Stocks 6.6
DATA AS OF JUNE 30, 2005. 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 PORTFOLIO WILL NORMALLY INVEST AT LEAST 80% OF ITS ASSETS IN INCOME-PRODUCING EQUITY AND FIXED-INCOME SECURITIES, WITH NORMALLY AT LEAST 65% OF ITS ASSETS INVESTED IN INCOME-PRODUCING EQUITY SECURITIES, INCLUDING COMMON STOCK, PREFERRED STOCK, CONVERTIBLE SECURITIES AND REAL ESTATE INVESTMENT TRUSTS (COMMONLY KNOWN AS "REITs"). THE PORTFOLIO'S "INVESTMENT ADVISER," MORGAN STANLEY INVESTMENT ADVISORS INC., UTILIZES A VALUE-ORIENTED STYLE IN THE SELECTION OF SECURITIES. INVESTMENTS ARE NORMALLY MADE PRIMARILY IN (i) COMMON STOCKS (INCLUDING DEPOSITARY RECEIPTS) OF LARGE CAPITALIZATION COMPANIES WITH A RECORD OF PAYING DIVIDENDS AND WHICH, IN THE OPINION OF THE INVESTMENT ADVISER, HAVE THE POTENTIAL FOR MAINTAINING DIVIDENDS, (ii) PREFERRED STOCK AND (iii) SECURITIES CONVERTIBLE INTO COMMON STOCKS OF SMALL-, MID- AND LARGE-CAP COMPANIES -- INCLUDING "SYNTHETIC" AND "EXCHANGEABLE" CONVERTIBLES. THE PORTFOLIO'S INVESTMENTS CAN ALSO INCLUDE "RULE 144A" SECURITIES, WHICH ARE SUBJECT TO RESALE RESTRICTIONS, AND FOREIGN SECURITIES. THE PORTFOLIO MAY INVEST UP TO 20% OF ITS NET ASSETS IN COMMON STOCKS THAT DO NOT PAY A DIVIDEND. FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY PORTFOLIO PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE PORTFOLIO'S SECOND AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY PORTFOLIO 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 PORTFOLIO'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 PORTFOLIO VOTED PROXIES RELATING TO PORTFOLIO SECURITIES DURING THE MOST RECENT TWELVE-MONTH PERIOD ENDED JUNE 30 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. 4 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED JUNE 30, 2005
CLASS X SHARES CLASS Y SHARES (SINCE 01/21/97) (SINCE 06/05/00) 1 YEAR 9.63%(3) 9.29%(3) 5 YEARS 6.09(3) 5.81(3) SINCE INCEPTION 6.81(3) 5.08(3)
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 THE 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 PORTFOLIO SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. THE PERFORMANCE OF THE PORTFOLIO'S TWO SHARE CLASSES VARIES BECAUSE EACH HAS DIFFERENT EXPENSES. THE PORTFOLIO'S TOTAL RETURN FIGURES ASSUME THE REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE IMPACT OF ANY CHARGES BY YOUR INSURANCE COMPANY. SUCH COSTS WOULD LOWER PERFORMANCE. (1) THE RUSSELL 1000(R) VALUE INDEX MEASURES THE PERFORMANCE OF THOSE COMPANIES IN THE RUSSELL 1000(R) INDEX WITH LOWER PRICE -TO-BOOK RATIOS AND LOWER FORECASTED GROWTH VALUES. 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. GOVERNMENT/CREDIT INDEX TRACKS THE PERFORMANCE OF GOVERNMENT AND CORPORATE OBLIGATIONS, INCLUDING U.S. GOVERNMENT AGENCY AND TREASURY SECURITIES AND CORPORATE AND YANKEE BONDS. 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) FIGURE ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS FOR THE UNDERLYING PORTFOLIO BASED ON NET ASSET VALUE (NAV). IT DOES NOT REFLECT THE DEDUCTION OF INSURANCE EXPENSES, AN ANNUAL CONTRACT MAINTENANCE FEE, OR SURRENDER CHARGES. 5 EXPENSE EXAMPLE As a shareholder of the Portfolio, you incur two types of costs: (1) insurance company charges; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Portfolio expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Portfolio 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 01/01/05 - 06/30/05. 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 Portfolio's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Portfolio'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 Portfolio 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 insurance company charges. 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 insurance company charges were included, your costs would have been higher.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD * ------------- ------------- --------------- 01/01/05 - 01/01/05 06/30/05 06/30/05 ------------- ------------- --------------- CLASS X Actual (1.55% return) $ 1,000.00 $ 1,015.50 $ 4.05 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,020.78 $ 4.06 CLASS Y Actual (1.43% return) $ 1,000.00 $ 1,014.30 $ 5.29 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,019.54 $ 5.31
- ---------- * EXPENSES ARE EQUAL TO THE PORTFOLIO'S ANNUALIZED EXPENSE RATIO OF 0.81% AND 1.06% 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 fixed income securities trading. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Portfolio's Administrator under the Administration Agreement, including accounting, clerical, bookkeeping, compliance, business management and planning, and the provision of supplies, office space and utilities. (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 administrative and investment advisory services to the Portfolio. 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 Portfolio. 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 The Board reviewed the Portfolio's performance for the one-, three- and five-year periods ended November 30, 2004, as shown in reports provided by Lipper (the "Lipper Reports"), compared to the performance of comparable funds selected by Lipper (the "performance peer group"), and noted that the Portfolio's performance was lower than its performance peer group average for the one-year period but better for the three- and five-year periods. The Board concluded that the Portfolio's overall performance was competitive with its performance peer group. FEES RELATIVE TO OTHER FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT STRATEGIES The Board reviewed the advisory and administrative fees (together, the "management fee") paid by the Fund under the Management Agreement. The Board noted that the rate was comparable to the management fee rates charged by the Adviser to any other funds it manages with investment strategies comparable to those of the Portfolio. FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS The Board reviewed the management fee rate and the total expense ratio of the Portfolio. The Board noted that: (i) the Portfolio's management fee rate was higher than the average management fee rate for funds, selected by Lipper (the "expense peer group"), managed by other advisers with investment strategies comparable to those of 7 the Portfolio, as shown in the Lipper Report for the Portfolio; but (ii) the Portfolio's total expense ratio was lower than the average total expense ratio of the funds included in the Portfolio's expense peer group. The Board concluded that the Portfolio's management fee 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 Portfolio's management fee schedule under the Management Agreement and noted that it includes a breakpoint. The Board also reviewed the level of the Portfolio's management fee and noted that the fee, as a percentage of the Portfolio's net assets, would decrease as net assets increase because the management fee includes a breakpoint. The Board concluded that the Portfolio's management fee would reflect economies of scale as assets increase. PROFITABILITY OF ADVISER AND AFFILIATES The Board considered and reviewed information concerning the costs incurred and profits realized by the Adviser and its affiliates during the last two years from their relationship with the Portfolio and the Morgan Stanley Fund Complex and reviewed with the Controller of the Adviser the cost allocation methodology used to determine the Adviser's profitability. Based on their review of the information they received, the Board concluded that the profits earned by the Adviser and its affiliates were not excessive in light of the advisory, administrative and other services provided to the Portfolio. FALL-OUT BENEFITS The Board considered so-called "fall-out benefits" derived by the Adviser and its affiliates from their relationship with the Portfolio and the Morgan Stanley Fund Complex, such as "float" benefits derived from handling of checks for purchases and redemptions of Portfolio 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 Portfolio 12b-1 fees for distribution and shareholder services. The Board also considered that an affiliate of the Adviser, through a joint venture, receives revenue in connection with trading done on behalf of the Portfolio through an electronic trading system network ("ECN"). The Board concluded that the float benefits and the above-referenced ECN-related revenue were relatively small and that the 12b-1 fees were competitive with those of other broker-dealer affiliates of investment advisers of mutual funds. 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 Portfolio and/or other funds managed by the Adviser would be used to pay for research that a securities broker obtains 8 from third parties, or to pay for both research and execution services from securities brokers who effect transactions for the Portfolio. The Adviser informed the Board that it does not use Portfolio 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 Portfolio and other funds in the Morgan Stanley Fund Complex. ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE PORTFOLIO'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 PORTFOLIO AND THE ADVISER The Board also reviewed and considered the historical relationship between the Portfolio and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Portfolio'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 Portfolio 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 Portfolio'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 Portfolio's business. GENERAL CONCLUSION After considering and weighing all of the above factors, the Board concluded it would be in the best interest of the Portfolio and its shareholders to approve renewal of the Management Agreement for another year. 9 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INCOME BUILDER PORTFOLIO PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
NUMBER OF SHARES VALUE - --------------------------------------------------------------------------------------------- COMMON STOCKS (57.8%) AEROSPACE & DEFENSE (1.3%) 10,970 Northrop Grumman Corp. $ 606,093 14,350 Raytheon Co. 561,372 ------------ 1,167,465 ------------ BEVERAGES: NON-ALCOHOLIC (0.8%) 18,590 Coca-Cola Co. (The) 776,132 ------------ BIOTECHNOLOGY (0.6%) 14,740 Chiron Corp.* 514,279 ------------ BROADCASTING (1.2%) 33,950 Clear Channel Communications, Inc. 1,050,074 ------------ CHEMICALS: MAJOR DIVERSIFIED (2.2%) 40,470 Bayer AG (ADR) (Germany) 1,346,841 12,380 Dow Chemical Co. (The) 551,281 4,297 Lanxess (Germany)* ++ 96,129 ------------ 1,994,251 ------------ COMPUTER PROCESSING HARDWARE (0.9%) 33,700 Hewlett-Packard Co. 792,287 ------------ DEPARTMENT STORES (0.7%) 11,300 Kohl's Corp.* 631,783 ------------ DISCOUNT STORES (1.3%) 5,980 Target Corp. 379,782 17,600 Wal-Mart Stores, Inc. 848,320 ------------ 1,228,102 ------------ ELECTRIC UTILITIES (2.3%) 13,480 American Electric Power Co., Inc. 497,008 7,880 Entergy Corp. 595,334 8,940 Exelon Corp. 458,890 12,190 FirstEnergy Corp. 586,461 ------------ 2,137,693 ------------ FINANCE/RENTAL/LEASING (1.3%) 15,350 Freddie Mac 1,001,280 7,030 MBNA Corp. 183,905 ------------ 1,185,185 ------------ FINANCIAL CONGLOMERATES (4.3%) 28,380 Citigroup, Inc. 1,312,007 41,086 JPMorgan Chase & Co. 1,451,157
SEE NOTES TO FINANCIAL STATEMENTS 10
NUMBER OF SHARES VALUE - --------------------------------------------------------------------------------------------- 10,390 Prudential Financial, Inc.* $ 682,207 9,150 State Street Corp. 441,488 ------------ 3,886,859 ------------ FINANCIAL PUBLISHING/SERVICES (0.3%) 7,980 Equifax, Inc. 284,966 ------------ FOOD: MAJOR DIVERSIFIED (1.7%) 11,310 Kraft Foods Inc. (Class A) 359,771 17,970 Unilever N.V. (NY Registered Shares) (Netherlands) 1,164,995 ------------ 1,524,766 ------------ FOOD: SPECIALTY/CANDY (0.6%) 13,760 Cadbury Schweppes PLC (ADR) (United Kingdom) 527,421 ------------ HOTELS/RESORTS/CRUISELINES (0.3%) 4,340 Marriott International, Inc. (Class A) 296,075 ------------ HOUSEHOLD/PERSONAL CARE (0.6%) 8,700 Kimberly-Clark Corp. 544,533 ------------ INDUSTRIAL CONGLOMERATES (2.6%) 34,230 General Electric Co. 1,186,069 5,746 Ingersoll-Rand Co. Ltd. (Class A) (Bermuda) 409,977 10,510 Siemens AG (ADR) (Germany) 763,552 ------------ 2,359,598 ------------ INDUSTRIAL MACHINERY (0.2%) 3,240 Parker Hannifin Corp. 200,912 ------------ INTEGRATED OIL (4.3%) 17,050 BP PLC (ADR) (United Kingdom) 1,063,579 16,958 ConocoPhillips 974,915 13,440 Exxon Mobil Corp. 772,397 17,320 Royal Dutch Petroleum Co. (NY Registered Shares) (Netherlands) 1,124,068 ------------ 3,934,959 ------------ INVESTMENT BANKS/BROKERS (3.3%) 2,280 Goldman Sachs Group Inc. (The) 232,606 9,980 Lehman Brothers Holdings Inc. 990,814 20,590 Merrill Lynch & Co., Inc. 1,138,157 53,750 Schwab (Charles) Corp. (The) 606,300 ------------ 2,967,877 ------------ LIFE/HEATH INSURANCE (0.2%) 14,270 Aegon N.V. (NY Registered Shares) (Netherlands) 183,655 ------------
SEE NOTES TO FINANCIAL STATEMENTS 11
NUMBER OF SHARES VALUE - --------------------------------------------------------------------------------------------- MAJOR BANKS (1.3%) 17,570 Bank of America Corp. $ 801,368 6,420 PNC Financial Services Group 349,633 ------------ 1,151,001 ------------ MAJOR TELECOMMUNICATIONS (2.0%) 18,110 France Telecom S.A. (ADR) (France) 527,725 19,600 Sprint Corp. 491,764 24,030 Verizon Communications Inc. 830,237 ------------ 1,849,726 ------------ MANAGED HEALTH CARE (1.1%) 9,430 CIGNA Corp. 1,009,293 ------------ MEDIA CONGLOMERATES (2.8%) 30,110 Disney (Walt) Co. (The)* 758,170 74,820 Time Warner, Inc.* 1,250,242 17,290 Viacom Inc. (Class B) (Non-Voting) 553,626 ------------ 2,562,038 ------------ MEDICAL SPECIALTIES (1.0%) 6,680 Applera Corp. - Applied Biosystems Group 131,396 9,140 Bausch & Lomb, Inc. 758,620 ------------ 890,016 ------------ MOTOR VEHICLES (0.7%) 26,250 Honda Motor Co., Ltd. (ADR) (Japan) 646,012 ------------ MULTI-LINE INSURANCE (0.5%) 5,950 Hartford Financial Services Group, Inc. (The) 444,941 ------------ OIL & GAS PIPELINES (0.6%) 30,300 Williams Companies, Inc. (The) 575,700 ------------ OIL REFINING/MARKETING (0.8%) 9,730 Valero Energy Corp. 769,740 ------------ OILFIELD SERVICES EQUIPMENT (1.2%) 14,820 Schlumberger Ltd. (Netherlands Antilles) 1,125,431 ------------ PACKAGED SOFTWARE (0.8%) 32,430 Symantec Corp.* 705,028 ------------ PHARMACEUTICALS: MAJOR (7.3%) 61,450 Bristol-Myers Squibb Co. 1,535,021 9,980 GlaxoSmithKline PLC (ADR) (United Kingdom) 484,130 13,970 Lilly (Eli) & Co. 778,269 19,910 Roche Holdings Ltd. (ADR) (Switzerland) 1,254,330
SEE NOTES TO FINANCIAL STATEMENTS 12
NUMBER OF SHARES VALUE - --------------------------------------------------------------------------------------------- 15,370 Sanofi-Aventis (ADR) (France) $ 630,016 60,450 Schering-Plough Corp. 1,152,177 18,820 Wyeth 837,490 ------------ 6,671,433 ------------ PRECIOUS METALS (0.7%) 17,540 Newmont Mining Corp. 684,586 ------------ PROPERTY - CASUALTY INSURERS (2.1%) 12,080 Chubb Corp. (The) 1,034,169 21,643 St. Paul Travelers Companies, Inc. (The) 855,548 ------------ 1,889,717 ------------ RAILROADS (0.3%) 9,010 Norfolk Southern Corp. 278,950 ------------ RESTAURANTS (0.2%) 8,000 McDonald's Corp.* 222,000 ------------ SEMICONDUCTORS (1.3%) 26,160 Intel Corp. 681,729 46,670 Micron Technology, Inc.* 476,501 ------------ 1,158,230 ------------ TELECOMMUNICATION EQUIPMENT (0.9%) 46,095 Motorola, Inc. 841,695 ------------ TOBACCO (0.6%) 8,290 Altria Group, Inc. 536,031 ------------ WIRELESS TELECOMMUNICATIONS (0.6%) 17,660 Nextel Communications, Inc. (Class A)* 570,595 ------------ TOTAL COMMON STOCKS (COST $44,396,895) 52,771,035 ------------ PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE - --------- ------ -------- CONVERTIBLE BONDS (15.8%) AIRLINES (1.4%) $ 1,500 Continental Airlines Inc. 4.50% 02/01/07 1,297,500 ------------ BIOTECHNOLOGY (1.1%) 800 Invitrogen Inc. 2.00 08/01/23 1,054,000 ------------ CABLE/SATELLITE TV (1.1%) 1,000 Echostar Communications Corp. 5.75 05/15/06 997,500 ------------
SEE NOTES TO FINANCIAL STATEMENTS 13
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - --------------------------------------------------------------------------------------------- ELECTRIC UTILITIES (0.6%) $ 173 PG&E Corp. 9.50% 06/30/10 $ 511,215 ------------ ELECTRONIC COMPONENTS (1.0%) 1,000 SCI Systems, Inc. 3.00 03/15/07 945,000 ------------ ELECTRONIC EQUIPMENT/INSTRUMENTS (0.2%) 221 Agilent Technologies, Inc. 3.00 12/01/21 219,066 ------------ ELECTRONIC PRODUCTION EQUIPMENT (1.1%) 1,100 Veeco Instruments, Inc. 4.125 12/21/08 988,625 ------------ HOSPITAL/NURSING MANAGEMENT (1.3%) 1,000 Community Health Systems 4.25 10/15/08 1,157,500 ------------ HOTELS/RESORTS/CRUISELINES (1.3%) 1,000 Hilton Hotels Corp. - 144A** 3.375 04/15/23 1,208,750 ------------ HOUSEHOLD/PERSONAL CARE (1.5%) 1,000 Church & Dwight Co., Inc. - 144A** 5.25 08/15/33 1,328,750 ------------ INDUSTRIAL CONGLOMERATES (1.4%) 1,000 Tyco International Group SA (Luxembourg) 2.75 01/15/18 1,295,000 ------------ INTERNET RETAIL (0.9%) 901 Amazon.com, Inc. 4.75 02/01/09 867,213 ------------ INVESTMENT BANKS/BROKERS (0.6%) 509 E*Trade Financial Corp. 6.00 02/01/07 514,726 ------------ MEDIA CONGLOMERATES (1.2%) 1,080 Walt Disney Co. (The) 2.125 04/15/23 1,113,750 ------------ SEMICONDUCTORS (1.1%) 950 Skyworks Solutions, Inc. 4.75 11/15/07 969,000 ------------ TOTAL CONVERTIBLE BONDS (COST $13,772,616) 14,467,595 ------------ CORPORATE BONDS (16.3%) AGRICULTURAL COMMODITIES/MILLING (1.7%) 1,460 Corn Products International Inc. 8.25 07/15/07 1,567,618 ------------ APPAREL/FOOTWEAR (1.4%) 1,250 Tommy Hilfiger USA Inc. 6.85 06/01/08 1,262,500 ------------ BROADCASTING (1.4%) 1,200 Clear Channel Communications, Inc. 8.00 11/01/08 1,291,143 ------------ BUILDING PRODUCTS (1.5%) 1,200 American Standard, Inc. 8.25 06/01/09 1,357,429 ------------ HOME BUILDING (1.4%) 1,200 Toll Corp. 8.25 02/01/11 1,278,000 ------------
SEE NOTES TO FINANCIAL STATEMENTS 14
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - --------------------------------------------------------------------------------------------- HOSPITAL/NURSING MANAGEMENT (1.0%) $ 851 Manor Care, Inc. 7.50% 06/15/06 $ 873,216 ------------ HOTELS/RESORTS/CRUISELINES (2.5%) 2,000 Starwood Hotels & Resorts Worldwide, Inc. 7.875 05/01/12 2,265,000 ------------ MANAGED HEALTH CARE (1.2%) 1,000 Magellan Health Services, Inc. (Series A) 9.375 11/15/08 1,070,000 ------------ OTHER METALS/MINERALS (1.3%) 1,200 USEC Inc. 6.625 01/20/06 1,194,000 ------------ PUBLISHING: NEWSPAPERS (1.1%) 1,000 Media General Inc. 6.95 09/01/06 1,028,476 ------------ SPECIALTY STORES (1.0%) 967 National Vision Inc. 12.00 03/30/09 962,603 ------------ TRUCKS/CONSTRUCTION/FARM MACHINERY (0.8%) 700 Navistar International (Series B) 9.375 06/01/06 728,000 ------------ TOTAL CORPORATE BONDS (COST $14,555,492) 14,877,985 ------------ NUMBER OF SHARES - --------- CONVERTIBLE PREFERRED STOCKS (6.6%) ELECTRIC UTILITIES (1.3%) 18,000 FPL Group, Inc. $4.00 1,162,980 ------------ INVESTMENT BANKS/BROKERS (1.1%) 38,000 Lehman Brothers Holdings Inc. (Series GIS) $1.5625 963,300 ------------ LIFE/HEALTH INSURANCE (1.3%) 44,000 MetLife, Inc (Series B) $6.375 1,153,680 ------------ PHARMACEUTICALS: MAJOR (0.7%) 13,500 Schering-Plough Corp. $3.00 688,230 ------------ PROPERTY - CASUALTY INSURERS (0.7%) 30,000 Travelers Property Casualty Corp. $1.125 671,400 ------------ REAL ESTATE INVESTMENT TRUST (0.4%) 9,000 Equity Residential Properties Trust (Series E) $1.75 371,250 ------------ TELECOMMUNICATION EQUIPMENT (1.1%) 1,000 Lucent Technologies Capital Trust $77.50 979,625 ------------ TOTAL CONVERTIBLE PREFERRED STOCKS (COST $5,668,034) 5,990,465 ------------
SEE NOTES TO FINANCIAL STATEMENTS 15
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - --------------------------------------------------------------------------------------------- SHORT-TERM INVESTMENT (3.1%) REPURCHASE AGREEMENT $ 2,868 The Bank of New York (dated 06/30/05; proceeds $2,868,203) (a) (COST $2,867,954) 3.125% 07/01/05 $ 2,867,954 ------------ Total Investments (COST $81,260,992) (b) 99.6% 90,975,034 Other Assets In Excess Of Liabilities 0.4 337,361 ------ ------------ Net Assets 100.0% $ 91,312,395 ====== ============
- ---------- ADR AMERICAN DEPOSITARY RECEIPT. * NON-INCOME PRODUCING SECURITY. ** RESALE IS RESTRICTED TO QUALIFIED INSTITUTIONAL INVESTORS. ++ SECURITIES WITH TOTAL MARKET VALUE EQUAL TO $96,129 HAVE BEEN VALUED AT THEIR FAIR VALUE AS DETERMINED IN GOOD FAITH UNDER PROCEDURES ESTABLISHED BY AND UNDER THE GENERAL SUPERVISION OF THE FUND'S TRUSTEES. (a) COLLATERALIZED BY FEDERAL NATIONAL MORTGAGE ASSOCIATION 4.1265 DUE 07/01/18 VALUED AT $2,925,313. (b) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES APPROXIMATES THE AGGREGATE COST FOR BOOK PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION IS $11,626,560 AND THE AGGREGATE GROSS UNREALIZED DEPRECIATION IS $1,912,518, RESULTING IN NET UNREALIZED APPRECIATION OF $9,714,042. SEE NOTES TO FINANCIAL STATEMENTS 16 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INCOME BUILDER PORTFOLIO SUMMARY OF INVESTMENTS - JUNE 30, 2005
PERCENT OF INDUSTRY VALUE NET ASSETS - -------------------------------------------------------------------------------- Pharmaceuticals: Major $ 7,359,663 8.1% Investment Banks/Brokers 4,445,903 4.9 Integrated Oil 3,934,959 4.3 Financial Conglomerates 3,886,860 4.3 Electric Utilities 3,811,888 4.2 Hotels/Resorts/Cruiselines 3,769,825 4.1 Media Conglomerates 3,675,788 4.0 Industrial Conglomerates 3,654,598 4.0 Repurchase Agreement 2,867,954 3.1 Property - Casualty Insurers 2,561,117 2.8 Broadcasting 2,341,215 2.6 Semiconductors 2,127,231 2.3 Managed Health Care 2,079,293 2.3 Hospital/Nursing Management 2,030,716 2.2 Chemicals: Major Diversified 1,994,252 2.2 Household/Personal Care 1,873,283 2.1 Major Telecommunications 1,849,726 2.0 Telecommunication Equipment 1,821,320 2.0 Biotechnology 1,568,279 1.7 Agricultural Commodities/ Milling 1,567,618 1.7 Food: Major Diversified 1,524,766 1.7 Building Products 1,357,429 1.5 Life/Health Insurance 1,337,335 1.5 Airlines 1,297,500 1.4 Home Building 1,278,000 1.4 Apparel/Footwear 1,262,500 1.4 Discount Stores 1,228,102 1.3 Other Metals/Minerals 1,194,000 1.3 Finance/Rental/Leasing 1,185,185 1.3 Aerospace & Defense 1,167,465 1.3 Major Banks 1,151,001 1.3 Oilfield Services/Equipment $ 1,125,431 1.2% Publishing: Newspapers 1,028,476 1.1 Cable/Satellite TV 997,500 1.1 Electronic Production Equipment 988,625 1.1 Specialty Stores 962,603 1.1 Electronic Components 945,000 1.0 Medical Specialties 890,016 1.0 Internet Retail 867,212 1.0 Computer Processing Hardware 792,287 0.9 Beverages: Non-Alcoholic 776,132 0.8 Oil Refining/Marketing 769,740 0.8 Trucks/Construction/ Farm Machinery 728,000 0.8 Packaged Software 705,028 0.8 Precious Metals 684,586 0.7 Motor Vehicles 646,012 0.7 Department Stores 631,783 0.7 Oil & Gas Pipelines 575,700 0.6 Wireless Telecommunications 570,595 0.6 Tobacco 536,031 0.6 Food: Specialty/Candy 527,421 0.6 Multi-Line Insurance 444,941 0.5 Real Estate Investment Trusts 371,250 0.4 Financial Publishing/ Services 284,966 0.3 Railroads 278,950 0.3 Restaurants 222,000 0.2 Electronic Equipment/ Instruments 219,066 0.2 Industrial Machinery 200,912 0.2 ------------- ---------- $ 90,975,034 99.6% ============= ==========
SEE NOTES TO FINANCIAL STATEMENTS 17 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INCOME BUILDER PORTFOLIO FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 2005 (UNAUDITED) ASSETS: Investments in securities, at value (cost $81,260,992) $ 90,975,034 Receivable for: Interest 405,893 Dividends 121,342 Investments sold 95,477 Prepaid expenses and other assets 1,104 --------------- TOTAL ASSETS 91,598,850 --------------- LIABILITIES: Payable for: Investments purchased 196,421 Investment advisory fee 50,739 Distribution fee 9,765 Administration fee 6,058 Shares of beneficial interest redeemed 54 Accrued expenses and other payables 23,418 --------------- TOTAL LIABILITIES 286,455 --------------- NET ASSETS $ 91,312,395 =============== COMPOSITION OF NET ASSETS: Paid-in-capital $ 86,701,592 Net unrealized appreciation 9,714,042 Accumulated net investment loss (490,128) Accumulated net realized loss (4,613,111) --------------- NET ASSETS $ 91,312,395 =============== CLASS X SHARES: Net Assets $ 44,223,855 Shares Outstanding (unlimited authorized, $.01 par value) 3,763,197 NET ASSET VALUE PER SHARE $ 11.75 =============== CLASS Y SHARES: Net Assets $ 47,088,540 Shares Outstanding (unlimited authorized, $.01 par value) 4,016,317 NET ASSET VALUE PER SHARE $ 11.72 ===============
SEE NOTES TO FINANCIAL STATEMENTS 18 STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2005 (UNAUDITED) NET INVESTMENT INCOME: Income Interest $ 852,467 Dividends (net of $22,514 foreign withholding tax) 743,424 --------------- TOTAL INCOME 1,595,891 --------------- EXPENSES Investment advisory fee 312,715 Distribution fee (Class Y shares) 59,373 Administration fee 37,339 Custodian fees 11,688 Professional fees 10,607 Shareholder reports and notices 3,607 Trustees' fees and expenses 578 Transfer agent fees and expenses 250 Other 3,096 --------------- TOTAL EXPENSES 439,253 --------------- NET INVESTMENT INCOME 1,156,638 --------------- NET REALIZED AND UNREALIZED GAIN (LOSS): Net realized gain 3,691,278 Net change in unrealized appreciation (3,479,918) --------------- NET GAIN 211,360 --------------- NET INCREASE $ 1,367,998 ===============
SEE NOTES TO FINANCIAL STATEMENTS 19 STATEMENT OF CHANGES IN NET ASSETS
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 --------------- ----------------- (UNAUDITED) INCREASE (DECREASE) IN NET ASSETS: OPERATIONS: Net investment income $ 1,156,638 $ 2,827,123 Net realized gain 3,691,278 3,742,506 Net change in unrealized appreciation (3,479,918) 3,159,772 --------------- ----------------- NET INCREASE 1,367,998 9,729,401 --------------- ----------------- DIVIDENDS TO SHAREHOLDERS FROM NET INVESTMENT INCOME: Class X shares (653,573) (1,825,001) Class Y shares (633,879) (1,617,524) --------------- ----------------- TOTAL DIVIDENDS (1,287,452) (3,442,525) --------------- ----------------- Net decrease from transactions in shares of beneficial interest (6,386,690) (3,001,050) --------------- ----------------- NET INCREASE (DECREASE) (6,306,144) 3,285,826 --------------- ----------------- NET ASSETS: Beginning of period 97,618,539 94,332,713 --------------- ----------------- END OF PERIOD (INCLUDING ACCUMULATED NET INVESTMENT LOSSES OF $490,128 AND $359,314, RESPECTIVELY) $ 91,312,395 $ 97,618,539 =============== =================
SEE NOTES TO FINANCIAL STATEMENTS 20 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INCOME BUILDER PORTFOLIO NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) 1. ORGANIZATION AND ACCOUNTING POLICIES Morgan Stanley Variable Investment Series (the "Fund") - Income Builder Portfolio (the "Portfolio"), one of 15 separate portfolios, is registered under the Investment Company Act of 1940, as amended (the "Act"), as a diversified, open-end management investment company. The Fund is offered exclusively to life insurance companies in connection with particular life insurance and/or annuity contracts they offer. The Portfolio's primary investment objective is to earn reasonable income and, as a secondary objective, growth of capital. The Fund was organized as a Massachusetts business trust on February 25, 1983 and the Portfolio commenced operations on January 21, 1997. On June 5, 2000, the Portfolio commenced offering one additional class of shares (Class Y). The Portfolio offers Class X shares and Class Y shares. The two are identical except that Class Y shares incur distribution expenses. Class X shares are generally available to holders of contracts offered by Metropolitan Life Insurance Company (formerly Paragon Life Insurance Company) and other contracts offered before May 1, 2000. Class Y shares are available to holders of contracts offered on or after June 5, 2000. 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) when market quotations are not readily available or Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") determines that the latest sale price, the bid price or the mean between the last reported bid and asked price do not reflect a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees. Occasionally, developments affecting the closing prices of securities and other assets may occur between the times at which valuations of such securities are determined (that is, close of the foreign market on which the securities trade) and the close of business on the NYSE. If developments occur during such periods that are expected to materially affect the value of such securities, such valuations may be adjusted to reflect the estimated fair value of such securities as of the close of the NYSE, as determined in good faith by 21 the Fund's Trustees or by the Investment Adviser using a pricing service and/or procedures approved by the Trustees of the Fund; (6) certain portfolio securities may be valued by an outside pricing service approved by the Fund's Trustees; and (7) 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 -- The Fund may 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. FEDERAL INCOME TAX POLICY -- It is the Fund's policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute substantially all of its taxable income to its shareholders. Accordingly, no federal income tax provision is required. F. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- Dividends and distributions to shareholders are recorded on the ex-dividend date. G. Expenses -- Direct expenses are charged to the Portfolio and general Fund expenses are allocated on the basis of relative net assets or equally among Portfolios. H. 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, the Portfolio pays the Investment Adviser an advisory fee, accrued daily and payable monthly, by applying the following annual rates to the net assets of the Portfolio determined at the close of each business day: 0.67% to the portion of the daily net assets not exceeding $500 million; and 0.645% to the portion of the daily net assets in excess of $500 million. 22 Pursuant to an Administration Agreement with Morgan Stanley Services Company Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Portfolio pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.08% to the Portfolio'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. Under the Plan, Class Y shares of the Portfolio will pay a distribution fee which is accrued daily and paid monthly at the annual rate of 0.25% of the average daily net assets of the class. 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 June 30, 2005, aggregated $17,480,073 and $22,410,968, respectively. Included in the aforementioned are purchases and sales of $6,718 and $2,470, respectively, with other Morgan Stanley funds including a net realized gain of $480. Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and Distributor, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and compensation. Aggregate pension costs for the six months ended June 30, 2005 included in Trustees' fees and expenses in the Statement of Operations amounted to $47. At June 30, 2005, the Portfolio had an accrued pension liability of $1,072 which is included in accrued expenses in the Statement of Assets and Liabilities. On December 2, 2003, the Trustees voted to close the plan to new participants and eliminate the future benefits growth due to increases to compensation after July 31, 2003. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 23 5. SHARES OF BENEFICIAL INTEREST Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 ------------------------------ ------------------------------ (UNAUDITED) SHARES AMOUNT SHARES AMOUNT ------------- ------------- ------------- ------------- CLASS X SHARES Sold 291,088 $ 3,406,281 794,935 $ 8,898,223 Reinvestment of dividends 55,915 653,574 161,416 1,825,001 Redeemed (769,328) (9,005,160) (1,497,979) (16,742,836) ------------- ------------- ------------- ------------- Net decrease -- Class X (422,325) (4,945,305) (541,628) (6,019,612) ------------- ------------- ------------- ------------- CLASS Y SHARES Sold 381,976 4,446,838 1,108,132 12,416,695 Reinvestment of dividends 54,368 633,879 143,262 1,617,524 Redeemed (561,096) (6,522,102) (985,119) (11,015,657) ------------- ------------- ------------- ------------- Net increase (decrease) -- Class Y (124,752) (1,441,385) 266,275 3,018,562 ------------- ------------- ------------- ------------- Net decrease in Portfolio (547,077) $ (6,386,690) (275,353) $ (3,001,050) ============= ============= ============= =============
6. 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 December 31, 2004, the Portfolio had a net capital loss carryforward of approximately $8,110,000 of which $2,835,000 will expire on December 31, 2009, $4,754,000 will expire on December 31, 2010, $521,000 will expire on December 31, 2011 to offset future capital gains to the extent provided by regulations. As of December 31, 2004, the Portfolio had temporary book/tax differences primarily attributable to capital loss deferrals on wash sales and book amortization of premiums on debt securities. 24 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INCOME BUILDER PORTFOLIO FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ---------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ---------- ---------- ---------- ---------- ---------- (UNAUDITED) CLASS X SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 11.74 $ 10.98 $ 9.38 $ 10.61 $ 10.86 $ 11.44 ------------- ---------- ---------- ---------- ---------- ---------- Income (loss) from investment operations: Net investment income@ 0.17 0.34 0.32 0.42 0.47 0.55 Net realized and unrealized gain (loss) (0.07) 0.84 1.60 (1.22) (0.22) (0.54) ------------- ---------- ---------- ---------- ---------- ---------- Total income (loss) from investment operations 0.10 1.18 1.92 (0.80) 0.25 0.01 ------------- ---------- ---------- ---------- ---------- ---------- Less dividends and distributions from: Net investment income (0.09) (0.42) (0.32) (0.42) (0.48) (0.56) Net realized gain - - - (0.01)++ (0.02)++ (0.03)++ ------------- ---------- ---------- ---------- ---------- ---------- Total dividends and distributions (0.09) (0.42) (0.32) (0.43) (0.50) (0.59) ------------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period $ 11.75 $ 11.74 $ 10.98 $ 9.38 $ 10.61 $ 10.86 ============= ========== ========== ========== ========== ========== TOTAL RETURN+ 1.55%(2) 10.96% 20.84% (7.64)% 2.30% 0.17% RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.81%(3) 0.82% 0.84% 0.80% 0.81% 0.81% Net investment income 2.87%(3) 3.07% 3.26% 4.20% 4.34% 5.07% SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 44,224 $ 49,126 $ 51,890 $ 49,505 $ 63,060 $ 59,383 Portfolio turnover rate 19%(2) 38% 62% 75% 45% 51%
- ---------- * PRIOR TO JUNE 5, 2000, THE PORTFOLIO ISSUED ONE CLASS OF SHARES. ALL SHARES OF THE PORTFOLIO HELD PRIOR TO MAY 1, 2000 HAVE BEEN DESIGNATED CLASS X SHARES. @ 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. ++ DISTRIBUTION FROM PAID-IN-CAPITAL. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 25
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ---------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ---------- ---------- ---------- ---------- ---------- (UNAUDITED) CLASS Y SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 11.71 $ 10.95 $ 9.36 $ 10.60 $ 10.85 $ 11.15 ------------- ---------- ---------- ---------- ---------- ---------- Income (loss) from investment operations: Net investment income@ 0.15 0.32 0.31 0.39 0.42 0.32 Net realized and unrealized gain (loss) (0.06) 0.83 1.58 (1.22) (0.19) (0.21) ------------- ---------- ---------- ---------- ---------- ---------- Total income (loss) from investment operations 0.09 1.15 1.89 (0.83) 0.23 0.11 ------------- ---------- ---------- ---------- ---------- ---------- Less dividends and distributions from: Net investment income (0.08) (0.39) (0.30) (0.40) (0.46) (0.39) Net realized gain - - - (0.01)++ (0.02)++ (0.02)++ ------------- ---------- ---------- ---------- ---------- ---------- Total dividends and distributions (0.08) (0.39) (0.30) (0.41) (0.48) (0.41) ------------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period $ 11.72 $ 11.71 $ 10.95 $ 9.36 $ 10.60 $ 10.85 ============= ========== ========== ========== ========== ========== TOTAL RETURN+ 1.43%(2) 10.72% 20.51% (7.96)% 2.10% 1.06%(2) RATIOS TO AVERAGE NET ASSETS(1): Expenses 1.06%(3) 1.07% 1.09% 1.05 % 1.06% 1.06%(3) Net investment income 2.62%(3) 2.82% 3.04% 3.95 % 3.88% 5.17%(3) SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 47,089 $ 48,493 $ 42,443 $ 13,930 $ 7,147 $ 965 Portfolio turnover rate 19%(2) 38% 62% 75 % 45% 51%
- ---------- * FOR THE PERIOD JUNE 5, 2000 (ISSUED DATE) THROUGH DECEMBER 31, 2000. @ 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. ++ DISTRIBUTION FROM PAID-IN-CAPITAL. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 26 TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo Chairman of the Board Mitchell M. Merin PRESIDENT Ronald E. Robison EXECUTIVE VICE PRESIDENT AND PRINCIPAL EXECUTIVE OFFICER Joseph J. McAlinden VICE PRESIDENT Barry Fink VICE PRESIDENT Amy R. Doberman VICE PRESIDENT Carsten Otto CHIEF COMPLIANCE OFFICER Stefanie V. Chang VICE PRESIDENT Francis J. Smith TREASURER AND CHIEF FINANCIAL OFFICER Thomas F. Caloia VICE PRESIDENT Mary E. Mullin SECRETARY TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT 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 Portfolio 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 Portfolio. For more detailed information about the Portfolio, its fees and expenses and other pertinent information, please read its Prospectus. The Portfolio's Statement of Additional Information contains additional information about the Portfolio, 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 Portfolio 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) 2005 Morgan Stanley RA05-00691P-Y06/05 [MORGAN STANLEY LOGO] MORGAN STANLEY FUNDS MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INCOME BUILDER PORTFOLIO SEMIANNUAL REPORT JUNE 30, 2005 [MORGAN STANLEY LOGO] WELCOME, SHAREHOLDER: IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INCOME PLUS PORTFOLIO 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 PORTFOLIO'S FINANCIAL STATEMENTS AND A LIST OF PORTFOLIO INVESTMENTS. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE PORTFOLIO BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE PORTFOLIO WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE PORTFOLIO IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE PORTFOLIO WILL DECLINE AND, THEREFORE, THE VALUE OF THE PORTFOLIO'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS PORTFOLIO. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT For the six months ended June 30, 2005 TOTAL RETURN FOR THE 6 MONTHS ENDED JUNE 30, 2005
LEHMAN BROTHERS CLASS X CLASS Y U.S. AGGREGATE INDEX(1) 3.24% 3.12% 2.51%
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. SEE PERFORMANCE SUMMARY FOR PERFORMANCE INFORMATION AND INDEX DEFINITIONS. MARKET CONDITIONS As expected, the Federal Open Market Committee (the "Fed") increased the federal funds target rate at each of its four meetings in the first half of 2005. Consequently, the benchmark overnight rate increased from 2.25 percent at the beginning of the review period to 3.25 percent at the end. Despite the actions of the Fed, most U.S. Treasury yields fell during the second half of the six-month period, erasing all of the gains posted by long-term Treasuries and much of the gains posted by short and intermediate-term Treasuries during the first half of the six-month period. Nevertheless, the period concluded on a positive note, with bond markets achieving positive returns during the month of June. It is important to note, however, that as of the end of the period, we have yet to see the full effects of the Fed's actions on economic activity. For the most part, the market's concerns over rising energy prices and inflation as well as faltering growth have muted the impact of the Fed's rate increases. With two-year and five-year Treasuries near the 3.6 percent to 3.7 percent range at the end of June, the market reflects neither underlying fundamental trends nor a more likely course for Fed policy. PERFORMANCE ANALYSIS The Income Plus Portfolio outperformed the Lehman Brothers U.S. Aggregate Index for the six-month period ended June 30, 2005. The Portfolio's corporate position had a favorable impact on relative performance during the period. An underweighted position relative to the Lehman Index in both the banking and finance and the energy sectors contributed positively to performance. We kept the Portfolio's overall interest-rate exposure well below that of its benchmark during the period. This posture was beneficial as interest rates rose across the short- and intermediate-portions of the curve. However, during periods of declining rates as was experienced during the latter part of the period, the position detracted from relative performance. THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM WELL OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE PORTFOLIO IN THE FUTURE. 2 PORTFOLIO COMPOSITION* Corporate Bonds 75.1% U.S. Government Agencies & Obligations 14.1 Asset-Backed Securities 7.5 Foreign Government Obligations 2.1 Short-Term Investments 1.2
CREDIT ANALYSIS AAA 23.9% AA 8.5 A 25.6 BBB 37.4 BB 4.6
DATA AS OF JUNE 30, 2005. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES FOR PORTFOLIO COMPOSITION ARE AS A PERCENTAGE OF TOTAL INVESTMENTS. ALL PERCENTAGES FOR LONG-TERM CREDIT ANALYSIS ARE AS A PERCENTAGE OF TOTAL LONG-TERM 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. * DOES NOT INCLUDE LONG FUTURES CONTRACTS WITH AN UNDERLYING FACE AMOUNT OF $13,048,906, WITH UNREALIZED APPRECIATION OF $154,191 AND SHORT FUTURES CONTRACTS WITH AN UNDERLYING FACE AMOUNT OF $191,638,050 WITH NET DEPRECIATION OF $97,260. INVESTMENT STRATEGY THE PORTFOLIO WILL NORMALLY INVEST AT LEAST 80 PERCENT OF ITS ASSETS IN (i) U.S. GOVERNMENT SECURITIES ISSUED OR GUARANTEED AS TO PRINCIPAL AND INTEREST BY THE U.S. GOVERNMENT, ITS AGENCIES OR INSTRUMENTALITIES, (ii) DEBT SECURITIES (INCLUDING ZERO COUPON SECURITIES AND ASSET-BACKED SECURITIES) RATED AT THE TIME OF PURCHASE WITHIN THE FOUR HIGHEST BOND RATING CATEGORIES BY MOODY'S INVESTORS SERVICE, INC. ("MOODY'S") OR STANDARD & POOR'S RATINGS GROUP, A DIVISION OF THE MCGRAW HILL COMPANIES INC. ("S&P") OR, IF NOT RATED, DETERMINED TO BE OF COMPARABLE QUALITY BY THE "INVESTMENT ADVISER," MORGAN STANLEY INVESTMENT ADVISORS INC., AND (iii) YANKEE GOVERNMENT BONDS RATED AT THE TIME OF PURCHASE WITHIN THE FOUR HIGHEST RATING CATEGORIES OF MOODY'S OR S&P OR IF NOT RATED DETERMINED TO BE OF COMPARABLE QUALITY BY THE INVESTMENT ADVISER. THE PORTFOLIO MAY ALSO INVEST UP TO 20 PERCENT OF ITS NET ASSETS IN U.S. DOLLAR DENOMINATED DEBT SECURITIES RATED BELOW INVESTMENT GRADE (COMMONLY KNOWN AS "JUNK BONDS") AND UP TO 10% OF ITS NET ASSETS IN NON-U.S. DOLLAR DENOMINATED DEBT SECURITIES WHICH ARE RATED AT THE TIME OF PURCHASE WITHIN THE FOUR HIGHEST RATING CATEGORIES BY MOODY'S OR S&P OR IF NOT RATED, DETERMINED TO BE OF COMPARABLE QUALITY BY THE INVESTMENT ADVISER. THE PORTFOLIO IS NOT LIMITED AS TO THE MATURITIES OF THE U.S. GOVERNMENT AND OTHER DEBT SECURITIES IN WHICH IT MAY INVEST. FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY PORTFOLIO PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE PORTFOLIO'S SECOND AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS 3 ARE FILED ON FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY PORTFOLIO 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 PORTFOLIO'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 PORTFOLIO VOTED PROXIES RELATING TO PORTFOLIO SECURITIES DURING THE MOST RECENT TWELVE-MONTH PERIOD ENDED JUNE 30 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. 4 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED JUNE 30, 2005
CLASS X SHARES CLASS Y SHARES (SINCE 03/01/87) (SINCE 06/05/00) 1 YEAR 8.72%(2) 8.57%(2) 5 YEARS 7.96(2) 7.69(2) 10 YEARS 6.77(2) -- SINCE INCEPTION 7.81(2) 7.75(2)
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 THE 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 PORTFOLIO SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. THE PERFORMANCE OF THE PORTFOLIO'S TWO SHARE CLASSES VARIES BECAUSE EACH HAS DIFFERENT EXPENSES. THE PORTFOLIO'S TOTAL RETURN FIGURES ASSUME THE REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE IMPACT OF ANY CHARGES BY YOUR INSURANCE COMPANY. SUCH COSTS WOULD LOWER PERFORMANCE. (1) THE LEHMAN BROTHERS U.S. AGGREGATE INDEX TRACKS THE PERFORMANCE OF ALL 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. (2) FIGURE ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS FOR THE UNDERLYING PORTFOLIO BASED ON NET ASSET VALUE (NAV). IT DOES NOT REFLECT THE DEDUCTION OF INSURANCE EXPENSES, AN ANNUAL CONTRACT MAINTENANCE FEE, OR SURRENDER CHARGES. 5 EXPENSE EXAMPLE As a shareholder of the Portfolio, you incur two types of costs: (1) insurance company charges; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Portfolio expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Portfolio 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 01/01/05 - 06/30/05. 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 Portfolio's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Portfolio'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 Portfolio 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 insurance company charges. 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 insurance company charges were included, your costs would have been higher.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD * ------------- ------------- --------------- 01/01/05 - 01/01/05 06/30/05 06/30/05 ------------- ------------- --------------- CLASS X Actual (3.24% return) $ 1,000.00 $ 1,032.40 $ 2.72 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,022.12 $ 2.71 CLASS Y Actual (3.12% return) $ 1,000.00 $ 1,031.20 $ 3.98 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,020.88 $ 3.96
- ---------- * EXPENSES ARE EQUAL TO THE PORTFOLIO'S ANNUALIZED EXPENSE RATIO OF 0.54% AND 0.79% 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 fixed income securities trading. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Portfolio's Administrator under the Administration Agreement, including accounting, clerical, bookkeeping, compliance, business management and planning, and the provision of supplies, office space and utilities. (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 administrative and investment advisory services to the Portfolio. 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 Portfolio. 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 The Board reviewed the Portfolio's performance for the one, three and five year periods ended November 30, 2004, as shown in reports provided by Lipper (the "Lipper Reports"), compared to the performance of comparable funds selected by Lipper (the "performance peer group"), and noted that the Portfolio's performance was better than its performance peer group average for all three periods. The Board concluded that the Portfolio's performance was satisfactory. FEES RELATIVE TO OTHER FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT STRATEGIES The Board reviewed the advisory and administrative fees (together, the "management fee") paid by the Portfolio under the Management Agreement. The Board noted that the rate was comparable to the management fee rates charged by the Adviser to any other funds it manages with investment strategies comparable to those of the Portfolio. FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS The Board reviewed the management fee rate and the total expense ratio of the Portfolio. The Board noted that: (i) the Portfolio's management fee rate was lower than the average management fee rate for funds, selected by Lipper (the "expense peer group"), managed by other advisers with investment strategies comparable to those of 7 the Portfolio, as shown in the Lipper Report for the Portfolio; and (ii) the Portfolio's total expense ratio was also lower than the average total expense ratio of the funds included in the Portfolio's expense peer group. The Board concluded that the Portfolio's management fee 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 Portfolio's management fee schedule under the Management Agreement and noted that it includes breakpoints. The Board also reviewed the level of the Portfolio's management fee and noted that the fee, as a percentage of the Portfolio's net assets, would decrease as net assets increase because the management fee includes breakpoints. The Board concluded that the Portfolio's management fee would reflect economies of scale as assets increase. PROFITABILITY OF ADVISER AND AFFILIATES The Board considered and reviewed information concerning the costs incurred and profits realized by the Adviser and its affiliates during the last two years from their relationship with the Portfolio and the Morgan Stanley Fund Complex and reviewed with the Controller of the Adviser the cost allocation methodology used to determine the Adviser's profitability. Based on their review of the information they received, the Board concluded that the profits earned by the Adviser and its affiliates were not excessive in light of the advisory, administrative and other services provided to the Portfolio. FALL-OUT BENEFITS The Board considered so-called "fall-out benefits" derived by the Adviser and its affiliates from their relationship with the Portfolio and the Morgan Stanley Fund Complex, such as "float" benefits derived from handling of checks for purchases and redemptions of Portfolio shares through a broker-dealer affiliate of the Adviser. The Board also considered that a broker-dealer affiliate of the Adviser receives from the Portfolio 12b-1 fees for distribution and shareholder services. The Board concluded that the float benefits were relatively small and that the 12b-1 fees were competitive with those of other broker-dealer affiliates of investment advisers. SOFT DOLLAR BENEFITS The Board considered whether the Adviser realizes any benefits from commissions paid to brokers who execute securities transactions for the Portfolio ("soft dollars"). The Board noted that the Portfolio invests only in fixed income securities, which do not generate soft dollars. 8 ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE PORTFOLIO'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 PORTFOLIO AND THE ADVISER The Board also reviewed and considered the historical relationship between the Portfolio and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Portfolio'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 Portfolio 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 Portfolio'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 Portfolio's business. GENERAL CONCLUSION After considering and weighing all of the above factors, the Board concluded it would be in the best interest of the Portfolio and its shareholders to approve renewal of the Management Agreement for another year. 9 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INCOME PLUS PORTFOLIO PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ---------------------------------------------------------------------------------------------------------- CORPORATE BONDS (74.6%) ADVERTISING/MARKETING SERVICES (0.4%) $ 1,670 WPP Finance (UK) Corp. (United Kingdom) 5.875% 06/15/14 $ 1,768,710 ------------ AEROSPACE & DEFENSE (0.9%) 2,739 Raytheon Co. 6.15 11/01/08 2,892,310 1,093 Systems 2001 Asset Trust LLC - 144A* (Cayman Islands) 6.664 09/15/13 1,192,458 ------------ 4,084,768 ------------ AIR FREIGHT/COURIERS (1.1%) 4,288 FedEx Corp. (Series 97-A) 7.50 01/15/18 5,005,413 ------------ AIRLINES (1.4%) 3,063 America West Airlines, Inc. (Class A) 6.85 07/02/09 3,051,590 1,497 America West Airlines, Inc. (Series 01-1) 7.10 04/02/21 1,585,973 1,865 Southwest Airlines Co. (Series 01-1) 5.496 11/01/06 1,897,787 ------------ 6,535,350 ------------ AUTO PARTS: O.E.M. (0.3%) 420 ArvinMeritor, Inc. 8.75 03/01/12 439,950 475 Lear Corp. (Series B) 8.11 05/15/09 491,573 550 Meritor Automotive Inc. 6.80 02/15/09 547,250 ------------ 1,478,773 ------------ BEVERAGES: ALCOHOLIC (0.4%) 1,880 FBG Finance Ltd. - 144A* (Australia) 5.125 06/15/15 1,891,000 ------------ CABLE/SATELLITE TV (1.9%) 4,405 Comcast Corp. 6.50 01/15/15 4,918,848 2,530 Cox Communications, Inc. 7.75 11/01/10 2,867,783 445 TCI Communications, Inc. 7.875 02/15/26 557,343 ------------ 8,343,974 ------------ CASINO/GAMING (0.8%) 3,345 MGM Mirage Inc. 8.50 09/15/10 3,729,675 ------------ CONTAINERS/PACKAGING (0.6%) 2,435 Sealed Air Corp. - 144A* 5.625 07/15/13 2,506,177 ------------ DEPARTMENT STORES (0.8%) 1,875 May Department Stores Co., Inc. 5.95 11/01/08 1,959,546 1,405 Penney (JC) Co., Inc. 7.40 04/01/37 1,524,425 ------------ 3,483,971 ------------ DISCOUNT STORES (0.2%) 763 Wal-Mart Stores, Inc. (Series 92A1) 7.49 06/21/07 789,173 ------------
SEE NOTES TO FINANCIAL STATEMENTS 10
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ---------------------------------------------------------------------------------------------------------- DRUGSTORE CHAINS (0.7%) $ 970 CVS Corp. 3.875% 11/01/07 $ 965,847 2,345 CVS Corp. 5.625 03/15/06 2,369,639 ------------ 3,335,486 ------------ ELECTRIC UTILITIES (8.4%) 2,640 Arizona Public Service Co. 5.80 06/30/14 2,840,970 1,625 Arizona Public Service Co. 6.75 11/15/06 1,680,263 1,055 CC Funding Trust I 6.90 02/16/07 1,099,295 1,545 Cincinnati Gas & Electric Co. 5.70 09/15/12 1,653,902 5,000 Consolidated Edison Co. of New York (Series B) 7.50 09/01/10 5,760,240 1,495 Consolidated Natural Gas Co. 5.00 12/01/14 1,515,197 320 Consolidated Natural Gas Co. (Series A) 5.00 03/01/14 325,171 2,555 Consolidated Natural Gas Co. (Series C) 6.25 11/01/11 2,791,177 1,730 Consumers Energy Co. 4.80 02/17/09 1,752,983 2,250 Detroit Edison Co. (The) 6.125 10/01/10 2,430,995 2,170 Duquesne Light Co. (Series O) 6.70 04/15/12 2,443,377 940 Entergy Gulf States, Inc. 3.60 06/01/08 920,829 1,875 Entergy Gulf States, Inc. 3.73+ 12/01/09 1,881,229 3,280 Exelon Corp. 6.75 05/01/11 3,646,980 2,540 Pacific Gas & Electric Co. 6.05 03/01/34 2,809,291 565 Panhandle Eastern Pipe Line Co. (Series B) 2.75 03/15/07 550,479 2,500 Public Service Electric & Gas Co. (Series UU) 6.75 03/01/06 2,545,948 1,120 Texas Eastern Transmission, LP 7.00 07/15/32 1,374,125 ------------ 38,022,451 ------------ ELECTRICAL PRODUCTS (0.4%) 1,945 Cooper Industries Inc. 5.25 07/01/07 1,981,473 ------------ ENVIRONMENTAL SERVICES (1.3%) 5,155 Waste Management, Inc. 7.375 08/01/10 5,770,744 ------------ FINANCE/RENTAL/LEASING (6.4%) 2,100 CIT Group, Inc. 2.875 09/29/06 2,071,089 295 CIT Group, Inc. 3.65 11/23/07 291,016 325 CIT Group, Inc. 7.375 04/02/07 342,544 4,645 Countrywide Home Loans, Inc. (Series MTN) 3.25 05/21/08 4,513,180
SEE NOTES TO FINANCIAL STATEMENTS 11
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ---------------------------------------------------------------------------------------------------------- $ 3,000 Ford Capital B.V. (Netherlands) 9.50% 06/01/10 $ 3,103,188 2,685 Ford Motor Credit Co. 7.25 10/25/11 2,586,887 915 MBNA America Bank 7.125 11/15/12 1,053,580 3,345 MBNA Corp. 3.64+ 05/05/08 3,367,355 3,355 MBNA Corp. 6.125 03/01/13 3,661,647 2,450 Residential Capital Corp. - 144A* 6.375 06/30/10 2,464,386 2,360 SLM Corp. 4.00 01/15/10 2,333,700 3,075 SLM Corp. (Series MTNA) 5.00 10/01/13 3,155,098 ------------ 28,943,670 ------------ FINANCIAL CONGLOMERATES (8.7%) 3,785 American Express Co. 5.50 09/12/06 3,844,731 4,585 American Express Co. 6.875 11/01/05 4,630,291 330 Bank One Corp. (Series MTNA) 6.00 02/17/09 348,096 4,295 Citigroup Inc. 5.625 08/27/12 4,594,379 1,345 Citigroup Inc. 6.00 02/21/12 1,470,779 4,565 General Electric Capital Corp. (Series MTNA) 6.75 03/15/32 5,652,479 8,965 General Motors Acceptance Corp. 6.875 09/15/11 8,285,605 4,550 General Motors Acceptance Corp. 8.00 11/01/31 4,070,485 5,290 JPMorgan Chase & Co. 6.75 02/01/11 5,857,056 320 Prudential Holdings, LLC (FSA) - 144A* 7.245 12/18/23 397,705 ------------ 39,151,606 ------------ FOOD RETAIL (1.3%) 3,465 Albertson's Inc. 7.45 08/01/29 3,957,494 1,610 Safeway Inc. 7.25 02/01/31 1,870,163 ------------ 5,827,657 ------------ FOOD: MAJOR DIVERSIFIED (0.5%) 2,305 Kraft Foods Inc. 5.625 11/01/11 2,448,452 ------------ FOREST PRODUCTS (0.1%) 540 Weyerhaeuser Co. 6.00 08/01/06 549,760 ------------ GAS DISTRIBUTORS (0.7%) 1,870 NiSource Finance Corp. 3.854+ 11/23/09 1,879,191 1,125 Sempra Energy 4.621 05/17/07 1,130,815 ------------ 3,010,006 ------------ HOME FURNISHINGS (0.4%) 1,570 Mohawk Industries, Inc. (Series D) 7.20 04/15/12 1,796,840 ------------ HOTELS/RESORTS/CRUISELINES (0.8%) 620 Marriott International, Inc. (Series E) 7.00 01/15/08 659,234
SEE NOTES TO FINANCIAL STATEMENTS 12
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ---------------------------------------------------------------------------------------------------------- $ 2,700 Starwood Hotels & Resorts Worldwide, Inc. 7.875% 05/01/12 $ 3,057,750 ------------ 3,716,984 ------------ INDUSTRIAL CONGLOMERATES (1.4%) 615 Hutchison Whampoa International Ltd. - 144A* (Cayman Islands) 6.50 02/13/13 668,905 1,705 Textron Financial Corp. 4.125 03/03/08 1,703,986 3,775 United Technologies Corp. 4.375 05/01/10 3,814,018 ------------ 6,186,909 ------------ INSURANCE BROKERS/SERVICES (2.5%) 2,505 Farmers Exchange Capital - 144A* 7.05 07/15/28 2,716,898 3,105 Farmers Insurance Exchange - 144A* 8.625 05/01/24 3,864,393 4,570 Marsh & McLennan Companies, Inc. 5.375 07/15/14 4,560,229 ------------ 11,141,520 ------------ INVESTMENT BANKS/BROKERS (0.2%) 515 Goldman Sachs Group Inc. (The) 5.25 10/15/13 532,319 295 Goldman Sachs Group Inc. (The) 6.60 01/15/12 328,306 ------------ 860,625 ------------ LIFE/HEALTH INSURANCE (2.0%) 5,000 John Hancock Financial Services, Inc. 5.625 12/01/08 5,227,940 3,350 MetLife, Inc. (Note 4) 6.125 12/01/11 3,643,018 ------------ 8,870,958 ------------ MAJOR BANKS (3.6%) 1,035 Bank of New York Co., Inc. (The) 5.20 07/01/07 1,055,205 1,660 HSBC Finance Corp. 6.75 05/15/11 1,844,766 1,800 Huntington National Bank (Series BKNT) 4.375 01/15/10 1,803,578 5,000 Wachovia Bank NA (Series BKNT) 7.80 08/18/10 5,813,940 5,000 Well Fargo Bank NA 7.55 06/21/10 5,743,105 ------------ 16,260,594 ------------ MAJOR TELECOMMUNICATIONS (3.5%) 3,510 AT&T Corp. 9.75 11/15/31 4,584,938 2,790 Deutsche Telekom International Finance NV (Netherlands) 8.75 06/15/30 3,789,333 2,660 France Telecom S.A. (France) 8.75 03/01/31 3,720,210 1,000 GTE Corp. 7.90 02/01/27 1,083,743 1,920 Sprint Capital Corp. 8.75 03/15/32 2,679,287 ------------ 15,857,511 ------------
SEE NOTES TO FINANCIAL STATEMENTS 13
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ---------------------------------------------------------------------------------------------------------- MANAGED HEALTH CARE (3.0%) $ 3,930 Aetna, Inc. 7.375% 03/01/06 $ 4,012,640 1,165 Aetna, Inc. 7.875 03/01/11 1,361,432 3,920 Anthem, Inc. 6.80 08/01/12 4,429,573 850 UnitedHealth Group Inc. 5.20 01/17/07 863,988 1,565 UnitedHealth Group Inc. 7.50 11/15/05 1,582,833 1,450 WellPoint Health Networks Inc. 6.375 06/15/06 1,481,471 ------------ 13,731,937 ------------ MEDIA CONGLOMERATES (2.1%) 2,190 Historic TW Inc. 6.625 05/15/29 2,447,905 1,140 News America, Inc. 7.28 06/30/28 1,329,377 562 News America Inc. 7.30 04/30/28 655,984 4,130 Time Warner, Inc. 7.70 05/01/32 5,241,383 ------------ 9,674,649 ------------ MEDICAL SPECIALTIES (0.2%) 895 Fisher Scientific International, Inc. 6.75 08/15/14 939,750 ------------ MOTOR VEHICLES (2.2%) 725 DaimlerChrysler North American Holdings Co. 7.30 01/15/12 811,203 1,490 DaimlerChrysler North American Holdings Co. 8.00 06/15/10 1,685,953 1,420 DaimlerChrysler North American Holdings Co. 8.50 01/18/31 1,804,359 210 Ford Motor Co. 7.45 07/16/31 175,760 6,510 General Motors Corp. 8.375 07/15/33 5,468,400 ------------ 9,945,675 ------------ MULTI-LINE INSURANCE (3.7%) 4,400 American General Finance Corp. (Series MTNF) 5.875 07/14/06 4,477,198 500 American General Finance Corp. (Series MTNH) 4.625 09/01/10 502,919 465 AXA Financial Inc. 6.50 04/01/08 492,685 165 Hartford Financial Services Group, Inc. (The) 2.375 06/01/06 162,088 4,900 Hartford Financial Services Group, Inc. (The) 7.90 06/15/10 5,643,413 5,000 Nationwide Financial Services, Inc. 8.00 03/01/27 5,478,115 ------------ 16,756,418 ------------
SEE NOTES TO FINANCIAL STATEMENTS 14
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ---------------------------------------------------------------------------------------------------------- OIL & GAS PRODUCTION (2.1%) $ 880 Kerr-McGee Corp. 7.875% 09/15/31 $ 1,006,464 1,085 Pemex Project Funding Master Trust 7.375 12/15/14 1,219,540 2,670 Pemex Project Funding Master Trust 8.00 11/15/11 3,039,795 1,710 Pemex Project Funding Master Trust 8.625 02/01/22 2,111,850 1,610 Pemex Project Funding Master Trust 9.125 10/13/10 1,889,335 ------------ 9,266,984 ------------ OTHER METALS/MATERIALS (0.4%) 1,605 Brascan Corp. (Canada) 7.125 06/15/12 1,808,010 ------------ PHARMACEUTICALS: OTHER (0.0%) 99 Marion Merrell Dow Inc. ASOP 9.11 08/01/05 99,533 ------------ PROPERTY - CASUALTY INSURERS (1.1%) 2,500 Mantis Reef Ltd. - 144A* (Australia) 4.692 11/14/08 2,509,485 2,500 St. Paul Travelers 5.01 08/16/07 2,532,420 ------------ 5,041,905 ------------ PULP & PAPER (1.4%) 1,000 Abitibi-Consolidated Inc. (Canada) 8.55 08/01/10 1,047,500 3,535 Abitibi-Consolidated Inc. (Canada) 8.85 08/01/30 3,402,438 1,705 Sappi Papier Holding AG - 144A* (Austria) 6.75 06/15/12 1,824,604 ------------ 6,274,542 ------------ RAILROADS (2.1%) 3,533 Burlington Northern Santa Fe Corp. (Series 95-A) 7.97 01/01/15 4,094,208 1,470 Norfolk Southern Corp. 7.35 05/15/07 1,552,249 1,575 Union Pacific Corp. 6.625 02/01/08 1,665,240 1,030 Union Pacific Corp. 6.65 01/15/11 1,147,197 790 Union Pacific Corp. (Series MTNE) 6.79 11/09/07 836,435 ------------ 9,295,329 ------------ REAL ESTATE DEVELOPMENT (0.4%) 205 World Financial Properties - 144A* 6.95 09/01/13 222,650 1,610 World Financial Properties - 144A* 6.91 09/01/13 1,745,640 ------------ 1,968,290 ------------ REGIONAL BANKS (1.0%) 4,335 Marshall & Ilsley Bank (Series BKNT) 3.80 02/08/08 4,303,115 ------------ SAVINGS BANKS (1.8%) 500 Household Finance Corp. 4.125 11/16/09 495,083 1,140 Household Finance Corp. 6.375 10/15/11 1,248,028
SEE NOTES TO FINANCIAL STATEMENTS 15
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ---------------------------------------------------------------------------------------------------------- $ 1,915 Household Finance Corp. 8.00% 07/15/10 $ 2,211,972 3,630 Washington Mutual Inc. 8.25 04/01/10 4,173,131 ------------ 8,128,214 ------------ TOBACCO (1.0%) 1,570 Altria Group, Inc. 7.00 11/04/13 1,759,802 2,195 Altria Group, Inc. 7.75 01/15/27 2,643,342 ------------ 4,403,144 ------------ WIRELESS TELECOMMUNICATIONS (0.4%) 1,655 AT&T Wireless Services, Inc. 7.875 03/01/11 1,925,620 ------------ TOTAL CORPORATE BONDS (COST $318,303,605) 336,913,345 ------------ ASSET-BACKED SESCURITIES (7.4%) FINANCE/RENTAL/LEASING 1,800 American Express Credit Account Master Trust 2001-2 A 5.53 10/15/08 1,822,023 2,300 Chase Manhattan Auto Owner Trust 2004-A A4 2.83 09/15/10 2,246,970 1,600 CIT Equipment Collateral 2004-EF1 A3 3.50 09/20/08 1,581,144 2,500 DaimlerChrysler Auto Trust 2003-B A4 2.86 03/09/09 2,460,269 1,750 Ford Credit Auto Owner Trust 2005-B A3 4.17 01/15/09 1,755,275 2,200 Harley-Davidson Motorcycle Trust 2004-2 A2 3.56 02/15/12 2,183,667 3,150 Harley-Davidson Motorcycle Trust 2005-1 A2 3.76 12/17/12 3,132,845 2,600 Honda Auto Receivables Owner Trust 2004-1 A4 3.06 10/21/09 2,556,938 1,400 Honda Auto Receivables Owner Trust 2005-2 A3 3.93 01/15/09 1,399,599 3,500 MBNA Credit Card Master Note Trust 2004-A4 A4 2.70 09/15/09 3,426,546 2,425 TXU Electric Delivery Transition Bond Co. LLC 2004-1 A2 4.81 11/17/14 2,487,639 1,300 USAA Auto Owner Trust 2004-2 A3 3.03 06/16/08 1,288,870 3,500 USAA Auto Owner Trust 2004-2 A4 3.58 02/15/11 3,471,318 2,100 USAA Auto Owner Trust 2005-1 A3 3.90 07/15/09 2,098,378 1,700 Volkswagen Auto Lease Trust 2005-A A3 3.82 05/20/08 1,697,701 ------------ TOTAL ASSET-BACKED SESCURITIES (COST $33,862,479) 33,609,182 ------------
SEE NOTES TO FINANCIAL STATEMENTS 16
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ---------------------------------------------------------------------------------------------------------- U.S. GOVERNMENT & AGENCIES OBLIGATIONS (14.0%) Federal Home Loan Mortgage Corp. $ 14 6.50% 12/01/28 $ 14,238 57 8.50 01/01/22 - 12/01/24 62,161 4 Federal Home Loan Mortgage Corp. Gold 11.50 05/01/19 4,016 Federal National Mortgage Assoc. 271 7.50 06/01/28 - 04/01/32 289,573 3,160 8.00 08/01/29 - 04/01/32 3,399,347 2 9.00 06/01/21 - 01/01/25 2,475 Government National Mortgage Assoc. 2 7.50 04/15/24 - 09/15/27 1,627 975 8.00 10/15/24 - 11/15/29 1,054,761 165 8.50 06/15/17 - 03/01/28 180,336 110 9.00 07/15/24 - 12/15/24 121,328 13 10.00 05/15/16 - 04/15/19 14,403 U.S. Treasury Bond 18,200 6.125 08/15/29 23,244,112 7,050 6.375 08/15/27 9,142,694 15,950 U.S. Treasury Note 4.25 08/15/13 16,353,742 22,000 U.S. Treasury Strip 0.00 02/15/25 - 02/15/27 9,288,872 ------------ TOTAL U.S. GOVERNMENT AGENCIES & OBLIGATIONS (COST $58,931,128) 63,173,685 ------------ FOREIGN GOVERNMENT OBLIGATIONS (2.1%) 2,900 United Mexican States (Mexico) 8.375 01/14/11 3,382,850 870 United Mexican States (Mexico) 9.875 02/01/10 1,054,440 4,145 United Mexican States (Mexico) (Series MTNA) 8.00 09/24/22 5,087,988 ------------ TOTAL FOREIGN GOVERNMENT OBLIGATIONS (COST $8,345,927) 9,525,278 ------------ SHORT-TERM INVESTMENTS (1.1%) U.S. GOVERNMENT AGENCY (a) (0.1%) 700 U.S. Treasury Bill** (COST $699,347) 2.585 07/14/05 699,347 ------------
SEE NOTES TO FINANCIAL STATEMENTS 17
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ---------------------------------------------------------------------------------------------------------- REPURCHASE AGREEMENT (1.0%) $ 4,408 The Bank of New York (dated 06/30/05; proceeds $4,408,189) (b) (COST $4,407,806) 3.125% 07/01/05 $ 4,407,806 ------------- TOTAL SHORT-TERM INVESTMENTS (COST $5,107,153) 5,107,153 ------------- TOTAL INVESTMENTS (COST $424,550,292) (c) (d) 99.2% 448,328,643 OTHER ASSETS IN EXCESS OF LIABILITIES 0.8 3,675,209 ----- ------------- NET ASSETS 100.0% $ 452,003,852 ===== =============
- ---------- FSA FINANCIAL SECURITY ASSURANCE INC. * RESALE IS RESTRICTED TO QUALIFIED INSTITUTIONAL INVESTORS. ** A PORTION OF THIS SECURITY HAS BEEN PHYSICALLY SEGREGATED IN CONNECTION WITH OPEN FUTURES CONTRACTS IN THE AMOUNT OF $554,850. + FLOATING RATE SECURITY, RATE SHOWN IS THE RATE IN EFFECT AT JUNE 30, 2005. (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 A AMOUNT EQUAL TO $203,883,668 IN CONNECTION WITH SECURITIES PURCHASED ON A FORWARD COMMITMENT BASIS AND 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 $24,426,184 AND THE AGGREGATE GROSS UNREALIZED DEPRECIATION IS $2,906,068 RESULTING IN NET UNREALIZED APPRECIATION OF $21,520,116. FUTURES CONTRACTS OPEN AT JUNE 30, 2005:
UNREALIZED NUMBER OF DESCRIPTION, DELIVERY UNDERLYING FACE APPRECIATION/ CONTRACTS LONG/SHORT MONTH AND YEAR AMOUNT AT VALUE (DEPRECIATION) - ------------------------------------------------------------------------------------------------------------ 115 Long U.S. Treasury Bonds 10 year, $ 13,048,906 $ 154,191 September 2005 30 Short U.S. Treasury Notes 20 year, (3,562,500) (126,982) September 2005 579 Short U.S. Treasury Notes 5 year, (63,047,675) 33,554 September 2005 602 Short U.S. Treasury Notes 2 year, (125,027,875) (3,832) September 2005 ------------ NET UNREALIZED APPRECIATION $ 56,931 ============
SEE NOTES TO FINANCIAL STATEMENTS 18 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INCOME PLUS PORTFOLIO FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 2005 (UNAUDITED) ASSETS: Investments in securities, at value (cost $421,077,886) $ 444,685,625 Investments in affiliates, at value (cost $3,472,406) 3,643,018 Cash 1,102,332 Receivable for: Interest 6,623,941 Investments sold 779,876 Prepaid expenses and other assets 15,641 --------------- TOTAL ASSETS 456,850,433 --------------- LIABILITIES: Payable for: Investments purchased 4,479,327 Investment advisory fee 155,473 Variation margin 84,922 Distribution fee 37,018 Administration fee 29,614 Shares of beneficial interest redeemed 39 Accrued expenses and other payables 60,188 --------------- TOTAL LIABILITIES 4,846,581 --------------- NET ASSETS $ 452,003,852 --------------- COMPOSITION OF NET ASSETS: Paid-in-capital $ 456,689,725 Net unrealized appreciation 23,835,282 Dividends in excess of net investment income (3,443,957) Accumulated net realized loss (25,077,198) --------------- NET ASSETS $ 452,003,852 =============== CLASS X SHARES: Net Assets $ 269,074,224 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 25,043,958 NET ASSET VALUE PER SHARE $ 10.74 =============== CLASS Y SHARES: Net Assets $ 182,929,628 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 17,050,039 NET ASSET VALUE PER SHARE $ 10.73 ===============
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2005 (UNAUDITED) NET INVESTMENT INCOME: INCOME Interest $ 12,089,125 Interest from affiliates 101,938 --------------- TOTAL INCOME 12,191,063 --------------- EXPENSES Investment advisory fee 955,646 Distribution fee (Class Y shares) 221,946 Administration fee 182,028 Custodian fees 25,396 Shareholder reports and notices 19,457 Professional fees 14,911 Trustees' fees and expenses 3,245 Transfer agent fees and expenses 250 Other 20,277 --------------- TOTAL EXPENSES 1,443,156 --------------- NET INVESTMENT INCOME 10,747,907 --------------- NET REALIZED AND UNREALIZED GAIN (LOSS): NET REALIZED GAIN (LOSS) ON: Investments 7,711,220 Futures contracts (564,933) --------------- NET REALIZED GAIN 7,146,287 --------------- NET CHANGE IN UNREALIZED APPRECIATION/ DEPRECIATION ON: Investments (3,829,656) Futures contracts 182,305 --------------- NET DEPRECIATION (3,647,351) --------------- NET GAIN 3,498,936 --------------- NET INCREASE $ 14,246,843 ===============
SEE NOTES TO FINANCIAL STATEMENTS 19 STATEMENT OF CHANGES IN NET ASSETS
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 --------------- ----------------- (UNAUDITED) INCREASE (DECREASE) IN NET ASSETS: OPERATIONS: Net investment income $ 10,747,907 $ 24,572,043 Net realized gain 7,146,287 4,539,039 Net change in unrealized appreciation (3,647,351) (5,101,089) --------------- --------------- NET INCREASE 14,246,843 24,009,993 --------------- --------------- DIVIDENDS TO SHAREHOLDERS FROM NET INVESTMENT INCOME: Class X shares (7,286,970) (17,981,590) Class Y shares (4,490,642) (8,324,916) --------------- --------------- TOTAL DIVIDENDS (11,777,612) (26,306,506) --------------- --------------- Net decrease from transactions in shares of beneficial interest (22,764,795) (29,588,916) --------------- --------------- NET DECREASE (20,295,564) (31,885,429) NET ASSETS: Beginning of period 472,299,416 504,184,845 --------------- --------------- END OF PERIOD (INCLUDING DIVIDENDS IN EXCESS OF NET INVESTMENT INCOME OF $3,443,957 AND $2,414,252, RESPECTIVELY) $ 452,003,852 $ 472,299,416 =============== ===============
SEE NOTES TO FINANCIAL STATEMENTS 20 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INCOME PLUS PORTFOLIO NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) 1. ORGANIZATION AND ACCOUNTING POLICIES Morgan Stanley Variable Investment Series (the "Fund") -- Income Plus Portfolio (the "Portfolio"), formerly Morgan Stanley Variable Investment Series -- Quality Income Plus Portfolio, one of 15 separate portfolios, is registered under the Investment Company Act of 1940, as amended (the "Act"), as a diversified, open-end management investment company. The Fund is offered exclusively to life insurance companies in connection with particular life insurance and/or annuity contracts they offer. The Portfolio's primary investment objective is to earn a high level of current income and, as a secondary objective, capital appreciation, but only when consistent with its primary objective. The Fund was organized as a Massachusetts business trust on February 25, 1983 and the Portfolio commenced operations on March 1, 1987. On June 5, 2000, the Portfolio commenced offering one additional class of shares (Class Y). The Portfolio offers Class X shares and Class Y shares. The two are identical except that Class Y shares incur distribution expenses. Class X shares are generally available to holders of contracts offered by Metropolitan Life Insurance Company (formerly Paragon Life Insurance Company) and other contracts offered before May 1, 2000. Class Y shares are available to holders of contracts offered on or after June 5, 2000. The following is a summary of significant accounting policies: A. VALUATION OF INVESTMENTS -- (1) certain portfolio securities may be valued by an outside pricing service approved by the Fund's Trustees; (2) portfolio securities for which over-the-counter market quotations are readily available are valued at the mean between the last reported bid and asked price; (3) futures are valued at the latest price published by the commodities exchange on which they trade; (4) when market quotations are not readily available or Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") determines that the market quotations are not reflective of a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees; and (5) short-term debt securities having a maturity date of more than sixty days at time of purchase are valued on a mark-to-market basis until sixty days prior to maturity and thereafter at amortized cost based on their value on the 61st day. Short-term debt securities having a maturity date of sixty days or less at the time of purchase are valued at amortized cost. B. ACCOUNTING FOR INVESTMENTS -- Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Realized gains and losses on security transactions are determined by the identified cost method. Discounts are accreted and premiums are amortized over the life of the respective securities. Interest income is accrued daily. 21 C. REPURCHASE AGREEMENTS -- The Fund may 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. 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 Portfolio 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 Portfolio 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 Portfolio 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. F. 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. G. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- Dividends and distributions to shareholders are recorded on the ex-dividend date. H. EXPENSES -- Direct expenses are charged to the Portfolio and general Fund expenses are allocated on the basis of relative net assets or equally among the Portfolios. I. 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, the Portfolio pays the Investment Adviser an advisory fee, accrued daily and payable monthly, by applying the following annual rates to the net assets of the Portfolio determined at the close of each business day: 0.42% to the portion of daily net assets not exceeding $500 million; 0.35% to the portion of daily net assets exceeding $500 million but not exceeding $1.25 billion and 0.22% to the portion of daily net assets in excess of $1.25 billion. 22 Pursuant to an Administration Agreement with Morgan Stanley Services Company Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Portfolio pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.08% to the Portfolio'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 Class Y shares of the Portfolio will pay a distribution fee which is accrued daily and paid monthly at the annual rate of 0.25% of the average daily net assets of the class. 4. SECURITY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES The cost of purchases and proceeds from sales/prepayments of portfolio securities, excluding short-term investments, for the six months ended June 30, 2005, aggregated $145,221,502 and $158,079,776, respectively. Included in the aforementioned are purchases and sales/prepayments of U.S. Government Securities in the amount of $63,877,014 and $33,857,874, respectively. The Portfolio had income from MetLife Corp., an affiliate of the Fund, for $101,938 with a value of $3,643,018. Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and Distributor, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and compensation. Aggregate pension costs for the six months ended June 30, 2005 included in Trustees' fees and expenses in the Statement of Operations amounted to $400. At June 30, 2005, the Portfolio had an accrued pension liability of $7,494 which is included in accrued expenses in the Statement of Assets and Liabilities. On December 2, 2003, the Trustees voted to close the plan to new participants and eliminate the future benefits growth due to increases to compensation after July 31, 2003. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received 23 from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 5. SHARES OF BENEFICIAL INTEREST Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 -------------------------------- -------------------------------- (UNAUDITED) SHARES AMOUNT SHARES AMOUNT -------------- -------------- -------------- -------------- CLASS X SHARES Sold 2,264,200 $ 24,145,095 6,339,005 $ 68,175,506 Reinvestment of dividends 685,455 7,286,970 1,690,773 17,981,590 Redeemed (5,637,735) (60,051,780) (14,195,320) (151,775,569) -------------- -------------- -------------- -------------- Net decrease -- Class X (2,688,080) (28,619,715) (6,165,542) (65,618,473) -------------- -------------- -------------- -------------- CLASS Y SHARES Sold 2,581,884 27,439,566 6,059,037 64,569,427 Reinvestment of dividends 423,031 4,490,642 784,156 8,324,916 Redeemed (2,458,382) (26,075,288) (3,469,059) (36,864,786) -------------- -------------- -------------- -------------- Net increase -- Class Y 546,533 5,854,920 3,374,134 36,029,557 -------------- -------------- -------------- -------------- Net decrease in Portfolio (2,141,547) $ (22,764,795) (2,791,408) $ (29,588,916) ============== ============== ============== ==============
6. 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 December 31, 2004, the Portfolio had a net capital loss carryforward of approximately $32,345,000 of which $959,000 will expire on December 31, 2007, $10,496,000 will expire on December 31, 2008 and $20,890,000 will expire on December 31, 2010 to offset future capital gains to the extent provided by regulations. As of December 31, 2004, the Portfolio had temporary book/tax differences primarily attributable to book amortization of premiums on debt securities, capital loss deferrals on wash sales and capital loss from mark-to-market of futures contracts. 24 7. PURPOSES OF RISKS RELATING TO CERTAIN FINANCIAL INSTRUMENTS To hedge against adverse interest rate, foreign currency and market risks, the Portfolio may purchase and sell interest rate and index futures contracts ("futures contract"). Futures contracts involve elements of market risk in excess of the amount reflected in the Statement of Assets and Liabilities. The Portfolio bears the risk of an unfavorable change in the value of the underlying securities. Risks may also arise upon entering into these contracts from the potential inability of the counterparties to meet the terms of their contracts. 25 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INCOME PLUS PORTFOLIO FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED -------------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ----------- ----------- ----------- ----------- ----------- (UNAUDITED) CLASS X SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 10.68 $ 10.73 $ 10.47 $ 10.55 $ 10.22 $ 9.86 ----------- ----------- ----------- ----------- ----------- ----------- Income (loss) from investment operations: Net investment income++ 0.25 0.55 0.56 0.58 0.61 0.68 Net realized and unrealized gain (loss) 0.09 (0.01) 0.30 (0.02) 0.34 0.37 ----------- ----------- ----------- ----------- ----------- ----------- Total income from investment operations 0.34 0.54 0.86 0.56 0.95 1.05 ----------- ----------- ----------- ----------- ----------- ----------- Less dividends from net investment income (0.28) (0.59) (0.60) (0.64) (0.62) (0.69) ----------- ----------- ----------- ----------- ----------- ----------- Net asset value, end of period $ 10.74 $ 10.68 $ 10.73 $ 10.47 $ 10.55 $ 10.22 =========== =========== =========== =========== =========== =========== TOTAL RETURN+ 3.24%(2) 5.23% 8.45% 5.51% 9.57% 11.09% RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.54%(3) 0.54% 0.53% 0.52% 0.53% 0.52% Net investment income 4.82%(3) 5.18% 5.30% 5.57% 5.82% 6.90% SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 269,074 $ 296,246 $ 363,555 $ 423,685 $ 452,757 $ 406,508 Portfolio turnover rate 33%(2) 28% 72% 106% 150% 105%
- ---------- * PRIOR TO JUNE 5, 2000, THE PORTFOLIO ISSUED ONE CLASS OF SHARES. ALL SHARES OF THE PORTFOLIO HELD PRIOR TO MAY 1, 2000 HAVE BEEN DESIGNATED CLASS X SHARES. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 26
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ------------------------------------------------------------------ JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ----------- ----------- ----------- ----------- ----------- (UNAUDITED) CLASS Y SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 10.67 $ 10.71 $ 10.46 $ 10.54 $ 10.21 $ 9.80 ----------- ----------- ----------- ----------- ----------- ----------- Income (loss) from investment operations: Net investment income++ 0.24 0.52 0.54 0.54 0.57 0.38 Net realized and unrealized gain (loss) 0.09 0.01 0.29 (0.01) 0.36 0.42 ----------- ----------- ----------- ----------- ----------- ----------- Total income from investment operations 0.33 0.53 0.83 0.53 0.93 0.80 ----------- ----------- ----------- ----------- ----------- ----------- Less dividends from net investment income (0.27) (0.57) (0.58) (0.61) (0.60) (0.39) ----------- ----------- ----------- ----------- ----------- ----------- Net asset value, end of period $ 10.73 $ 10.67 $ 10.71 $ 10.46 $ 10.54 $ 10.21 =========== =========== =========== =========== =========== =========== TOTAL RETURN+ 3.12%(2) 5.07% 8.09% 5.26% 9.33% 8.31%(2) RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.79%(3) 0.79% 0.78% 0.77% 0.78% 0.77%(3) Net investment income 4.57%(3) 4.93% 5.05% 5.32% 5.57% 6.53%(3) SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 182,930 $ 176,054 $ 140,629 $ 102,262 $ 54,115 $ 5,176 Portfolio turnover rate 33%(2) 28% 72% 106% 150% 105%
- ---------- * FOR THE PERIOD JUNE 5, 2000 (ISSUED DATE) THROUGH DECEMBER 31, 2000. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 27 TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo CHAIRMAN OF THE BOARD Mitchell M. Merin PRESIDENT Ronald E. Robison EXECUTIVE VICE PRESIDENT and PRINCIPAL EXECUTIVE OFFICER Joseph J. McAlinden VICE PRESIDENT Barry Fink VICE PRESIDENT Amy R. Doberman VICE PRESIDENT Carsten Otto CHIEF COMPLIANCE OFFICER Stefanie V. Chang VICE PRESIDENT Francis J. Smith TREASURER and CHIEF FINANCIAL OFFICER Thomas F. Caloia VICE PRESIDENT Mary E. Mullin SECRETARY TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT 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 Portfolio 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 Portfolio. For more detailed information about the Portfolio, its fees and expenses and other pertinent information, please read its Prospectus. The Portfolio's Statement of Additional Information contains additional information about the Portfolio, 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 Portfolio 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) 2005 Morgan Stanley [MORGAN STANLEY LOGO] RA05-00667P-Y06/05 [GRAPHIC] MORGAN STANLEY FUNDS MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INCOME PLUS PORTFOLIO SEMIANNUAL REPORT JUNE 30, 2005 [MORGAN STANLEY LOGO] WELCOME, SHAREHOLDER: IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INFORMATION PORTFOLIO 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 PORTFOLIO'S FINANCIAL STATEMENTS AND A LIST OF PORTFOLIO INVESTMENTS. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE PORTFOLIO BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE PORTFOLIO WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE PORTFOLIO IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE PORTFOLIO WILL DECLINE AND, THEREFORE, THE VALUE OF THE PORTFOLIO'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS PORTFOLIO. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT For the six months ended June 30, 2005 TOTAL RETURN FOR THE 6 MONTHS ENDED JUNE 30, 2005
S&P 500(R) CLASS X CLASS Y INDEX(1) -6.04% -6.29% -0.81%
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. SEE PERFORMANCE SUMMARY FOR PERFORMANCE INFORMATION AND INDEX DEFINITIONS. MARKET CONDITIONS The broad stock market turned in a flat performance for the six months ended June 30, 2005, as evidenced by the S&P 500(R) Index's -0.81 percent return. U.S. economic growth continued at a moderate rate, but investors feared its future pace was in jeopardy against a backdrop of rising interest rates and high oil prices. The Federal Open Market Committee (the "Fed") maintained its "measured" interest rate increases, which were generally unsurprising to the market. However, when investors began to believe that the Fed was nearing the end of its rate hikes, sentiment turned more optimistic. Driven by growing demand and tight supply concerns, oil prices reached a new high, topping $60 per barrel by the end of the period. But the market did not collapse under these pressures. Generally speaking, companies reported strong earnings, built up cash flows and were financially healthier than in recent years. Consumer spending trends remained robust, and inflation appeared contained. Technology stocks faced a particularly challenging investment environment. Rising interest rates and spiking oil prices dampened investors' enthusiasm for technology related stocks. Instead, investors opted for more "defensive" areas of the broad market such as energy, utilities and health care. Additionally, corporations still hesitated in deploying their cash stockpiles for technology spending and improvements. PERFORMANCE ANALYSIS The Information Portfolio underperformed the S&P 500(R) Index for the six months ended June 30, 2005. Within the Portfolio, computer hardware and peripherals stocks lagged most significantly. Negative company-specific news fuelled a pessimistic sentiment that significantly hurt the entire industry during the reporting period. The software sector was also an area of weakness, although strong stock selection offset some of the negative impact to performance. We attribute this weakness to the seasonality of software stocks, a trend we have observed in each of the past few years. Specifically, company managements have historically spent more on technology in the second half of a calendar year in order to flush their budgets. As a result, software stocks have tended to languish in the first half of the year. However, the Portfolio did include some strong pockets of performance. Semiconductor stocks added to the Portfolio's overall return, as improving industry fundamentals drove gains. Sentiment also brightened as investors became increasingly confident that the stock market was not heading towards another downturn and that the semiconductor inventory surplus had been resolved. Strong stock selection in telecommunication services also served the Portfolio well. New subscriber growth and healthier balance sheets indicated that these companies' fundamentals continued to improve from previous years. Internet services and software holdings 2 also contributed to the Portfolio's overall return, due to company-specific events. THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM WELL OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE PORTFOLIO IN THE FUTURE. TOP 10 HOLDINGS Intel Corp. 6.0% Microsoft Corp. 5.8 Corning Inc. 4.4 Oracle Corp. 4.3 Cisco Systems, Inc. 4.2 Dell, Inc. 4.2 QUALCOMM, Inc. 3.8 Marvell Technology Group, Ltd. (Bermuda) 3.3 Linear Technology Corp. 3.2 VERITAS Software Corp. 3.2
TOP FIVE INDUSTRIES Packaged Software 19.5% Semiconductors 18.1 Telecommunications Equipment 12.1 Computer Processing Hardware 8.0 Internet Software/Services 7.0
DATA AS OF JUNE 30, 2005. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES FOR TOP 10 HOLDINGS AND TOP FIVE INDUSTRIES ARE AS A PERCENTAGE OF NET ASSETS. 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. INVESTMENT STRATEGY THE PORTFOLIO WILL NORMALLY INVEST AT LEAST 80% OF ITS ASSETS IN COMMON STOCKS AND OTHER EQUITY SECURITIES OF COMPANIES LOCATED THROUGHOUT THE WORLD THAT ARE ENGAGED IN THE COMMUNICATIONS AND INFORMATION INDUSTRY. THE PORTFOLIO NORMALLY HOLDS COMMON STOCKS AND OTHER EQUITY SECURITIES OF COMPANIES LOCATED IN AT LEAST THREE COUNTRIES, ONE OF WHICH IS THE UNITED STATES. THE PORTFOLIO MAY INVEST UP TO 50% OF ITS NET ASSETS IN THE SECURITIES (INCLUDING DEPOSITARY RECEIPTS) OF FOREIGN COMPANIES; HOWEVER, IT WILL NOT INVEST MORE THAN 25% OF ITS NET ASSETS IN ANY ONE FOREIGN COUNTRY. IN ADDITION, THE PORTFOLIO WILL NOT INVEST MORE THAN 10% OF ITS NET ASSETS IN CONVERTIBLE SECURITIES. IN DECIDING WHICH SECURITIES TO BUY, HOLD OR SELL, THE PORTFOLIO'S "INVESTMENT ADVISER," MORGAN STANLEY INVESTMENT ADVISORS INC., CONSIDERS BUSINESS, ECONOMIC AND POLITICAL CONDITIONS. FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY PORTFOLIO PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE PORTFOLIO'S SECOND AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY PORTFOLIO 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 3 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 PORTFOLIO'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 PORTFOLIO VOTED PROXIES RELATING TO PORTFOLIO SECURITIES DURING THE MOST RECENT TWELVE-MONTH PERIOD ENDED JUNE 30 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. 4 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED JUNE 30, 2005
CLASS X SHARES CLASS Y SHARES (SINCE 11/06/00) (SINCE 11/06/00) 1 YEAR (1.27%)(2) (1.49%)(2) SINCE INCEPTION (14.83)(2) (15.07)(2)
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 THE 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 PORTFOLIO SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. THE PERFORMANCE OF THE PORTFOLIO'S TWO SHARE CLASSES VARIES BECAUSE EACH HAS DIFFERENT EXPENSES. THE PORTFOLIO'S TOTAL RETURN FIGURES ASSUME THE REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE IMPACT OF ANY CHARGES BY YOUR INSURANCE COMPANY. SUCH COST WOULD LOWER PERFORMANCE. (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) FIGURE ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS FOR THE UNDERLYING PORTFOLIO BASED ON NET ASSET VALUE (NAV). IT DOES NOT REFLECT THE DEDUCTION OF INSURANCE EXPENSES, AN ANNUAL CONTRACT MAINTENANCE FEE, OR SURRENDER CHARGES. 5 EXPENSE EXAMPLE As a shareholder of the Portfolio, you incur two types of costs: (1) insurance company charges; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Portfolio expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Portfolio 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 01/01/05 - 06/30/05. 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 Portfolio's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Portfolio'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 Portfolio 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 insurance company charges. 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 insurance company charges were included, your costs would have been higher.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD * --------------- --------------- --------------- 01/01/05 - 01/01/05 06/30/05 06/30/05 --------------- --------------- --------------- CLASS X Actual (-6.04% return) $ 1,000.00 $ 939.60 $ 4.86 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,019.79 $ 5.06 CLASS Y Actual (-6.29% return) $ 1,000.00 $ 937.10 $ 6.05 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,018.55 $ 6.31
- ---------- * EXPENSES ARE EQUAL TO THE PORTFOLIO'S ANNUALIZED EXPENSE RATIO OF 1.01% AND 1.26% 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 fixed income securities trading. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Portfolio's Administrator under the Administration Agreement, including accounting, clerical, bookkeeping, compliance, business management and planning, and the provision of supplies, office space and utilities. (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 administrative and investment advisory services to the Portfolio. 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 Portfolio. 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 The Board reviewed the Portfolio's performance for the one-, three- and five-year periods ended November 30, 2004, as shown in reports provided by Lipper (the "Lipper Reports"), compared to the performance of comparable funds selected by Lipper (the "performance peer group"), and noted that the Portfolio's performance was lower than its performance peer group average for all three periods. The Board discussed with the Adviser possible steps to improve performance. The Adviser informed the Board that, in order to try to improve performance, it transferred responsibility to the Global Research Technology team with five portfolio managers each responsible for managing investments of the Portfolio in a different industry or industries. The Board concluded that this change was reasonably designed to improve performance. FEES RELATIVE TO OTHER FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT STRATEGIES The Board reviewed the advisory and administrative fees (together, the "management fee") paid by the Fund under the Management Agreement. The Board noted that the rate was comparable to the management fee rates charged by the Adviser to any other funds it manages with investment strategies comparable to those of the Portfolio. 7 FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS The Board reviewed the management fee rate and the total expense ratio of the Portfolio. The Board noted that: (i) the Portfolio's management fee rate was higher than the average management fee rate for funds, selected by Lipper (the "expense peer group"), managed by other advisers with investment strategies comparable to those of the Portfolio, as shown in the Lipper Report for the Portfolio; but (ii) the Portfolio's total expense ratio was lower than the average total expense ratio of the funds included in the Portfolio's expense peer group. The Board concluded that the management fee rate was competitive in light of the fact that the Adviser managed the Portfolio so that the expense ratio of the Portfolio was less than the total expense ratio of the funds in the expense peer group average. BREAKPOINTS AND ECONOMIES OF SCALE The Board reviewed the structure of the Portfolio's management fee schedule under the Management Agreement and noted that it includes breakpoints. The Board also reviewed the level of the Portfolio's management fee and noted that the fee, as a percentage of the Portfolio's net assets, would decrease as net assets increase because the management fee includes breakpoints. The Board concluded that the Portfolio's management fee would reflect economies of scale as assets increase. PROFITABILITY OF ADVISER AND AFFILIATES The Board considered and reviewed information concerning the costs incurred and profits realized by the Adviser and its affiliates during the last two years from their relationship with the Portfolio and the Morgan Stanley Fund Complex and reviewed with the Controller of the Adviser the cost allocation methodology used to determine the Adviser's profitability. Based on their review of the information they received, the Board concluded that the profits earned by the Adviser and its affiliates were not excessive in light of the advisory, administrative and other services provided to the Portfolio. FALL-OUT BENEFITS The Board considered so-called "fall-out benefits" derived by the Adviser and its affiliates from their relationship with the Portfolio and the Morgan Stanley Fund Complex, such as "float" benefits derived from handling of checks for purchases and redemptions of Portfolio 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 Portfolio 12b-1 fees for distribution and shareholder services. The Board also considered that an affiliate of the Adviser, through a joint venture, receives revenue in connection with trading done on behalf of the Portfolio through an electronic trading system network ("ECN"). The Board concluded that the float benefits and the above-referenced ECN-related revenue were relatively small and that the 12b-1 fees were competitive with those of other broker-dealer affiliates of investment advisers of mutual funds. 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 Portfolio 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 Portfolio. The Adviser informed the Board that it does not use Portfolio 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 Portfolio and other funds in the Morgan Stanley Fund Complex. ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE PORTFOLIO'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 PORTFOLIO AND THE ADVISER The Board also reviewed and considered the historical relationship between the Portfolio and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Portfolio'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 Portfolio 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 Portfolio'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 Portfolio's business. GENERAL CONCLUSION After considering and weighing all of the above factors, the Board concluded it would be in the best interest of the Portfolio and its shareholders to approve renewal of the Management Agreement for another year. 9 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INFORMATION PORTFOLIO PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ COMMON STOCKS (97.0%) ADVERTISING/MARKETING SERVICES (0.5%) 900 Getty Images, Inc.* $ 66,834 ------------- CABLE/SATELLITE TV (1.1%) 4,560 Comcast Corp.(Class A)* 139,992 ------------- COMPUTER COMMUNICATIONS (6.1%) 28,700 Cisco Systems, Inc.* 548,457 9,870 Juniper Networks, Inc.* 248,527 ------------- 796,984 ------------- COMPUTER PERIPHERALS (5.7%) 23,430 EMC Corp.* 321,225 5,790 Network Appliance, Inc.* 163,683 14,420 Seagate Technology (ADR) (Cayman Islands)* 253,071 ------------- 737,979 ------------- COMPUTER PROCESSING HARDWARE (8.0%) 7,110 Apple Computer, Inc.* 261,719 13,710 Dell, Inc.* 541,682 7,100 Hewlett-Packard Co. 166,921 20,650 Sun Microsystems, Inc.* 77,024 ------------- 1,047,346 ------------- DATA PROCESSING SERVICES (1.2%) 2,400 First Data Corp. 96,336 980 Global Payments Inc. 66,444 ------------- 162,780 ------------- ELECTRONIC COMPONENTS (1.0%) 1,620 Jabil Circuit, Inc.* 49,783 3,520 SanDisk Corp.* 83,530 ------------- 133,313 ------------- ELECTRONIC PRODUCTION EQUIPMENT (2.6%) 4,260 Applied Materials, Inc. 68,927 4,960 ASML Holding N.V (Netherlands)* 77,674 4,460 KLA-Tencor Corp. 194,902 ------------- 341,503 ------------- INDUSTRIAL SPECIALTIES (0.6%) 1,420 Nitto Denko Corp.(Japan)** $ 80,747 ------------- INFORMATION TECHNOLOGY SERVICES (4.9%) 2,910 Accenture Ltd.(Class A) (Bermuda)* 65,970 2,580 Amdocs Ltd.(Guernsey)* 68,189 4,210 Cognizant Technology Solutions Corp.(Class A)* 198,417 4,190 International Business Machines Corp. 310,898 ------------- 643,474 ------------- INTERNET RETAIL (0.5%) 2,820 IAC/InterActiveCorp.* 67,821 ------------- INTERNET SOFTWARE/SERVICES (7.0%) 840 Google, Inc.(Class A)* 247,086 2,700 Netease.com Inc.(ADR) (Cayman Islands)* 154,197 7,280 VeriSign, Inc.* 209,373 8,680 Yahoo!, Inc.* 300,762 ------------- 911,418 ------------- MAJOR TELECOMMUNICATIONS (2.4%) 5,100 France Telecom S.A.(ADR) (France) 148,614 6,680 Sprint Corp. 167,601 ------------- 316,215 ------------- MEDIA CONGLOMERATES (1.1%) 8,350 News Corp.(Class B) 140,781 ------------- MISCELLANEOUS COMMERCIAL SERVICES (0.9%) 1,470 Corporate Executive Board Co.(The) 115,145 ------------- OTHER CONSUMER SERVICES (2.6%) 1,650 Apollo Group, Inc.(Class A)* 129,063 4,180 eBay, Inc.* 137,982 800 Strayer Education, Inc. 69,008 ------------- 336,053 -------------
SEE NOTES TO FINANCIAL STATEMENTS 10
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ PACKAGED SOFTWARE (19.5%) 10,410 Mercury Interactive Corp.* $ 399,328 30,400 Microsoft Corp. 755,136 42,600 Oracle Corp.* 562,320 10,700 Red Hat, Inc.* 140,170 12,290 Symantec Corp.* 267,185 16,950 VERITAS Software Corp.* 413,580 ------------- 2,537,719 ------------- RECREATIONAL PRODUCTS (0.6%) 1,410 Electronic Arts, Inc.* 79,820 SEMICONDUCTORS (18.1%) 30,210 Intel Corp. 787,273 11,410 Linear Technology Corp. 418,633 11,250 Marvell Technology Group, Ltd.(Bermuda)* 427,950 6,900 Microchip Technology Inc. 204,378 12,130 Texas Instruments Inc. 340,489 7,270 Xilinx, Inc. 185,385 ------------- 2,364,108 ------------- TELECOMMUNICATION EQUIPMENT (12.1%) 20,630 Andrew Corp.* 263,239 10,230 Comverse Technology, Inc.* 241,939 34,610 Corning Inc.* 575,218 14,890 QUALCOMM Inc. 491,519 ------------- 1,571,915 ------------- WIRELESS TELECOMMUNICATIONS (0.5%) 960 NII Holdings, Inc.(Class B)* $ 61,382 ------------- TOTAL COMMON STOCKS (COST $12,232,193) 12,653,329 TOTAL INVESTMENTS (COST $12,232,193)(a) 97.0% 12,653,329 OTHER ASSETS IN EXCESS OF LIABILITIES 3.0 386,096 ------ ------------- NET ASSETS 100.0% $ 13,039,425 ====== =============
- ---------- ADR AMERICAN DEPOSITARY RECEIPT. * NON-INCOME PRODUCING SECURITY. ** SECURITIES WITH TOTAL MARKET VALUE EQUAL TO $80,747 HAVE BEEN VALUED AT THEIR FAIR VALUE AS DETERMINED IN GOOD FAITH UNDER PROCEDURES ESTABLISHED BY AND UNDER THE GENERAL SUPERVISION OF THE FUND'S TRUSTEES. (a) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES APPROXIMATES THE AGGREGATE COST FOR BOOK PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION IS $1,045,993 AND THE AGGREGATE GROSS UNREALIZED DEPRECIATION IS $624,857, RESULTING IN NET UNREALIZED APPRECIATION OF $421,136. SEE NOTES TO FINANCIAL STATEMENTS 11 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INFORMATION PORTFOLIO SUMMARY OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
PERCENT OF INDUSTRY VALUE NET ASSETS - --------------------------------------------------------------------------- Packaged Software $ 2,537,719 19.5% Semiconductors 2,364,108 18.1 Telecommunication Equipment 1,571,915 12.1 Computer Processing Hardware 1,047,346 8.0 Internet Software/Services 911,418 7.0 Computer Communications 796,984 6.1 Computer Peripherals 737,979 5.7 Information Technology Services 643,474 4.9 Electronic Production Equipment 341,503 2.6 Other Consumer Services 336,053 2.6 Major Telecommunications 316,215 2.4 Data Processing Services 162,780 1.2 Media Conglomerates 140,781 1.1 Cable/Satellite TV 139,992 1.1 Electronic Components 133,313 1.0 Miscellaneous Commercial Services 115,145 0.9 Industrial Specialties 80,747 0.6 Recreational Products 79,820 0.6 Internet Retail 67,821 0.5 Advertising/Marketing Services 66,834 0.5 Wireless Telecommunications 61,382 0.5 ------------ ---- $ 12,653,329 97.0% ============ ====
SEE NOTES TO FINANCIAL STATEMENTS 12 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INFORMATION PORTFOLIO FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 2005 (UNAUDITED) ASSETS: Investments in securities, at value (cost $12,232,193) $ 12,653,329 Cash 163,482 Receivable for: Investments sold 428,662 Dividends 676 Prepaid expenses and other assets 1,022 --------------- TOTAL ASSETS 13,247,171 --------------- LIABILITIES: Payable for: Investments purchased 181,272 Investment advisory fee 7,391 Distribution fee 2,039 Administration fee 883 Accrued expenses and other payables 16,161 --------------- TOTAL LIABILITIES 207,746 --------------- NET ASSETS $ 13,039,425 =============== COMPOSITION OF NET ASSETS: Paid-in-capital $ 18,753,256 Net unrealized appreciation 421,136 Accumulated net investment loss (54,469) Accumulated net realized loss (6,080,498) --------------- NET ASSETS $ 13,039,425 =============== CLASS X SHARES: Net Assets $ 3,378,222 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 723,762 NET ASSET VALUE PER SHARE $ 4.67 =============== CLASS Y SHARES: Net Assets $ 9,661,203 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 2,089,087 NET ASSET VALUE PER SHARE $ 4.62 ===============
SEE NOTES TO FINANCIAL STATEMENTS 13 STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2005 (UNAUDITED) NET INVESTMENT LOSS: INCOME Dividends (net of $489 foreign withholding tax) $ 26,832 Interest 4,720 --------------- TOTAL INCOME 31,552 --------------- EXPENSES Investment advisory fee 48,394 Distribution fee (Class Y shares) 13,271 Professional fees 11,098 Administration fee 5,778 Custodian fees 3,825 Shareholder reports and notices 2,950 Transfer agent fees and expenses 250 Trustees' fees and expenses 81 Other 348 --------------- TOTAL EXPENSES 85,995 --------------- NET INVESTMENT LOSS (54,443) --------------- NET REALIZED AND UNREALIZED GAIN (LOSS): NET REALIZED GAIN/LOSS ON: Investments 1,085,635 Foreign exchange transactions (72) --------------- NET REALIZED GAIN 1,085,563 --------------- Net change in unrealized appreciation/depreciation on investments (2,133,239) --------------- NET LOSS (1,047,676) --------------- NET DECREASE $ (1,102,119) ===============
SEE NOTES TO FINANCIAL STATEMENTS 14 STATEMENT OF CHANGES IN NET ASSETS
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 --------------- ------------------ (UNAUDITED) INCREASE (DECREASE) IN NET ASSETS: OPERATIONS: Net investment loss $ (54,443) $ (63,466) Net realized gain 1,085,563 472,593 Net change in unrealized appreciation (2,133,239) (125,200) --------------- ------------------ NET INCREASE (DECREASE) (1,102,119) 283,927 --------------- ------------------ Net decrease from transactions in shares of beneficial interest (3,241,631) (1,379,059) --------------- ------------------ NET DECREASE (4,343,750) (1,095,132) NET ASSETS: Beginning of period 17,383,175 18,478,307 --------------- ------------------ END OF PERIOD (INCLUDING ACCUMULATED NET INVESTMENT LOSSES OF $54,469 AND $26, RESPECTIVELY) $ 13,039,425 $ 17,383,175 =============== ==================
SEE NOTES TO FINANCIAL STATEMENTS 15 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INFORMATION PORTFOLIO NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) 1. ORGANIZATION AND ACCOUNTING POLICIES Morgan Stanley Variable Investment Series (the "Fund") -- Information Portfolio (the "Portfolio"), one of 15 separate portfolios, is registered under the Investment Company Act of 1940, as amended (the "Act"), as a diversified, open-end management investment company. The Fund is offered exclusively to life insurance companies in connection with particular life insurance and/or annuity contracts they offer. The Portfolio's investment objective is long-term capital appreciation. The Fund was organized as a Massachusetts business trust on February 25, 1983 and the Portfolio commenced operations on November 6, 2000. On June 5, 2000, the Portfolio commenced offering one additional class of shares (Class Y). The Portfolio offers Class X shares and Class Y shares. The two are identical except that Class Y shares incur distribution expenses. Class X shares are generally available to holders of contracts offered by Metropolitan Life Insurance Company (formerly Paragon Life Insurance Company) and other contracts offered before May 1, 2000. Class Y shares are available to holders of contracts offered on or after June 5, 2000. 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) when market quotations are not readily available or Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") determines that the latest sale price, the bid price or the mean between the last reported bid and asked price do not reflect a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees. Occasionally, developments affecting the closing prices of securities and other assets may occur between the times at which valuations of such securities are determined (that is, close of the foreign market on which the securities trade) and the close of business on the NYSE. If developments occur during such periods that are expected to materially affect the value of such securities, such valuations may be adjusted to reflect the estimated fair value of such securities as of the close of the NYSE, as determined in good faith by 16 the Fund's Trustees or by the Investment Adviser using a pricing service and/or procedures approved by the Trustees of the Fund; (6) certain portfolio securities may be valued by an outside pricing service approved by the Fund's Trustees; and (7) 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 -- The Fund may 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. 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 Portfolio 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 Portfolio 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 Portfolio as unrealized gains and losses. Upon closing of the contract, the Portfolio 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. F. FOREIGN CURRENCY TRANSLATION AND FORWARD FOREIGN CURRENCY CONTRACTS -- The books and records of the Portfolio 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 17 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 Portfolio 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 Portfolio 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. G. 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. H. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- Dividends and distributions to shareholders are recorded on the ex-dividend date. I. EXPENSES -- Direct expenses are charged to the Portfolio and general Fund expenses are allocated on the basis of relative net assets or equally among the Portfolios. 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 Portfolio pays an advisory fee, accrued daily and payable monthly, by applying the following annual rates to the net assets of the Portfolio determined at the close of each business day: 0.67% to the portion of the daily net assets not exceeding $500 million; 0.645% to the portion of the daily net assets exceeding $500 million but not exceeding $3 billion and 0.62% to the portion of the daily net assets in excess of $3 billion. Pursuant to an Administration Agreement with Morgan Stanley Services Company Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Portfolio pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.08% to the Portfolio'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. Under the Plan, Class Y shares of the Portfolio will pay a 18 distribution fee which is accrued daily and paid monthly at the annual rate of 0.25% of the average daily net assets of the class. 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 June 30, 2005 aggregated $10,876,031 and $14,066,698, respectively. For the six months ended June 30, 2005, the Portfolio incurred brokerage commissions of $6,040 with Morgan Stanley & Co., Inc., an affiliate of the Investment Adviser, Administrator and Distributor, for transactions executed on behalf of the Portfolio. At June 30, 2005, the Portfolio's receivable for investments sold included unsettled trades with Morgan Stanley & Co., Inc. of $97,466. Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and Distributor, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and compensation. Aggregate pension costs for the six months ended June 30, 2005 included in Trustees' fees and expenses in the Statement of Operations amounted to $16. At June 30, 2005, the Portfolio had an accrued pension liability of $28 which is included in accrued expenses in the Statement of Assets and Liabilities. On December 2, 2003, the Trustees voted to close the plan to new participants and eliminate the future benefits growth due to increases to compensation after July 31, 2003. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 5. 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 19 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 December 31, 2004, the Portfolio had a net capital loss carryforward of approximately $6,989,000 of which $1,669,000 will expire on December 31, 2009 and $5,320,000 will expire on December 31, 2010, to offset future capital gains to the extent provided by regulations. As of December 31, 2004, the Portfolio had temporary book/tax differences primarily attributable to capital loss deferrals on wash sales. 6. SHARES OF BENEFICIAL INTEREST Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 -------------------------------- -------------------------------- (UNAUDITED) SHARES AMOUNT SHARES AMOUNT -------------- -------------- -------------- -------------- CLASS X SHARES Sold 225,426 $ 1,048,812 1,375,957 $ 6,656,455 Redeemed (403,309) (1,871,973) (1,576,724) (7,465,602) -------------- -------------- -------------- -------------- Net decrease -- Class X (177,883) (823,161) (200,767) (809,147) -------------- -------------- -------------- -------------- CLASS Y SHARES Sold 49,287 228,455 456,147 2,145,532 Redeemed (579,811) (2,646,925) (600,682) (2,715,444) -------------- -------------- -------------- -------------- Net decrease -- Class Y (530,524) (2,418,470) (144,535) (569,912) -------------- -------------- -------------- -------------- Net decrease in Portfolio (708,407) $ (3,241,631) (345,302) $ (1,379,059) ============== ============== ============== ==============
7. PURPOSES OF AND RISKS RELATING TO CERTAIN FINANCIAL INSTRUMENTS The Portfolio may enter into forward contracts to facilitate settlement of foreign currency denominated transactions or to manage foreign currency exposure associated with foreign currency denominated securities. To hedge against adverse interest rate and market risks, the Portfolio may enter into interest rate futures contracts ("futures contracts"). Forward contracts and futures contracts involve elements of market risk in excess of the amounts reflected in the Statement of Assets and Liabilities. The Portfolio bears the risk of an unfavorable change in the foreign exchange rates underlying the forward contracts or in the value of the underlying securities. Risks may also arise upon entering into these contracts from the potential inability of the counterparties to meet the terms of their contracts. 20 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- INFORMATION PORTFOLIO FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED -------------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- --------- --------- --------- --------- --------- (UNAUDITED) CLASS X SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 4.97 $ 4.80 $ 2.98 $ 5.31 $ 9.31 $ 10.00 ------------- --------- --------- --------- --------- --------- Income (loss) from investment operations: Net investment income (loss)++ (0.01) (0.01) (0.03) (0.03) 0.08 0.06 Net realized and unrealized gain (loss) (0.29) 0.18 1.85 (2.25) (4.07) (0.75) ------------- --------- --------- --------- --------- --------- Total income (loss) from investment operations (0.30) 0.17 1.82 (2.28) (3.99) (0.69) ------------- --------- --------- --------- --------- --------- Less dividends and distributions from: Net investment income - - - (0.05) (0.01) - Net realized gain - - - - - - ------------- --------- --------- --------- --------- --------- Total dividends and distributions - - - (0.05) (0.01) - ------------- --------- --------- --------- --------- --------- Net asset value, end of period $ 4.67 $ 4.97 $ 4.80 $ 2.98 $ 5.31 $ 9.31 ============= ========= ========= ========= ========= ========= TOTAL RETURN+ (6.04)%(2) 3.54% 61.07% (43.09)% (42.87)% (6.90)%(2) RATIOS TO AVERAGE NET ASSETS(1): Expenses 1.01%(3) 0.97% 1.12% 1.12% -%(5) -%(4) Net investment income (0.57)%(3) (0.18)% (0.88)% (0.88)% 1.27%(5) 3.80%(3)(4) SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 3,378 $ 4,478 $ 5,289 $ 2,002 $ 4,434 $ 2,686 Portfolio turnover rate 77%(2) 99% 176% 150% 170% 1%(2)
- ---------- * PRIOR TO JUNE 5, 2000, THE PORTFOLIO ISSUED ONE CLASS OF SHARES. ALL SHARES OF THE PORTFOLIO HELD PRIOR TO MAY 1, 2000 HAVE BEEN DESIGNATED CLASS X SHARES. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. (4) IF THE INVESTMENT ADVISER HAD NOT ASSUMED ALL EXPENSES (EXCEPT FOR DISTRIBUTION FEES) AND WAIVED ITS ADVISORY FEE FOR THE PERIOD NOVEMBER 6, 2000 THROUGH DECEMBER 31, 2000, THE RATIOS OF EXPENSES AND NET INVESTMENT INCOME TO AVERAGE NET ASSETS WOULD HAVE BEEN 1.82% AND 1.98%, RESPECTIVELY. (5) IF THE INVESTMENT ADVISER HAD NOT ASSUMED ALL ALL EXPENSES (EXCEPT FOR DISTIBUTION FEES) AND WAIVED ITS ADVISORY FEE FOR THE YEAR ENDED DECEMBER 31, 2001, THE RATIOS OF EXPENSES AND NET INVESTMENT INCOME (LOSS) TO AVERAGE NET ASSETS WOULD HAVE BEEN 1.62% AND (0.35)%, RESPECTIVELY SEE NOTES TO FINANCIAL STATEMENTS 21
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED -------------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- --------- --------- --------- --------- --------- (UNAUDITED) CLASS Y SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 4.93 $ 4.77 $ 2.97 $ 5.30 $ 9.31 $ 10.00 ------------- --------- --------- --------- --------- --------- Income (loss) from investment operations: Net investment income++ (0.02) (0.02) (0.04) (0.04) 0.06 0.05 Net realized and unrealized gain (loss) (0.29) 0.18 1.84 (2.25) (4.06) (0.74) ------------- --------- --------- --------- --------- --------- Total income (loss) from investment operations (0.31) 0.16 1.80 (2.29) (4.00) (0.69) ------------- --------- --------- --------- --------- --------- Less dividends and distributions from: Net investment income - - - (0.04) (0.01) - Net realized gain - - - - - - ------------- --------- --------- --------- --------- --------- Total dividends and distributions - - - (0.04) (0.01) - ------------- --------- --------- --------- --------- --------- Net asset value, end of period $ 4.62 $ 4.93 $ 4.77 $ 2.97 $ 5.30 $ 9.31 ============= ========= ========= ========= ========= ========= TOTAL RETURN+ (6.29)%(2) 3.35% 60.61% (43.29)% (42.99)% (6.90)%(2) RATIOS TO AVERAGE NET ASSETS(1): Expenses 1.26%(3) 1.22% 1.37% 1.37% 0.25%(5) 0.25%(3)(4) Net investment income (loss) (0.82)%(3) (0.43)% (1.13)% (1.13)% 1.02%(5) 3.55%(3)(4) SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 9,661 $ 12,905 $ 13,189 $ 5,066 $ 7,427 $ 1,915 Portfolio turnover rate 77%(2) 99% 176% 150% 170% 1%
- ---------- * FOR THE PERIOD JUNE 5, 2000 (ISSUED DATE) THROUGH DECEMBER 31, 2000. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. (4) IF THE INVESTMENT ADVISER HAD NOT ASSUMED ALL EXPENSES (EXCEPT FOR DISTRIBUTION FEES) AND WAIVED ITS ADVISORY FEE FOR THE PERIOD NOVEMBER 6, 2000 THROUGH DECEMBER 31, 2000, THE RATIOS OF EXPENSES AND NET INVESTMENT INCOME TO AVERAGE NET ASSETS WOULD HAVE BEEN 2.07% AND 1.73%, RESPECTIVELY. (5) IF THE INVESTMENT ADVISER HAD NOT ASSUMED ALL ALL EXPENSES (EXCEPT FOR DISTIBUTION FEES) AND WAIVED ITS ADVISORY FEE FOR THE YEAR ENDED DECEMBER 31, 2001, THE RATIOS OF EXPENSES AND NET INVESTMENT INCOME (LOSS) TO AVERAGE NET ASSETS WOULD HAVE BEEN 1.87% AND (0.60)%, RESPECTIVELY. SEE NOTES TO FINANCIAL STATEMENTS 22 TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo CHAIRMAN OF THE BOARD Mitchell M. Merin PRESIDENT Ronald E. Robison EXECUTIVE VICE PRESIDENT and PRINCIPAL EXECUTIVE OFFICER Joseph J. McAlinden VICE PRESIDENT Barry Fink VICE PRESIDENT Amy R. Doberman VICE PRESIDENT Carsten Otto CHIEF COMPLIANCE OFFICER Stefanie V. Chang VICE PRESIDENT Francis J. Smith TREASURER and CHIEF FINANCIAL OFFICER Thomas F. Caloia VICE PRESIDENT Mary E. Mullin SECRETARY TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT 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 Portfolio 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 Portfolio. For more detailed information about the Portfolio, its fees and expenses and other pertinent information, please read its Prospectus. The Portfolio's Statement of Additional Information contains additional information about the Portfolio, 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 Portfolio 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) 2005 Morgan Stanley [MORGAN STANLEY LOGO] RA05-006878-Y06/05 [GRAPHIC] MORGAN STANLEY FUNDS MORGAN STANLEY VARIABLE INVESTMENT SERIES-- INFORMATION PORTFOLIO SEMIANNUAL REPORT JUNE 30, 2005 [MORGAN STANLEY LOGO] WELCOME, SHAREHOLDER: IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY VARIABLE INVESTMENT SERIES -- LIMITED DURATION PORTFOLIO 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 PORTFOLIO'S FINANCIAL STATEMENTS AND A LIST OF PORTFOLIO INVESTMENTS. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE PORTFOLIO BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE PORTFOLIO WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE PORTFOLIO IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE PORTFOLIO WILL DECLINE AND, THEREFORE, THE VALUE OF THE PORTFOLIO'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS PORTFOLIO. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT FOR THE SIX MONTHS ENDED JUNE 30, 2005 TOTAL RETURN FOR THE 6 MONTHS ENDED JUNE 30, 2005
LEHMAN BROTHERS U.S. CLASS X CLASS Y CREDIT INDEX (1-5 YEAR)(1) 0.93% 0.81% 0.94%
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. SEE PERFORMANCE SUMMARY FOR PERFORMANCE INFORMATION AND INDEX DEFINITIONS. MARKET CONDITIONS As expected, the Federal Open Market Committee (the "Fed") increased the federal funds target rate at each of its four meetings in the first half of 2005. Consequently, the benchmark overnight rate increased from 2.25 percent at the beginning of the review period to 3.25 percent at the end. Despite the actions of the Fed, most U.S. Treasury yields fell during the second half of the six-month period, erasing all of the gains posted by long-term Treasuries and much of the gains posted by short- and intermediate-term Treasuries during the first half of the six-month period. Nevertheless, the period concluded on a positive note, with bond markets achieving positive returns during the month of June. It is important to note, however, that as of the end of the period, we have yet to see the full effects of the Fed's actions on economic activity. For the most part, the market's concerns over rising energy prices and inflation as well as faltering growth have muted the impact of the Fed's rate increases. With two-year and five-year Treasuries near the 3.6 percent to 3.7 percent area at the end of June, the market reflects neither underlying fundamental trends nor a more likely course for Fed policy. PERFORMANCE ANALYSIS Limited Duration Portfolio underperformed the Lehman Brothers U.S. Credit Index (1-5 Year) for the six-month period ended June 30, 2005. The Portfolio's corporate holdings had a small favorable impact on relative performance during the period. An underweight in banking and finance, and energy relative to the Lehman Brothers Index contributed positively to performance. The Portfolio's mortgage position, specifically the emphasis on higher coupon, slow prepaying mortgages, had a positive impact on relative performance. These types of mortgages tend to be less sensitive to rising interest rates than lower-coupon, fast pre-paying mortgages. We kept the Portfolio's overall interest-rate exposure well below that of its benchmark during the period. This posture was beneficial as interest rates rose across the short- and intermediate-portions of the curve. However, relative to the Lehman Brothers benchmark, the Portfolio's defensive interest rate position detracted from performance as rates at the short-end of the yield curve came down slightly. THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM WELL OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE PORTFOLIO IN THE FUTURE. DURATION IS A MEASURE OF THE SENSITIVITY OF A BOND'S PRICE TO CHANGES IN INTEREST RATES, EXPRESSED IN YEARS. EACH YEAR OF DURATION REPRESENTS AN EXPECTED 1 PERCENT CHANGE IN THE PRICE OF A BOND FOR EVERY 1 PERCENT CHANGE IN INTEREST RATES. THE LONGER A BOND'S DURATION, THE GREATER THE EFFECT OF INTEREST-RATE MOVEMENTS ON ITS PRICE. TYPICALLY, FUNDS WITH SHORTER DURATIONS PERFORM BETTER IN RISING-INTEREST-RATE ENVIRONMENTS, WHILE FUNDS WITH LONGER DURATIONS PERFORM BETTER WHEN RATES DECLINE. 2 PORTFOLIO COMPOSITION** Corporate Bonds 43.1% Asset-Backed Securities 19.4 Short-Term Investments 13.4 Mortgage-Backed Securities 10.8 U.S. Government Agency Obligations 10.0 Collateralized Mortgage Obligations 2.2 Foreign Government Obligations 1.1
LONG-TERM CREDIT ANALYSIS Aaa/AAA 58.1% Aa/AA 12.2 A/A 17.3 Baa/BBB 12.3 B/B 0.1
**DOES NOT INCLUDE OUTSTANDING LONG FUTURES CONTRACTS WITH AN UNDERLYING FACE AMOUNT OF $12,045,875 WITH UNREALIZED DEPRECIATION OF $9,191 AND SHORT FUTURES CONTRACTS WITH AN UNDERLYING FACE AMOUNT OF $17,323,751 WITH UNREALIZED DEPRECIATION OF $51,874. DATA AS OF JUNE 30, 2005. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES FOR PORTFOLIO COMPOSITION ARE AS A PERCENTAGE OF TOTAL INVESTMENTS. ALL PERCENTAGES FOR LONG-TERM CREDIT ANALYSIS ARE AS A PERCENTAGE OF TOTAL LONG-TERM 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. INVESTMENT STRATEGY THE PORTFOLIO WILL NORMALLY INVEST AT LEAST 65 PERCENT OF ITS ASSETS IN SECURITIES ISSUED OR GUARANTEED AS TO PRINCIPAL AND INTEREST BY THE U.S. GOVERNMENT, ITS AGENCIES OR INSTRUMENTALITIES (INCLUDING ZERO COUPON SECURITIES), INVESTMENT GRADE MORTGAGE-BACKED SECURITIES, INCLUDING COLLATERALIZED MORTGAGE OBLIGATIONS, AND INVESTMENT GRADE CORPORATE AND OTHER TYPES OF BONDS. IN SELECTING PORTFOLIO INVESTMENTS TO PURCHASE OR SELL, THE "INVESTMENT ADVISER," MORGAN STANLEY INVESTMENT ADVISORS INC., CONSIDERS BOTH DOMESTIC AND INTERNATIONAL ECONOMIC DEVELOPMENTS, INTEREST RATE LEVELS, THE STEEPNESS OF THE YIELD CURVE AND OTHER FACTORS, AND SEEKS TO MAINTAIN AN OVERALL AVERAGE DURATION FOR THE PORTFOLIO'S PORTFOLIO OF THREE YEARS OR LESS. FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY PORTFOLIO PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE PORTFOLIO'S SECOND AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY PORTFOLIO 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. 3 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED JUNE 30, 2005
CLASS X SHARES CLASS Y SHARES (SINCE 05/04/99) (SINCE 06/05/00) 1 YEAR 2.23%(2) 1.98%(2) 5 YEARS 3.74(2) 3.50(2) SINCE INCEPTION 3.68(2) 3.55(2)
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 THE 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 PORTFOLIO SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. THE PERFORMANCE OF THE PORTFOLIO'S TWO SHARE CLASSES VARIES BECAUSE EACH HAS DIFFERENT EXPENSES. THE PORTFOLIO'S TOTAL RETURN FIGURES ASSUME THE REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE IMPACT OF ANY CHARGES BY YOUR INSURANCE COMPANY. SUCH COSTS WOULD LOWER PERFORMANCE. (1) THE LEHMAN BROTHERS U.S. CREDIT INDEX (1-5 YEAR) INCLUDES U.S. CORPORATE AND SPECIFIED FOREIGN DEBENTURES AND SECURED NOTES WITH MATURITIES OF ONE TO FIVE YEARS. INDEXES ARE UNMANAGED AND THEIR RETURNS DO NOT INCLUDE ANY SALES CHARGES OR FEES. SUCH COSTS WOULD LOWER PERFORMANCE. IT IS NOT POSSIBLE TO INVEST DIRECTLY IN AN INDEX. (2) FIGURE ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS FOR THE UNDERLYING PORTFOLIO BASED ON NET ASSET VALUE (NAV). IT DOES NOT REFLECT THE DEDUCTION OF INSURANCE EXPENSES, AN ANNUAL CONTRACT MAINTENANCE FEE, OR SURRENDER CHARGES. 4 EXPENSE EXAMPLE As a shareholder of the Portfolio, you incur two types of costs: (1) insurance company charges; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Portfolio expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Portfolio 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 01/01/05 - 06/30/05. 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 Portfolio's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Portfolio'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 Portfolio 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 insurance company charges. 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 insurance company charges were included, your costs would have been higher.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD * ------------- ------------- --------------- 01/01/05 - 01/01/05 06/30/05 06/30/05 ------------- ------------- --------------- CLASS X Actual (0.93% return) $ 1,000.00 $ 1,009.30 $ 2.19 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,022.61 $ 2.21 CLASS Y Actual (0.81% return) $ 1,000.00 $ 1,008.10 $ 3.44 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,021.37 $ 3.46
- ---------- * EXPENSES ARE EQUAL TO THE PORTFOLIO'S ANNUALIZED EXPENSE RATIO OF 0.44% AND 0.69% RESPECTIVELY, MULTIPLIED BY THE AVERAGE ACCOUNT VALUE OVER THE PERIOD, MULTIPLIED BY 181/365 (TO REFLECT THE ONE-HALF YEAR PERIOD). 5 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 fixed income securities trading. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Portfolio's Administrator under the Administration Agreement, including accounting, clerical, bookkeeping, compliance, business management and planning, and the provision of supplies, office space and utilities. (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 administrative and investment advisory services to the Portfolio. 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 Portfolio. 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 The Board reviewed the Portfolio's performance for the one-, three- and five-year periods ended November 30, 2004, as shown in reports provided by Lipper (the "Lipper Reports"), compared to the performance of comparable funds selected by Lipper (the "performance peer group"), and noted that the Portfolio's performance was lower than its performance peer group average for all three periods. The Board considered that the Portfolio's performance, relative to its performance peer group, has improved, as the gap between the Portfolio's performance and the average of its performance peer group has narrowed from the five- to the three- to the one-year period. The Board concluded that the Portfolio's performance was improving and can reasonably be expected to be competitive with that of its performance peer group. FEES RELATIVE TO OTHER FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT STRATEGIES The Board reviewed the advisory and administrative fees (together, the "management fee") paid by the Portfolio under the Management Agreement. The Board noted that the rate was comparable to the management fee rates charged by the Adviser to any other funds it manages with investment strategies comparable to those of the Portfolio. 6 FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS The Board reviewed the management fee rate and the total expense ratio of the Portfolio. The Board noted that: (i) the Portfolio's management fee rate was lower than the average management fee rate for funds, selected by Lipper (the "expense peer group"), managed by other advisers with investment strategies comparable to those of the Portfolio, as shown in the Lipper Report for the Portfolio; and (ii) the Portfolio's total expense ratio was also lower than the average total expense ratio of the funds included in the Portfolio's expense peer group. The Board concluded that the Portfolio's management fee 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 Portfolio's management fee schedule under the Management Agreement and noted that it does not include any breakpoints. The Board also reviewed the level of the Portfolio's management fee and concluded that the Portfolio's management fee was sufficiently low that it did not need to consider adding breakpoints. PROFITABILITY OF ADVISER AND AFFILIATES The Board considered and reviewed information concerning the costs incurred and profits realized by the Adviser and its affiliates during the last two years from their relationship with the Portfolio and the Morgan Stanley Fund Complex and reviewed with the Controller of the Adviser the cost allocation methodology used to determine the Adviser's profitability. Based on their review of the information they received, the Board concluded that the profits earned by the Adviser and its affiliates were not excessive in light of the advisory, administrative and other services provided to the Portfolio. FALL-OUT BENEFITS The Board considered so-called "fall-out benefits" derived by the Adviser and its affiliates from their relationship with the Portfolio and the Morgan Stanley Fund Complex, such as "float" benefits derived from handling of checks for purchases and redemptions of Portfolio shares through a broker-dealer affiliate of the Adviser. The Board also considered that a broker-dealer affiliate of the Adviser receives from the Portfolio 12b-1 fees for distribution and shareholder services. The Board concluded that the float benefits were relatively small and that the 12b-1 fees were competitive with those of other broker-dealer affiliates of investment advisers. SOFT DOLLAR BENEFITS The Board considered whether the Adviser realizes any benefits from commissions paid to brokers who execute securities transactions for the Portfolio ("soft dollars"). The Board noted that the Portfolio invests only in fixed income securities, which do not generate soft dollars. 7 ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE PORTFOLIO'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 PORTFOLIO AND THE ADVISER The Board also reviewed and considered the historical relationship between the Portfolio and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Portfolio'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 Portfolio 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 Portfolio'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 Portfolio's business. GENERAL CONCLUSION After considering and weighing all of the above factors, the Board concluded it would be in the best interest of the Portfolio and its shareholders to approve renewal of the Management Agreement for another year. 8 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- LIMITED DURATION PORTFOLIO PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ----------------------------------------------------------------------------------------------- CORPORATE BONDS (42.6%) AEROSPACE & DEFENSE (0.4%) $ 230 McDonnell Douglas Corp. 6.875% 11/01/06 $ 237,253 195 Northrop Grumman Corp. 4.079 11/16/06 194,501 30 Raytheon Co. 6.15 11/01/08 31,679 111 Raytheon Co. 6.75 08/15/07 116,505 150 Raytheon Co. 8.30 03/01/10 174,005 ------------ 753,943 ------------ AIR FREIGHT/COURIERS (0.2%) 130 Fedex Corp. 2.65 04/01/07 126,666 145 Fedex Corp. 6.875 02/15/06 147,489 ------------ 274,155 ------------ AIRLINES (0.1%) 258 Southwest Airlines Co. (Series 01-1) 5.496 11/01/06 262,536 ------------ AUTO PARTS: O.E.M. (0.2%) 290 Johnson Controls, Inc. 5.00 11/15/06 293,691 ------------ BEVERAGES: ALCOHOLIC (0.2%) 385 Miller Brewing Co. - 144A* 4.25 08/15/08 383,597 ------------ BUILDING PRODUCTS (0.3%) 145 Masco Corp. 4.625 08/15/07 145,890 310 Masco Corp. 6.75 03/15/06 315,651 ------------ 461,541 ------------ CABLE/SATELLITE TV (0.7%) 490 Comcast Cable Communications, Inc. 6.875 06/15/09 534,227 270 Comcast Corp. 5.85 01/15/10 285,822 242 Cox Communications Inc. 3.95+ 12/14/07 243,445 150 Cox Communications Inc. 7.75 08/15/06 154,931 ------------ 1,218,425 ------------ CHEMICALS: MAJOR DIVERSIFIED (0.1%) 135 ICI Wilmington Inc. 4.375 12/01/08 134,079 ------------ CONTAINERS/PACKAGING (0.0%) 90 Sealed Air Corp. - 144A* 6.95 05/15/09 97,327 ------------ DEPARTMENT STORES (0.9%) 680 Federated Department Stores, Inc. 6.625 09/01/08 725,633 525 May Department Stores Co., Inc. 3.95 07/15/07 521,623 260 May Department Stores Co., Inc. 6.875 11/01/05 262,301 ------------ 1,509,557 ------------
SEE NOTES TO FINANCIAL STATEMENTS 9
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ----------------------------------------------------------------------------------------------- DISCOUNT STORES (0.7%) $ 1,165 Target Corp. 5.95% 05/15/06 $ 1,183,524 ------------ DRUGSTORE CHAINS (0.5%) 175 CVS Corp. 3.875 11/01/07 174,251 640 CVS Corp. 5.625 03/15/06 646,724 ------------ 820,975 ------------ ELECTRIC UTILITIES (4.9%) 580 Appalachian Power Co. (Series G) 3.60 05/15/08 569,732 710 Carolina Power & Light Company Inc. 6.80 08/15/07 746,542 290 CC Funding Trust I 6.90 02/16/07 302,176 248 Columbus Southern Power Co. 4.40 12/01/10 246,848 1,050 Consolidated Natural Gas Co. (Series B) 5.375 11/01/06 1,066,419 245 Consumers Energy Co. 4.80 02/17/09 248,255 635 DTE Energy Co. 6.45 06/01/06 648,118 240 Duke Energy Corp. 3.75 03/05/08 237,158 170 Entergy Gulf States, Inc. 3.60 06/01/08 166,533 220 Entergy Gulf States, Inc. 3.73+ 12/01/09 220,731 255 Exelon Corp. 6.75 05/01/11 283,530 765 FPL Group Capital Inc. 3.25 04/11/06 761,320 570 Pacific Gas & Electric Co. 3.60 03/01/09 557,243 90 Panhandle Eastern Pipe Line Co. (Series B) 2.75 03/15/07 87,687 390 Peco Energy Co. 3.50 05/01/08 383,375 775 Pinnacle West Capital Corp. 6.40 04/01/06 785,588 1,150 Public Service Electric & Gas Co. 3.577 06/23/06 1,150,179 150 Wisconsin Electric Power Co. 3.50 12/01/07 147,754 ------------ 8,609,188 ------------ ELECTRICAL PRODUCTS (0.2%) 295 Cooper Industries Inc. 5.25 07/01/07 300,532 ------------ ENVIRONMENTAL SERVICES (0.1%) 60 USA Waste Services, Inc. 7.125 10/01/07 63,506 130 WMX Technologies, Inc. 7.00 10/15/06 134,421 ------------ 197,927 ------------ FINANCE/RENTAL/LEASING (3.2%) 330 CIT Group Inc. 2.875 09/29/06 325,457 600 CIT Group Inc. 3.44+ 11/04/05 600,392 630 CIT Group Inc. 6.50 02/07/06 639,705 540 Countrywide Home Loans, Inc. (Series MTN) 3.25 05/21/08 524,675 550 Ford Motor Credit Co. 6.875 02/01/06 555,574
SEE NOTES TO FINANCIAL STATEMENTS 10
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ----------------------------------------------------------------------------------------------- $ 230 Ford Motor Credit Co. 6.50% 01/25/07 $ 231,736 250 MBNA Corp. 3.64+ 05/05/08 251,671 760 MBNA Corp. 6.125 03/01/13 829,464 815 Nationwide Buildings Society - 144A* (United Kingdom) 2.625 01/30/07 798,048 785 SLM Corp. 4.00 01/15/10 776,252 ------------ 5,532,974 ------------ FINANCIAL CONGLOMERATES (4.0%) 95 Bank One Corp. (Series MTNA) 6.00 02/17/09 100,209 475 Bank One NA Illinois 3.319+ 05/05/06 475,581 410 Bank One NA Illinois 5.50 03/26/07 419,985 150 Chase Manhattan Corp. 6.00 02/15/09 158,687 55 Chase Manhattan Corp. 7.00 11/15/09 60,554 460 Citicorp 6.375 11/15/08 490,842 220 Citicorp 6.75 08/15/05 220,774 195 Citigroup Global Markets Inc. 3.50+ 12/12/06 195,283 555 Citigroup Inc. 5.50 08/09/06 564,132 560 Citigroup Inc. 5.75 05/10/06 568,502 120 General Electric Capital Corp. 4.25 12/01/10 119,696 1,615 General Electric Capital Corp. 5.375 03/15/07 1,650,664 315 General Motors Acceptance Corp. 4.50 07/15/06 310,768 410 ING Security Life Institutional - 144A* 2.70 02/15/07 399,329 515 Pricoa Global Funding I - 144A* 3.90 12/15/08 509,718 340 Prudential Funding LLC (Series MTN) - 144A* 6.60 05/15/08 362,734 475 Prudential Insurance Co. - 144A* 6.375 07/23/06 486,137 ------------ 7,093,595 ------------ FOOD RETAIL (1.1%) 1,045 Kroger Co. 7.625 09/15/06 1,086,652 800 Safeway Inc. 6.15 03/01/06 808,726 ------------ 1,895,378 ------------ FOOD: MAJOR DIVERSIFIED (0.9%) 530 Conagra Foods, Inc. 6.00 09/15/06 539,181 125 General Mills Inc. 3.875 11/30/07 124,031 200 Kraft Foods Inc. 4.00 10/01/08 198,577 675 Kraft Foods Inc. 5.25 06/01/07 688,441 ------------ 1,550,230 ------------ FOREST PRODUCTS (0.0%) 77 Weyerhaeuser Co. 6.125 03/15/07 79,198 ------------
SEE NOTES TO FINANCIAL STATEMENTS 11
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ----------------------------------------------------------------------------------------------- GAS DISTRIBUTORS (0.5%) $ 180 Nisource Finance Corp. 3.854+% 11/23/09 $ 180,885 29 Ras Laffan Liquid Natural Gas Co. Ltd. - 144A* (Qatar) 7.628 09/15/06 29,453 650 Sempra Energy 4.75 05/15/09 656,419 ------------ 866,757 ------------ HOME FURNISHINGS (0.2%) 265 Mohawk Industries, Inc. (Class C) 6.50 04/15/07 274,617 ------------ HOME IMPROVEMENT CHAINS (0.2%) 330 Lowe's Companies, Inc. 7.50 12/15/05 335,265 ------------ HOTELS/RESORTS/CRUISELINES (0.5%) 285 Hyatt Equities LLC - 144A* 6.875 06/15/07 294,219 290 Marriott International Inc. (Series C) 7.875 09/15/09 327,581 90 Marriott International, Inc. (Series E) 7.00 01/15/08 95,695 130 Starwood Hotels & Resorts Worldwide, Inc. 7.375 05/01/07 136,500 ------------ 853,995 ------------ HOUSEHOLD/PERSONAL CARE (0.3%) 560 Clorox Co. 3.525+ 12/14/07 561,133 ------------ INDUSTRIAL CONGLOMERATES (0.7%) 1,100 Honeywell International, Inc. 5.125 11/01/06 1,114,099 30 Honeywell International, Inc. 6.875 10/03/05 30,217 165 Textron Financial Corp. 4.125 03/03/08 164,902 ------------ 1,309,218 ------------ INSURANCE BROKERS/SERVICES (0.5%) 800 Marsh & McLennan Companies Inc. 5.375 03/15/07 810,768 ------------ INTEGRATED OIL (0.4%) 725 Conoco Funding Co. (Canada) 5.45 10/15/06 738,303 ------------ INVESTMENT BANKS/BROKERS (1.2%) 775 Goldman Sachs Group Inc. (The) 4.125 01/15/08 775,016 35 Lehman Brothers Holdings, Inc. 2.79 04/20/07 35,045 1,160 Lehman Brothers Holdings, Inc. 8.25 06/15/07 1,249,992 ------------ 2,060,053 ------------ INVESTMENT MANAGERS (1.3%) 1,930 TIAA Global Markets - 144A* 3.875 01/22/08 1,919,061 455 TIAA Global Markets - 144A* 5.00 03/01/07 461,492 ------------ 2,380,553 ------------
SEE NOTES TO FINANCIAL STATEMENTS 12
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ----------------------------------------------------------------------------------------------- LIFE/HEALTH INSURANCE (3.0%) $ 1,625 Genworth Financial, Inc. 3.56+% 06/15/07 $ 1,628,825 645 John Hancock Financial Services, Inc. 5.625 12/01/08 674,404 270 John Hancock Global Funding II - 144A* 5.625 06/27/06 273,994 395 John Hancock Global Funding II - 144A* 7.90 07/02/10 459,839 695 Met Life Global Funding I - 144A* (Note 4) 3.375 10/05/07 683,395 175 MetLife, Inc. (Note 4) 5.25 12/01/06 177,862 300 Monumental Global Funding II - 144A* 3.85 03/03/08 297,521 1,085 Monumental Global Funding II - 144A* 6.05 01/19/06 1,097,438 ------------ 5,293,278 ------------ MAJOR BANKS (4.5%) 720 ABN Amro Bank (Netherlands) 3.31+ 05/11/07 721,017 545 Bank of America Corp. 3.375 02/17/09 531,599 260 Bank of America Corp. 3.875 01/15/08 259,132 445 Bank of America Corp. 4.75 10/15/06 449,746 320 Bank of America Corp. 5.25 02/01/07 326,700 215 Bank of New York Co., Inc. (The) 5.20 07/01/07 219,197 1,440 Branch Banking & Trust Corp. 3.42+ 06/04/07 1,442,994 395 FleetBoston Financial Corp. 7.25 09/15/05 397,794 125 HSBC Finance Corp. 6.75 05/15/11 138,913 285 Huntington National Bank 2.75 10/16/06 280,521 510 Key Bank NA 7.125 08/15/06 526,142 820 Suntrust Bank Atlanta 7.25 09/15/06 846,951 235 Wachovia Corp. 3.625 02/17/09 231,254 720 Wachovia Corp. 4.95 11/01/06 727,937 330 Wachovia Corp. 6.875 09/15/05 332,001 405 Wells Fargo Co. 3.45+ 03/03/06 405,396 ------------ 7,837,294 ------------ MAJOR TELECOMMUNICATIONS (1.5%) 470 Deutsche Telekom International Finance Corp. (Netherlands 8.50 06/15/10 545,264 1,000 GTE Corp. 6.36 04/15/06 1,017,295 285 Telecom Italia Capital SpA (Luxembourg) 4.00 11/15/08 280,914 660 Verizon Global Funding Corp. 6.125 06/15/07 684,681 150 Verizon Global Funding Corp. 7.25 12/01/10 170,219 ------------ 2,698,373 ------------ MANAGED HEALTH CARE (1.5%) 465 Aetna, Inc. 7.375 03/01/06 474,778 250 Aetna, Inc. 7.875 03/01/11 292,153 495 Anthem, Inc. 4.875 08/01/05 495,282
SEE NOTES TO FINANCIAL STATEMENTS 13
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ----------------------------------------------------------------------------------------------- $ 175 UnitedHealth Group Inc. 4.125% 08/15/09 $ 174,340 105 UnitedHealth Group Inc. 5.20 01/17/07 106,728 680 UnitedHealth Group Inc. 7.50 11/15/05 687,749 400 WellPoint Health Networks Inc. 6.375 06/15/06 408,682 ------------ 2,639,712 ------------ MEDIA CONGLOMERATES (0.5%) 465 Time Warner, Inc. 6.125 04/15/06 472,361 400 Time Warner, Inc. 6.15 05/01/07 414,066 ------------ 886,427 ------------ MOTOR VEHICLES (0.8%) 560 American Honda Finance Corp. - 144A* 3.85 11/06/08 555,304 155 DaimlerChrysler North American Holdings Co. 4.05 06/04/08 152,730 730 DaimlerChrysler North American Holdings Co. 6.40 05/15/06 744,410 ------------ 1,452,444 ------------ MULTI-LINE INSURANCE (0.9%) 180 American General Finance Corp. (Series MTNF) 5.875 07/14/06 183,158 690 American General Finance Corp. (Series MTNH) 4.625 09/01/10 694,028 250 Equitable Life Assurance Society - 144A* 6.95 12/01/05 253,038 185 Hartford Financial Services Group, Inc. (The) 2.375 06/01/06 181,735 190 International Lease Finance Corp. 3.75 08/01/07 188,455 ------------ 1,500,414 ------------ OTHER CONSUMER SERVICES (0.2%) 400 Cendant Corp. 6.25 01/15/08 417,490 ------------ PROPERTY - CASUALTY INSURERS (0.8%) 580 Allstate Finance Global Funding II - 144A* (Note 4) 2.625 10/22/06 569,388 595 Mantis Reef Ltd. - 144A* (Australia) 4.692 11/14/08 597,257 285 St. Paul Travelers 5.01 08/16/07 288,696 ------------ 1,455,341 ------------ PULP & PAPER (0.5%) 275 International Paper Co. 3.80 04/01/08 270,362 280 MeadWestvaco Corp. 2.75 12/01/05 278,661 260 Sappi Papier Holding AG - 144A* (Austria) 6.75 06/15/12 278,239 ------------ 827,262 ------------
SEE NOTES TO FINANCIAL STATEMENTS 14
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ----------------------------------------------------------------------------------------------- RAILROADS (0.6%) $ 165 Norfolk Southern Corp. 7.35% 05/15/07 $ 174,232 160 Union Pacific Corp. 3.625 06/01/10 153,914 670 Union Pacific Corp. (Series MTNE) 6.79 11/09/07 709,382 ------------ 1,037,528 ------------ REAL ESTATE DEVELOPMENT (0.6%) 696 World Financial Properties - 144A* 6.91 09/01/13 755,072 205 World Financial Properties - 144A* 6.95 09/01/13 222,650 ------------ 977,722 ------------ REGIONAL BANKS (0.4%) 400 U.S. Bank NA 2.85 11/15/06 393,530 310 US Bancorp 5.10 07/15/07 316,263 ------------ 709,793 ------------ SAVINGS BANKS (1.0%) 155 Household Finance Corp. 4.125 12/15/08 154,127 70 Household Finance Corp. 5.875 02/01/09 73,538 95 Household Finance Corp. 6.375 10/15/11 104,002 670 Household Finance Corp. 6.40 06/17/08 710,094 100 Sovereign Bank (Series CD) 4.00 02/01/08 99,170 165 Washington Mutual Inc. 7.50 08/15/06 170,835 445 Washington Mutual Inc. 8.25 04/01/10 511,582 ------------ 1,823,348 ------------ TOBACCO (0.3%) 220 Altria Group Inc. 5.625 11/04/08 228,410 260 Altria Group Inc. 7.65 07/01/08 283,270 ------------ 511,680 ------------ TRUCKS/CONSTRUCTION/FARM MACHINERY (1.0%) 610 Caterpillar Financial Services Corp. (Series MTNF) 3.625 11/15/07 602,685 435 John Deere Capital Corp. 3.375 10/01/07 428,121 640 John Deere Capital Corp. 4.50 08/22/07 644,812 ------------ 1,675,618 ------------ Total Corporate Bonds (COST $74,008,016) 74,586,758 ------------
SEE NOTES TO FINANCIAL STATEMENTS 15
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ----------------------------------------------------------------------------------------------- ASSET-BACKED SECURITIES (19.2%) FINANCE/RENTAL/LEASING $ 775 Americredit Automoblie Receivables Trust 2004-BM A3 2.07% 08/06/08 $ 763,624 1,700 BMW Vehicle Owner Trust 2005-A A3 4.04 02/25/09 1,703,922 800 Capital One Multi-Asset Execution 4.05 02/15/11 801,672 900 Caterpillar Financial Asset Trust 2005-A A3 3.90 02/25/09 899,103 249 Chase Manhattan Auto Owner Trust 2002A 4.24 09/15/08 249,864 328 Chase Manhattan Auto Owner Trust 2002-B A4 4.21 01/15/09 328,702 1,500 Chase Manhattan Auto Owner Trust 2003-C A4 2.94 06/15/10 1,474,947 1,300 Chase Manhattan Auto Owner Trust 2004-A A4 2.83 09/15/10 1,270,027 450 CIT Equipment Collateral 2004-EF1 A3 3.50 09/20/08 444,697 650 CNH Equipment Trust 2005-A A3 4.02 04/15/09 650,398 825 Daimler Chrysler Auto Trust 2005-B A3 4.04 09/08/09 826,374 1,000 DaimlerChrysler Auto Trust 2003-B A4 2.86 03/09/09 984,108 1,400 Daimler Chrysler Auto Trust 2004-A A4 2.58 04/08/09 1,367,633 525 Fifth Third Auto Trust 2004-A A3 3.19 02/20/08 520,967 700 Ford Credit Auto Owner Trust 2005B A3 4.17 01/15/09 702,110 375 Harley-Davidson Motorcycle Trust 2002-2 3.09 06/15/10 372,462 570 Harley-Davidson Motorcycle Trust 2003-1 2.63 11/15/10 561,538 1,200 Harley-Davidson Motorcycle Trust 2003-3 A2 2.76 05/15/11 1,184,529 900 Harley-Davidson Motorcycle Trust 2004-2 A2 3.56 02/15/12 893,318 750 Harley-Davidson Motorcycle Trust 2005-2 A2 4.07 02/15/12 751,069 1,050 Honda Auto Receivables Owner Trust 2003-1 2.48 07/18/08 1,038,367 1,400 Honda Auto Receivables Owner Trust 2003-3 A4 2.77 11/21/08 1,374,876 550 Honda Auto Receivables Owner Trust 2005-2 A3 3.93 01/15/09 549,842 400 Hyundai Auto Receivables Trust 2003-A A3 2.33 11/15/07 397,184 800 Hyundai Auto Receivables Trust 2004-A A3 2.97 05/15/09 790,312 1,400 MBNA Credit Card Master Note Trust 2004-A4 A4 2.70 09/15/09 1,370,618 1,025 Merrill Auto Trust Securitization 2005-1 A3 4.10 08/25/09 1,025,641 825 National City Auto Receivables Trust 2004-A A4 2.88 05/15/11 806,045 1,500 Nissan Auto Receivables Owner Trust 2003-A A4 2.61 07/15/08 1,480,680
SEE NOTES TO FINANCIAL STATEMENTS 16
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------ $ 1,100 Nissan Auto Receivables Owner Trust 2004-A A4 2.76% 07/15/09 $ 1,073,619 1,175 Nissan Auto Receivables Owner Trust 2005-B A3 3.99 07/15/09 1,175,900 1,118 TXU Electric Delivery Transition Bond Company LLC 2004-1 A1 3.52 11/15/11 1,105,913 1,400 USAA Auto Owner Trust 2004-1 A4 2.67 10/15/10 1,368,310 550 USAA Auto Owner Trust 2004-3 A3 3.16 02/17/09 544,439 800 USAA Auto Owner Trust 2005-1 A3 3.90 07/15/09 799,382 575 Wachovia Auto Owner Trust 2005-A A3 4.06 09/21/09 576,193 1,400 Whole Auto Loan Trust 2003-1 A4 2.58 03/15/10 1,376,228 ------------ TOTAL ASSET-BACKED SECURITIES (COST $33,960,248) 33,604,613 ------------ U.S. GOVERNMENT AGENCY OBLIGATIONS (9.9%) 10,100 Federal Home Loan Mortgage Corp. 2.75 08/15/06 9,988,678 7,410 Federal Home Loan Mortgage Corp. 3.625 02/15/07 7,392,816 ------------ U.S. GOVERNMENT AGENCY OBLIGATIONS (COST $17,555,154) 17,381,494 ------------ U.S. GOVERNMENT AGENCIES - MORTGAGE-BACKED SECURITIES (10.7%) 564 Federal Home Loan Mortgage Corp. (ARM) 3.598 07/01/34 556,825 800 Federal Home Loan Mortgage Corp. (ARM) 4.464 08/01/34 802,834 668 Federal Home Loan Mortgage Corp. (ARM) 4.354 10/01/33 664,166 1,125 Federal Home Loan Mortgage Corp. (ARM) 4.375 07/01/35 1,127,285 766 Federal Home Loan Mortgage Corp. PC Gold 7.50 02/01/27 - 08/01/32 820,862 559 Federal National Mortgage Assoc. (ARM) 3.655 07/01/34 558,699 321 Federal National Mortgage Assoc. (ARM) 3.805 06/01/34 322,400 780 Federal National Mortgage Assoc. (ARM) 4.15 09/01/34 780,950 897 Federal National Mortgage Assoc. (ARM) 4.257 04/01/35 902,768 745 Federal National Mortgage Assoc. (ARM) 4.503 04/01/35 752,657 1,406 Federal National Mortgage Assoc. (ARM) 4.547 05/01/35 1,412,141 977 Federal National Mortgage Assoc. (ARM) 4.243 05/01/35 981,855 799 Federal National Mortgage Assoc. (ARM) 4.345 05/01/35 803,551 775 Federal National Mortgage Assoc. (ARM) 4.778 07/01/35 780,813 1,874 Federal National Mortgage Assoc. 6.50 01/01/32 - 11/01/33 1,943,005 2,546 Federal National Mortgage Assoc. 7.00 11/01/24 - 02/01/33 2,686,392 2,707 Federal National Mortgage Assoc. 7.50 03/01/24 - 08/01/32 2,894,473 ------------ TOTAL U.S. GOVERNMENT AGENCIES - MORTGAGE-BACKED SECURITIES (COST $18,803,795) 18,791,676 ------------
SEE NOTES TO FINANCIAL STATEMENTS 17
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------ U.S. GOVERNMENT AGENCIES - COLLATERALIZED MORTGAGE OBLIGATIONS (2.2%) $ 1,600 FEDERAL HOME LOAN MORTGAGE CORP. 2644 AU (PAC) 3.50% 05/15/22 $ 1,580,315 453 Federal Home Loan Mortgage Corp. 2104 TE (PAC) 5.50 02/15/12 454,701 1,099 Federal National Mortgage Assoc. 2005-27 NA (PAC) 5.50 01/25/24 1,117,486 620 Federal National Mortgage Assoc. 2005-52 PA (PAC) 6.50 06/25/35 654,777 ------------- TOTAL U.S. GOVERNMENT AGENCIES - COLLATERALIZED MORTGAGE OBLIGATIONS (COST $3,885,364) 3,807,279 ------------- Foreign Government Obligations (1.1%) 675 Quebec Province (Canada) 6.125 01/22/11 738,067 160 Quebec Province (Canada) 5.50 04/11/06 162,369 390 United Mexican States (Mexico) 8.625 03/12/08 432,900 190 United Mexican States (Mexico) 8.375 01/14/11 221,635 240 United Mexican States (Mexico) 9.875 02/01/10 290,880 ------------- TOTAL FOREIGN GOVERNMENT OBLIGATIONS (COST $2,661,871) 1,845,851 ------------- SHORT-TERM INVESTMENTS (13.2%) U.S. GOVERNMENT & AGENCY OBLIGATIONS 4,600 Federal Home Loan Mortgage Corp. (a) 2.60 07/01/05 4,600,000 200 U.S. Treasury Bill (a)++ 2.82 07/14/05 199,796 9,000 U.S. Treasury Notes 1.625 02/28/06 8,896,293 9,500 U.S. Treasury Notes 1.875 01/31/06 9,419,108 ------------- TOTAL SHORT-TERM INVESTMENTS (COST $23,123,110) 23,115,197 ------------- TOTAL INVESTMENTS (COST $173,997,558) (b) (c) 98.9% 173,132,868 OTHER ASSETS IN EXCESS OF LIABILITIES 1.1 1,964,962 ----- ------------- NET ASSETS 100.0% $ 175,097,830 ===== =============
- ---------- ARM ADJUSTABLE RATE MORTGAGE. PAC PLANNED AMORTIZATION CLASS. * RESALE IS RESTRICTED TO QUALIFIED INSTITUTIONAL INVESTORS. + FLOATING RATE SECURITY, RATE SHOWN IS THE RATE IN EFFECT AT JUNE 30, 2005. ++ A PORTION OF THIS SECURITY HAS BEEN PHYSICALLY SEGREGATED IN CONNECTION WITH OPEN FUTURES CONTRACTS IN AN AMOUNT EQUAL TO $71,220. (a) PURCHASED ON A DISCOUNT BASIS. THE INTEREST RATES SHOWN HAVE BEEN ADJUSTED TO REFLECT A MONEY MARKET EQUIVALENT YIELD. (b) SECURITIES HAVE BEEN DESIGNATED AS COLLATERAL IN AN AMOUNT EQUAL TO $29,255,997 IN CONNECTION WITH SECURITIES PURCHASED ON A FORWARD COMMITMENT BASIS AND OPEN FUTURES CONTRACTS. (c) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES APPROXIMATES THE AGGREGATE COST FOR BOOK PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION IS $231,210 AND THE AGGREGATE GROSS UNREALIZED DEPRECIATION IS $1,095,900, RESULTING IN NET UNREALIZED DEPRECIATION OF $864,690. SEE NOTES TO FINANCIAL STATEMENTS 18 FUTURES CONTRACTS OPEN AT JUNE 30, 2005:
UNREALIZED NUMBER OF DESCRIPTION, DELIVERY UNDERLYING FACE APPRECIATION/ CONTRACTS LONG/SHORT MONTH AND YEAR AMOUNT AT VALUE (DEPRECIATION) - ----------------------------------------------------------------------------------------------------------- 58 Long U.S. Treasury Notes $ 12,045,875 $ (9,191) 2 year September 2005 132 Short U.S. Treasury Notes (14,373,563) (34,476) 5 year September 2005 26 Short U.S. Treasury Notes (2,950,188) (17,398) 10 year September 2005 ------------ Total unrealized depreciation $ (61,065) ============
SEE NOTES TO FINANCIAL STATEMENTS 19 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- LIMITED DURATION PORTFOLIO FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 2005 (UNAUDITED) ASSETS: Investments in securities, at value (cost $172,556,347) $ 171,702,223 Investments in affiliates (cost $1,441,211) 1,430,645 Cash 314,946 Receivable for: Interest 1,339,493 Principal paydowns 781,650 Prepaid expenses and other assets 5,641 --------------- TOTAL ASSETS 175,574,598 --------------- LIABILITIES: Payable for: Investments purchased 338,435 Investment advisory fee 43,142 Distribution fee (Class Y) 26,060 Variation margin 25,907 Administration fee 11,504 Accrued expenses and other payables 31,720 --------------- TOTAL LIABILITIES 476,768 --------------- NET ASSETS $ 175,097,830 =============== COMPOSITION OF NET ASSETS: Paid-in-capital $ 184,350,708 Net unrealized depreciation (925,755) Dividends in excess of net investment income (2,153,965) Accumulated net realized loss (6,173,158) --------------- NET ASSETS $ 175,097,830 =============== CLASS X SHARES: Net Assets $ 48,260,322 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 5,005,889 NET ASSET VALUE PER SHARE $ 9.64 =============== CLASS Y SHARES: Net Assets $ 126,837,508 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 13,173,391 NET ASSET VALUE PER SHARE $ 9.63 ===============
SEE NOTES TO FINANCIAL STATEMENTS 20 STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2005 (UNAUDITED) NET INVESTMENT INCOME: INCOME Interest $ 3,074,389 Interest from affiliates 14,861 --------------- TOTAL INCOME 3,089,250 --------------- EXPENSES Investment advisory fee 262,909 Distribution fee (Class Y shares) 156,538 Administration fee 70,109 Custodian fees 15,198 Professional fees 12,154 Shareholder reports and notices 8,571 Trustees' fees and expenses 1,167 Transfer agent fees and expenses 250 Other 13,052 --------------- TOTAL EXPENSES 539,948 --------------- NET INVESTMENT INCOME 2,549,302 --------------- NET REALIZED AND UNREALIZED GAIN (LOSS): NET REALIZED GAIN/LOSS ON: Investments (391,822) Futures contracts 167,610 --------------- NET REALIZED LOSS (224,212) --------------- NET CHANGE IN UNREALIZED APPRECIATION/DEPRECIATION ON: Investments (700,928) Futures contracts (110,507) --------------- NET DEPRECIATION (811,435) --------------- NET LOSS (1,035,647) --------------- NET INCREASE $ 1,513,655 ===============
SEE NOTES TO FINANCIAL STATEMENTS 21 STATEMENT OF CHANGES IN NET ASSETS
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 --------------- ----------------- (UNAUDITED) INCREASE (DECREASE) IN NET ASSETS: OPERATIONS: Net investment income $ 2,549,302 $ 4,876,672 Net realized loss (224,212) (1,020,451) Net change in unrealized depreciation (811,435) (1,626,595) --------------- ----------------- NET INCREASE 1,513,655 2,229,626 --------------- ----------------- DIVIDENDS TO SHAREHOLDERS FROM NET INVESTMENT INCOME: Class X shares (980,206) (2,415,061) Class Y shares (2,318,445) (5,031,244) --------------- ----------------- TOTAL DIVIDENDS (3,298,651) (7,446,305) --------------- ----------------- Net decrease from transactions in shares of beneficial interest (1,664,867) (6,428,141) --------------- ----------------- NET DECREASE (3,449,863) (11,644,820) NET ASSETS: Beginning of period 178,547,693 190,192,513 --------------- ----------------- END OF PERIOD (INCLUDING DIVIDENDS IN EXCESS OF NET INVESTMENT INCOME OF $2,153,965 AND $1,404,616, RESPECTIVELY) $ 175,097,830 $ 178,547,693 =============== =================
SEE NOTES TO FINANCIAL STATEMENTS 22 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- LIMITED DURATION PORTFOLIO NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) 1. ORGANIZATION AND ACCOUNTING POLICIES Morgan Stanley Variable Investment Series (the "Fund") -- Limited Duration Portfolio (the "Portfolio"), one of 15 separate portfolios, is registered under the Investment Company Act of 1940, as amended (the "Act"), as a diversified, open-end management investment company. The Fund is offered exclusively to life insurance companies in connection with particular life insurance and/or annuity contracts they offer. The Portfolio's investment objective is to provide a high level of current income consistent with the preservation of capital. The Fund was organized as a Massachusetts business trust on February 25, 1983 and the Portfolio commenced operations on May 4, 1999. On June 5, 2000, the Portfolio commenced offering one additional class of shares (Class Y). The Portfolio offers Class X shares and Class Y shares. The two classes are identical except that Class Y shares incur distribution expenses. Class X shares are generally available to holders of contracts offered by Metropolitan Life Insurance Company (formerly Paragon Life Insurance Company) and other contracts offered before May 1, 2000. Class Y shares are available to holders of contracts offered on or after June 5, 2000. The following is a summary of significant accounting policies: A. VALUATION OF INVESTMENTS -- (1) certain portfolio securities may be valued by an outside pricing service approved by the Fund's Trustees (2) portfolio securities for which over-the-counter market quotations are readily available are valued at the mean between the last reported bid and asked price; (3) futures are valued at the latest price published by the commodities exchange on which they trade; (4) when market quotations are not readily available or Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") determines that the market quotations are not reflective of a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees; and (5) short-term debt securities having a maturity date of more than sixty days at time of purchase are valued on a mark-to-market basis until sixty days prior to maturity and thereafter at amortized cost based on their value on the 61st day. Short-term debt securities having a maturity date of sixty days or less at the time of purchase are valued at amortized cost. B. ACCOUNTING FOR INVESTMENTS -- Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Realized gains and losses on security transactions are determined by the identified cost method. Discounts are accreted and premiums are amortized over the life of the respective securities. Interest income is accrued daily. C. REPURCHASE AGREEMENT -- The Fund may 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. 23 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. 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 Portfolio 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 Portfolio 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 Portfolio as unrealized gains and losses. Upon closing of the contract, the Portfolio 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. F. 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. G. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- Dividends and distributions to shareholders are recorded on the ex-dividend date. H. EXPENSES -- Direct expenses are charged to the Portfolio and general Fund expenses are allocated on the basis of relative net assets or equally among the Portfolios. I. 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, the Portfolio pays an advisory fee, accrued daily and payable monthly, by applying the annual rate of 0.30% of the portion of the daily net assets 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 Portfolio pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.08% to the Portfolio's daily net assets. 24 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 Class Y shares of the Portfolio will pay a distribution fee which is accrued daily and paid monthly at the annual rate of 0.25% of the average daily net assets of the class. 4. SECURITY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES The cost of purchases and proceeds from sales/prepayments of portfolio securities, excluding short-term investments, for the six months ended June 30, 2005 were $46,701,655, and $70,631,945, respectively. Included in the aforementioned are purchases and sales/prepayments of U.S. Government securities of $27,843,677 and $43,008,011, respectively. The portfolio also had the following transactions with affiliates:
NET REALIZED ISSUER PURCHASES SALES GAIN/LOSS INCOME VALUE - ------ ---------- ----- ------------ -------- --------- Allstate Corp -- -- -- $ 7,555 $ 569,388 MetLife, Inc $ 682,977 -- -- 7,306 $ 861,257
Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and Distributor, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and compensation. Aggregate pension costs for the six months ended June 30, 2005 included in Trustees' fees and expenses in the Statement of Operations amounted to $156. At June 30, 2005, the Portfolio had an accrued pension liability of $100 which is included in accrued expenses in the Statement of Assets and Liabilities. On December 2, 2003, the Trustees voted to close the plan to new participants and eliminate the future benefits growth due to increases to compensation after July 31, 2003. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 25 5. SHARES OF BENEFICIAL INTEREST Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 -------------------------------- -------------------------------- (UNAUDITED) SHARES AMOUNT SHARES AMOUNT -------------- -------------- -------------- -------------- CLASS X SHARES Sold 808,434 $ 7,822,702 2,897,615 $ 28,751,340 Reinvestment of dividends 101,483 980,206 244,877 2,415,061 Redeemed (1,324,153) (12,814,408) (4,170,692) (41,333,887) -------------- -------------- -------------- -------------- Net decrease -- Class X (414,236) (4,011,500) (1,028,200) (10,167,486) -------------- -------------- -------------- -------------- CLASS Y SHARES Sold 1,698,071 16,413,789 4,104,281 40,571,128 Reinvestment of dividends 240,383 2,318,445 510,966 5,031,244 Redeemed (1,695,398) (16,385,601) (4,243,335) (41,863,027) -------------- -------------- -------------- -------------- Net increase -- Class Y 243,056 2,346,633 371,912 3,739,345 -------------- -------------- -------------- -------------- Net decrease in Portfolio (171,180) $ (1,664,867) (656,288) $ (6,428,141) ============== ============== ============== ==============
6. PURPOSES OF AND RISKS RELATING TO CERTAIN FINANCIAL INSTRUMENTS To hedge against adverse interest rate and market risks on portfolio positions or anticipated positions in U.S. Government Securities, the Portfolio may enter into interest rate futures contracts ("future contracts") These futures contracts involve elements of market risk in excess of the amount reflected in the Statement of Assets and Liabilities. The Portfolio bears the risk of an unfavorable change in the value of the underlying securities. Risk may also arise upon entering into contracts from the potential inability of counterparts to meet the terms of their contacts. 7. EXPENSE OFFSET The expense offset represents a reduction of the custodian fees for earnings on cash balances maintained by the Portfolio. 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 26 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 December 31, 2004, the Portfolio had a net capital loss carryforward of approximately $5,900,000 of which $328,000 will expire on December 31, 2010, $1,546,000 will expire on December 31, 2011, and $4,026,000 will expire on December 31, 2012 to offset future capital gains to the extent provided by regulations. As of December 31, 2004, the Portfolio had temporary book/tax differences primarily attributable to capital loss from the mark-to-market of futures contracts and book amortization of premiums on debt securities. 27 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- LIMITED DURATION PORTFOLIO FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED -------------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ---------- ---------- ---------- ---------- ---------- (UNAUDITED) CLASS X SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 9.74 $ 10.01 $ 10.17 $ 10.17 $ 9.96 $ 9.88 ------------- ---------- ---------- ---------- ---------- ---------- Income (loss) from investment operations: Net investment income++ 0.15 0.28 0.21 0.27 0.40 0.51 Net realized and unrealized gain (loss) (0.06) (0.14) 0.01 0.13 0.26 0.05 ------------- ---------- ---------- ---------- ---------- ---------- Total income from investment operations 0.09 0.14 0.22 0.40 0.66 0.56 ------------- ---------- ---------- ---------- ---------- ---------- Less dividends and distributions from: Net investment income (0.19) (0.41) (0.38) (0.36) (0.45) (0.48) Net realized gain - - - (0.04) - - ------------- ---------- ---------- ---------- ---------- ---------- Total dividends and distributions (0.19) (0.41) (0.38) (0.40) (0.45) (0.48) ------------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period $ 9.64 $ 9.74 $ 10.01 $ 10.17 $ 10.17 $ 9.96 ============= ========== ========== ========== ========== ========== TOTAL RETURN+ 0.93%(2) 1.42% 2.23% 4.06% 6.72% 5.85% RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.44%(3) 0.49% 0.51% 0.48% 0.61%(4)# 0.98% Net investment income 3.09%(3) 2.77% 2.02% 2.65% 3.84%(4) 5.08% SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 48,260 $ 52,784 $ 64,576 $ 73,476 $ 25,858 $ 6,427 Portfolio turnover rate 29%(2) 128% 215% 58% 133% 16%
- ---------- * Prior to June 5, 2000, the Portfolio issued one class of shares. All shares of the Portfolio held prior to May 1, 2000 have been designated Class X shares. ++ 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. # Does not reflect the effect of expense offset of 0.06% (1) Refelects overall Portfolio ratios for investment income and non-class specific expenses. (2) Not annualized. (3) Annualized. (4) If the Investment Adviser had not "capped" all expenses (except for distribution fees) at 0.50% of its daily net assets for the period June 1, 2001 through December 31, 2001, the annualized expense and net investment income ratios would have been 0.65% and 3.80%, respectively. SEE NOTES TO FINANCIAL STATEMENTS 28
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ---------------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ----------- ----------- ----------- ----------- ----------- (unaudited) CLASS Y SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 9.73 $ 10.00 $ 10.16 $ 10.16 $ 9.95 $ 9.86 ------------- ----------- ----------- ----------- ----------- ----------- Income (loss) from investment operations: Net investment income++ 0.14 0.25 0.18 0.24 0.35 0.28 Net realized and unrealized gain (loss) (0.06) (0.14) 0.02 0.14 0.28 0.09 ------------- ----------- ----------- ----------- ----------- ----------- Total income from investment operations 0.08 0.11 0.20 0.38 0.63 0.37 ------------- ----------- ----------- ----------- ----------- ----------- Less dividends and distributions from: Net investment income (0.18) (0.38) (0.36) (0.34) (0.42) (0.28) Net realized gain - - - (0.04) - - ------------- ----------- ----------- ----------- ----------- ----------- Total dividends and distributions (0.18) (0.38) (0.36) (0.38) (0.42) (0.28) ------------- ----------- ----------- ----------- ----------- ----------- Net asset value, end of period $ 9.63 $ 9.73 $ 10.00 $ 10.16 $ 10.16 $ 9.95 ============= =========== =========== =========== =========== =========== TOTAL RETURN+ 0.81%(2) 1.17% 1.98% 3.81% 6.49% 3.82%(2) RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.69%(3) 0.74% 0.76% 0.73% 0.86%(4)# 1.17%(3) Net investment income 2.84%(3) 2.52% 1.77% 2.40% 3.59%(4) 5.00%(3) SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 126,838 $ 125,764 $ 125,616 $ 72,800 $ 25,050 $ 1,430 Portfolio turnover rate 29%(2) 128% 215% 58% 133% 16%(2)
- ---------- * For the period June 5, 2000 (issued date) through December 31, 2000. ++ 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. # Does not reflect the effect of expense offset of 0.06% (1) Refelects overall Portfolio ratios for investment income and non-class specific expenses. (2) Not annualized. (3) Annualized. (4) If the Investment Manager had not "capped" all expenses (except for distribution fees) at 0.50% of its daily net assets for the period June 1, 2001 through December 31, 2001, the annualized expense and net investment income ratios would have been 0.90% and 3.55%, respectively. SEE NOTES TO FINANCIAL STATEMENTS 29 TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo CHAIRMAN OF THE BOARD Mitchell M. Merin PRESIDENT Ronald E. Robison EXECUTIVE VICE PRESIDENT AND PRINCIPAL EXECUTIVE OFFICER Joseph J. McAlinden VICE PRESIDENT Barry Fink VICE PRESIDENT Amy R. Doberman VICE PRESIDENT Carsten Otto CHIEF COMPLIANCE OFFICER Stefanie V. Chang VICE PRESIDENT Francis J. Smith TREASURER AND CHIEF FINANCIAL OFFICER Thomas F. Caloia VICE PRESIDENT Mary E. Mullin SECRETARY TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT 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 Portfolio 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 Portfolio. For more detailed information about the Portfolio fees and expenses and other pertinent information, please read its Prospectus. The Portfolio's Statement of Additional Information contains additional information about the Portfolio, 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 Portfolio 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)2005 Morgan Stanley [MORGAN STANLEY LOGO] RA05-00684P-Y06/05 [GRAPHIC] MORGAN STANLEY FUNDS MORGAN STANLEY VARIABLE INVESTMENT SERIES -- LIMITED DURATION PORTFOLIO SEMIANNUAL REPORT JUNE 30, 2005 [MORGAN STANLEY LOGO] WELCOME, SHAREHOLDER: IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY VARIABLE INVESTMENT SERIES -- MONEY MARKET PORTFOLIO 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 PORTFOLIO'S FINANCIAL STATEMENTS AND A LIST OF PORTFOLIO INVESTMENTS. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE PORTFOLIO BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT A MUTUAL FUND WILL ACHIEVE ITS INVESTMENT OBJECTIVE. AN INVESTMENT IN A MONEY MARKET FUND IS NOT INSURED OR GUARANTEED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH THE PORTFOLIO SEEKS TO PRESERVE THE VALUE OF AN INVESTMENT AT $1.00 PER SHARE, IT IS POSSIBLE TO LOSE MONEY BY INVESTING IN THE PORTFOLIO. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT For the six months ended June 30, 2005 MARKET CONDITIONS The Federal Open Market Committee ("the Fed") increased its target rate for federal funds with four steps of 25 basis points each from January 1, 2005 to June 30, 2005. As a result, the Fed increased that rate from 2.25 percent to 3.25 percent, a three-year high. PERFORMANCE ANALYSIS As of June 30, 2005, Morgan Stanley Variable Investment Series Money Market Portfolio had net assets of more than $249 million with an average portfolio maturity of 36 days. For the seven-day period ended June 30, 2005, the Portfolio's Class X shares provided an effective annualized yield of 2.72 percent and a current yield of 2.68 percent, while its 30-day moving average yield for June was 2.61 percent. For the six-month period ended June 30, 2005, the Portfolio's Class X shares returned 1.11 percent. For the seven-day period ended June 30, 2005, the Portfolio's Class Y shares provided an effective annualized yield of 2.45 percent and a current yield of 2.43 percent, while its 30-day moving average yield for June was 2.36 percent. For the six-month period ended June 30, 2005, the Portfolio's Class Y shares provided a total return of 0.98 percent. PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. THE PERFORMANCE OF THE PORTFOLIO'S TWO SHARE CLASSES VARIES BECAUSE EACH HAS DIFFERENT EXPENSES. THE PORTFOLIO'S TOTAL RETURNS ASSUME THE REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE DEDUCTION OF ANY CHARGES BY YOUR INSURANCE COMPANY. SUCH COSTS WOULD LOWER PERFORMANCE. Our strategy in managing the Portfolio remained consistent with the Portfolio's long-term focus on maintaining preservation of capital and liquidity. We adhered to a conservative approach that emphasized purchasing high-quality money market obligations and avoided the use of derivatives or structured notes that might fluctuate excessively with changing interest rates. Approximately 93% of the Portfolio's holdings were due to mature in less than four months at the end of the measurement period. THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM WELL OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE PORTFOLIO IN THE FUTURE. PORTFOLIO COMPOSITION Commercial Paper 79.7% Short-Term Bank Notes 9.0 Certificate Of Deposit 7.9 U.S. Government Agencies 3.4
MATURITY SCHEDULE 1 - 30 Days 58.3% 31 - 60 Days 27.0 61 - 90 Days 6.4 91 - 120 Days 1.5 121+ Days 6.8
DATA AS OF JUNE 30, 2005. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES FOR PORTFOLIO COMPOSITION AND MATURITY SCHEDULE 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. 2 INVESTMENT STRATEGY THE PORTFOLIO INVESTS IN HIGH QUALITY, SHORT-TERM DEBT OBLIGATIONS. IN SELECTING INVESTMENTS, THE "INVESTMENT ADVISER," MORGAN STANLEY INVESTMENT ADVISORS INC., SEEKS TO MAINTAIN THE PORTFOLIO'S SHARE PRICE AT $1.00. A MUTUAL FUND'S SHARE PRICE REMAINING STABLE AT $1.00 MEANS THAT THE FUND WOULD PRESERVE THE PRINCIPAL VALUE OF THE SHAREHOLDERS' INVESTMENTS. AN INVESTMENT IN A MONEY MARKET FUND IS NOT INSURED OR GUARANTEED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH MONEY MARKET FUNDS SEEK TO PRESERVE THE VALUE OF AN INVESTMENT AT $1.00 PER SHARE, IT IS POSSIBLE TO LOSE MONEY BY INVESTING IN SUCH FUNDS. FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY PORTFOLIO PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE PORTFOLIO'S SECOND AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY PORTFOLIO 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. 3 EXPENSE EXAMPLE As a shareholder of the Portfolio, you incur two types of costs: (1) insurance company charges; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Portfolio expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Portfolio 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 01/01/05 - 06/30/05. 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 Portfolio's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Portfolio'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 Portfolio 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 insurance company charges. 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 insurance company charges were included, your costs would have been higher.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD * -------------- -------------- --------------- 01/01/05 - 01/01/05 06/30/05 06/30/05 -------------- -------------- --------------- CLASS X Actual (1.11% return) $ 1,000.00 $ 1,011.10 $ 2.69 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,022.12 $ 2.71 CLASS Y Actual (0.98% return) $ 1,000.00 $ 1,009.80 $ 3.94 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,020.88 $ 3.96
- ---------- * EXPENSES ARE EQUAL TO THE PORTFOLIO'S ANNUALIZED EXPENSE RATIO OF 0.54% AND 0.79% RESPECTIVELY, MULTIPLIED BY THE AVERAGE ACCOUNT VALUE OVER THE PERIOD, MULTIPLIED BY 181/365 (TO REFLECT THE ONE-HALF YEAR PERIOD). 4 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 fixed income securities trading. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Portfolio's Administrator under the Administration Agreement, including accounting, clerical, bookkeeping, compliance, business management and planning, and the provision of supplies, office space and utilities. (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 administrative and investment advisory services to the Portfolio. 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 Portfolio. 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 The Board reviewed the Portfolio's performance for the one-, three- and five-year periods ended November 30, 2004, as shown in reports provided by Lipper (the "Lipper Reports"), compared to the performance of comparable funds selected by Lipper (the "performance peer group"), and noted that the Portfolio's performance was lower than, but close to, its performance peer group average for the one- and three-year periods and better for the five-year period. The Board concluded that the Portfolio's overall performance was competitive with its performance peer group. FEES RELATIVE TO OTHER FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT STRATEGIES The Board reviewed the advisory and administrative fees (together, the "management fee") paid by the Portfolio under the Management Agreement. The Board noted that the rate was comparable to the management fee rates charged by the Adviser to any other funds it manages with investment strategies comparable to those of the Portfolio. FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS The Board reviewed the management fee rate and the total expense ratio of the Portfolio. The Board noted that: (i) the Portfolio's management fee rate was higher than the average management fee rate for funds, selected by 5 Lipper (the "expense peer group"), managed by other advisers with investment strategies comparable to those of the Portfolio, as shown in the Lipper Report for the Portfolio; and (ii) the Portfolio's total expense ratio was also higher than, but close to, the average total expense ratio of the funds included in the Portfolio's expense peer group. The Board concluded that the Portfolio's management fee 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 Portfolio's management fee schedule under the Management Agreement and noted that it includes breakpoints. The Board also reviewed the level of the Portfolio's management fee and noted that the fee, as a percentage of the Portfolio's net assets, would decrease as net assets increase because the management fee includes breakpoints. The Board concluded that the Portfolio's management fee would reflect economies of scale as assets increase. PROFITABILITY OF ADVISER AND AFFILIATES The Board considered and reviewed information concerning the costs incurred and profits realized by the Adviser and its affiliates during the last two years from their relationship with the Portfolio and the Morgan Stanley Fund Complex and reviewed with the Controller of the Adviser the cost allocation methodology used to determine the Adviser's profitability. Based on their review of the information they received, the Board concluded that the profits earned by the Adviser and its affiliates were not excessive in light of the advisory, administrative and other services provided to the Portfolio. FALL-OUT BENEFITS The Board considered so-called "fall-out benefits" derived by the Adviser and its affiliates from their relationship with the Portfolio and the Morgan Stanley Fund Complex, such as "float" benefits derived from handling of checks for purchases and redemptions of Portfolio shares through a broker-dealer affiliate of the Adviser. The Board also considered that a broker-dealer affiliate of the Adviser receives from the Portfolio 12b-1 fees for distribution and shareholder services. The Board concluded that the float benefits were relatively small and that the 12b-1 fees were competitive with those of other broker-dealer affiliates of investment advisers. SOFT DOLLAR BENEFITS The Board considered whether the Adviser realizes any benefits from commissions paid to brokers who execute securities transactions for the Portfolio ("soft dollars"). The Board noted that the Portfolio invests only in fixed income securities, which do not generate soft dollars. 6 ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE PORTFOLIO'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 PORTFOLIO AND THE ADVISER The Board also reviewed and considered the historical relationship between the Portfolio and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Portfolio'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 Portfolio 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 Portfolio'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 Portfolio's business. GENERAL CONCLUSION After considering and weighing all of the above factors, the Board concluded it would be in the best interest of the Portfolio and its shareholders to approve renewal of the Management Agreement for another year. 7 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- MONEY MARKET PORTFOLIO PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
ANNUALIZED PRINCIPAL YIELD AMOUNT IN ON DATE OF MATURITY THOUSANDS DESCRIPTION PURCHASE DATE VALUE - ---------------------------------------------------------------------------------------------------------------- COMMERCIAL PAPER (79.7%) ASSET-BACKED - AUTO (14.6%) $ 7,000 DaimlerChrysler Revolving Auto Conduit LLC 3.15% 07/19/05 $ 6,989,028 5,000 DRAC Owner Trust A1 3.36 08/24/05 4,974,950 8,000 FCAR Owner Trust 3.09 07/08/05 7,995,224 4,500 FCAR Owner Trust A1 3.33 08/10/05 4,483,400 12,000 New Center Asset Trust Series A1 3.22 - 3.31 08/08/05 - 08/12/05 11,956,161 ------------- 36,398,763 ------------- ASSET-BACKED - CORPORATE (2.4%) 6,000 CIESCO LLC 3.09 07/06/05 5,997,442 ------------- ASSET-BACKED - MORTGAGE (4.8%) 6,000 Mortgage Interest Networking Trust 3.10 07/11/05 5,994,850 6,000 Mortgage Interest Networking Trust A1 3.27 07/12/05 5,994,005 ------------- 11,988,855 ------------- FINANCE - CONSUMER (6.6%) 10,620 American Express Credit Corp. 3.08 07/13/05 10,609,168 6,000 HSBC Finance Corp. 3.24 08/23/05 5,971,645 ------------- 16,580,813 ------------- FINANCE - CORPORATE (4.0%) 10,000 CIT Group, Inc. 3.16 07/26/05 9,978,194 ------------- FINANCIAL CONGLOMERATES (3.9%) 9,785 General Electric Capital Corp. 3.21 - 3.56 08/29/05 - 12/14/05 9,676,327 ------------- INSURANCE (3.6%) 9,085 American General Finance Corp. 3.10 - 3.12 07/07/05 - 07/12/05 9,078,978 ------------- INTERNATIONAL BANKS (36.6%) 12,000 Banque Generale du Luxembourg 3.04 - 3.27 07/06/05 - 09/01/05 11,969,164 6,500 Danske Corp. 3.17 08/05/05 6,480,094 7,725 Deutsche Bank Financial LLC 3.05 07/01/05 7,725,000 12,650 DnB NOR Bank A.S.A. 3.05 - 3.21 07/06/05 - 07/18/05 12,636,548 2,000 HBOS Treasury Services plc 3.38 09/08/05 1,987,158 6,950 ING (U.S.) Funding LLC 3.36 08/30/05 6,911,312 7,000 Natexis Banques Populaires U.S. Finance Co. LLC 3.49 11/14/05 6,909,163 12,200 Nordea North America Inc. 3.23 - 3.27 08/03/05 - 08/26/05 12,148,842 7,480 Sanpaolo IMI U.S. Financial Co. 3.30 07/01/05 7,480,000
SEE NOTES TO FINANCIAL STATEMENTS 8
ANNUALIZED PRINCIPAL YIELD AMOUNT IN ON DATE OF MATURITY THOUSANDS DESCRIPTION PURCHASE DATE VALUE - ---------------------------------------------------------------------------------------------------------------- $ 9,240 Spintab AB 3.21 - 3.29% 07/21/05 - 08/11/05 $ 9,209,949 8,145 UBS Finance (Delaware) LLC 3.11 - 3.28 07/15/05 - 09/19/05 8,121,824 ------------- 91,579,054 ------------- INVESTMENT BANKS/BROKERS (3.2%) 8,000 Goldman Sachs Group Inc. 3.25 07/21/05 7,985,600 ------------- TOTAL COMMERCIAL PAPER (COST $199,264,026) 199,264,026 ------------- U.S. GOVERNMENT AGENCIES (3.4%) 8,583 Freddie Mac (COST $8,490,414) 3.28 - 3.37 10/04/05 - 11/15/05 8,490,414 ------------- SHORT-TERM BANK NOTES (9.0%) 12,600 Bank of America, N.A. 2.90 - 3.12 07/20/05 - 07/25/05 12,600,000 9,800 LaSalle Bank, N.A. 3.07 07/05/05 9,800,000 ------------- TOTAL SHORT-TERM BANK NOTES (COST $22,400,000) 22,400,000 ------------- CERTIFICATES OF DEPOSIT (7.9%) 9,700 Branch Banking & Trust 3.12 07/29/05 9,700,000 10,000 First Tennessee Bank, N.A. 3.16 08/09/05 10,000,000 ------------- TOTAL CERTIFICATES OF DEPOSIT (COST $19,700,000) 19,700,000 ------------- TOTAL INVESTMENTS (COST $249,854,440) (a) 100.0% 249,854,440 OTHER ASSETS IN EXCESS OF LIABILITIES 0.0 78,179 ----- ------------- NET ASSETS 100.0% $ 249,932,619 ===== =============
- ---------- (a) COST IS THE SAME FOR FEDERAL INCOME TAX PURPOSES. SEE NOTES TO FINANCIAL STATEMENTS 9 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- MONEY MARKET PORTFOLIO FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 2005 (UNAUDITED) ASSETS: Investments in securities, at value (cost $249,854,440) $ 249,854,440 Cash 11,780 Interest receivable 225,894 Prepaid expenses and other assets 7,936 -------------- TOTAL ASSETS 250,100,050 -------------- LIABILITIES: Payable for: Investment advisory fee 93,172 Distribution fee (Class Y) 19,120 Administration fee 10,371 Shares of beneficial interest redeemed 68 Accrued expenses and other payables 44,700 -------------- TOTAL LIABILITIES 167,431 -------------- NET ASSETS $ 249,932,619 ============== COMPOSITION OF NET ASSETS: Paid-in-capital $ 249,932,571 Accumulated undistributed net investment income 48 -------------- NET ASSETS $ 249,932,619 ============== CLASS X SHARES: Net Assets $ 157,514,114 Shares Outstanding (UNLIMITED AUTHORIZED SHARES OF $.01 PAR VALUE) 157,514,106 NET ASSET VALUE PER SHARE $ 1.00 ============== CLASS Y SHARES: Net Assets $ 92,418,505 Shares Outstanding (UNLIMITED AUTHORIZED SHARES OF $.01 PAR VALUE) 92,418,464 NET ASSET VALUE PER SHARE $ 1.00 ==============
SEE NOTES TO FINANCIAL STATEMENTS 10 STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2005 (UNAUDITED) NET INVESTMENT INCOME: INTEREST INCOME $ 3,507,172 -------------- EXPENSES Investment advisory fee 570,818 Distribution fee (Class Y shares) 113,001 Administration fee 63,731 Shareholder reports and notices 15,688 Professional fees 14,411 Custodian fees 9,257 Trustees' fees and expenses 1,672 Transfer agent fees and expenses 250 Other 7,686 -------------- TOTAL EXPENSES 796,514 -------------- NET INVESTMENT INCOME $ 2,710,658 ==============
SEE NOTES TO FINANCIAL STATEMENTS 11 STATEMENT OF CHANGES IN NET ASSETS
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 ------------- ----------------- (UNAUDITED) INCREASE (DECREASE) IN NET ASSETS: OPERATIONS: Net investment income $ 2,710,658 $ 2,250,306 ------------- ----------------- DIVIDENDS TO SHAREHOLDERS FROM NET INVESTMENT INCOME: Class X shares (1,816,824) (1,713,991) Class Y shares (893,874) (536,468) ------------- ----------------- TOTAL DIVIDENDS (2,710,698) (2,250,459) ------------- ----------------- Net decrease from transactions in shares of beneficial interest (18,584,081) (77,069,431) ------------- ----------------- NET DECREASE (18,584,121) (77,069,584) NET ASSETS: Beginning of period 268,516,740 345,586,324 ------------- ----------------- END OF PERIOD (INCLUDING ACCUMULATED UNDISTRIBUTED NET INVESTMENT INCOME OF $48 AND $88, RESPECTIVELY) $ 249,932,619 $ 268,516,740 ============= =================
SEE NOTES TO FINANCIAL STATEMENTS 12 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- MONEY MARKET PORTFOLIO NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) 1. ORGANIZATION AND ACCOUNTING POLICIES Morgan Stanley Variable Investment Series (the "Fund") -- Money Market Portfolio (the "Portfolio"), one of 15 separate portfolios, is registered under the Investment Company Act of 1940, as amended (the "Act"), as a diversified, open-end management investment company. The Fund is offered exclusively to life insurance companies in connection with particular life insurance and/or annuity contracts they offer. The Portfolio's investment objective is to seek high current income, preservation of capital and liquidity. The Fund was organized as a Massachusetts business trust on February 25, 1983 and the Portfolio commenced operations on March 9, 1984. On June 5, 2000, the Portfolio commenced offering one additional class of shares (Class Y). The Portfolio offers Class X and Class Y shares. The two are identical except that Class Y shares incurs distribution expenses. Class X shares are generally available to holders of contracts offered by Metropolitan Life Insurance Company (formerly Paragon Life Insurance Company) and other contracts offered before May 1, 2000. Class Y shares are available to holders of contracts offered on or after June 5, 2000. The following is a summary of significant accounting policies: A. VALUATION OF INVESTMENTS -- Portfolio securities are valued at amortized cost, which approximates market value. B. ACCOUNTING FOR INVESTMENTS -- Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Realized gains and losses on security transactions are determined by the identified cost method. Discounts are accreted and premiums are amortized over the life of the respective securities. Interest income is accrued daily. C. REPURCHASE AGREEMENTS -- The Fund may 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. 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. E. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- The Fund records dividends and distributions to shareholders as of the close of each business day. F. EXPENSES -- Direct expenses are charged to the Portfolio and general Fund expenses are allocated on the basis of relative net assets or equally among the Portfolios. 13 G. USE OF ESTIMATES -- The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts and disclosures. Actual results could differ from those estimates. 2. INVESTMENT ADVISORY/ADMINISTRATION AGREEMENTS Pursuant to an Investment Advisory Agreement, the Portfolio pays the Investment Adviser an advisory fee, accrued daily and payable monthly, by applying the following annual rates to the net assets of the Portfolio determined at the close of each business day: 0.45% to the portion of the daily net assets not exceeding $250 million; 0.375% to the portion of the daily net assets exceeding $250 million but not exceeding $750 million; 0.325% to the portion of the daily net assets exceeding $750 million but not exceeding $1.25 billion; 0.30% to the portion of the daily net assets exceeding $1.25 billion but not exceeding $1.5 billion; and 0.275% to the portion of the daily net assets in excess of $1.5 billion. Pursuant to an Administration Agreement with Morgan Stanley Services Company Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Portfolio pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.05% to the Portfolio'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. Under the Plan, Class Y shares of the Portfolio will pay a distribution fee which is accrued daily and paid monthly at the annual rate of 0.25% of the average daily net assets of the class. 4. SECURITY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES The cost of purchases and proceeds from sales/maturities of portfolio securities for the six months ended June 30, 2005 aggregated $1,626,249,583 and $1,641,494,000, respectively. Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and Distributor, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and compensation. Aggregate pension costs for the six months ended June 30, 2005, included in Trustees' fees and expenses in the Statement of Operations amounted to $240. At June 30, 2005, the Portfolio had an accrued pension liability of $11,858 which is included in accrued expenses in the Statement of 14 Assets and Liabilities. On December 2, 2003, the Trustees voted to close the plan to new participants and eliminate the future benefits growth due to increases to compensation after July 31, 2003. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 5. SHARES OF BENEFICIAL INTEREST Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 ------------------------------ ------------------------------ (UNAUDITED) SHARES AMOUNT SHARES AMOUNT ------------- ------------- ------------- ------------- CLASS X SHARES Sold 153,857,802 $ 153,857,802 393,599,095 $ 393,599,095 Reinvestment of dividends 1,816,825 1,816,825 1,713,991 1,713,991 Redeemed (176,760,251) (176,760,251) (468,491,675) (468,491,675) ------------- ------------- ------------- ------------- Net decrease -- Class X (21,085,624) (21,085,624) (73,178,589) (73,178,589) ------------- ------------- ------------- ------------- CLASS Y SHARES Sold 42,115,971 42,115,971 101,822,604 101,822,604 Reinvestment of dividends 893,874 893,874 536,468 536,468 Redeemed (40,508,302) (40,508,302) (106,249,914) (106,249,914) ------------- ------------- ------------- ------------- Net increase (decrease) -- Class Y 2,501,543 2,501,543 (3,890,842) (3,890,842) ------------- ------------- ------------- ------------- Net decrease in Fund (18,584,081) $ (18,584,081) (77,069,431) $ (77,069,431) ============= ============= ============= =============
15 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- MONEY MARKET PORTFOLIO FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- --------- --------- --------- --------- --------- (UNAUDITED) CLASS X SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 --------- --------- --------- --------- --------- --------- Net income from investment operations++ 0.011 0.009 0.007 0.013 0.039 0.058 Less dividends and distributions from net investment income (0.011) (0.009)** (0.007)** (0.013)** (0.039)** (0.058)** --------- --------- --------- --------- --------- --------- Net asset value, end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 ========= ========= ========= ========= ========= ========= TOTAL RETURN+ 1.11%(2) 0.87% 0.67% 1.34% 3.94% 6.01% RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.54%(3) 0.53% 0.52% 0.51% 0.51% 0.52% Net investment income 2.21%(3) 0.85% 0.69% 1.32% 3.69% 5.83% SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 157,514 $ 178,600 $ 251,779 $ 432,817 $ 452,765 $ 358,793 Portfolio turnover rate N/A N/A N/A N/A N/A N/A
- ---------- * PRIOR TO JUNE 5, 2000, THE PORTFOLIO ISSUED ONE CLASS OF SHARES. ALL SHARES OF THE PORTFOLIO HELD PRIOR TO MAY 1, 2000 HAVE BEEN DESIGNATED CLASS X SHARES. ** INCLUDES CAPITAL GAIN DISTRIBUTION OF LESS THAN $0.001. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 16
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- --------- --------- --------- --------- --------- (UNAUDITED) CLASS Y SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 --------- --------- --------- --------- --------- --------- Net income from investment operations++ 0.010 0.006 0.004 0.011 0.036 0.033 Less dividends and distributions from net investment income (0.010) (0.006)** (0.004)** (0.011)** (0.036)** (0.033)** --------- --------- --------- --------- --------- --------- Net asset value, end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 ========= ========= ========= ========= ========= ========= TOTAL RETURN+ 0.98%(2) 0.62% 0.42% 1.08% 3.68% 3.37%(2) RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.79%(3) 0.78% 0.77% 0.76% 0.76% 0.77%(3) Net investment income 1.96%(3) 0.60% 0.44% 1.07% 3.44% 5.86%(3) SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 92,419 $ 89,917 $ 93,808 $ 133,506 $ 105,952 $ 13,813 Portfolio turnover rate N/A N/A N/A N/A N/A N/A
- ---------- * FOR THE PERIOD JUNE 5, 2000 (ISSUED DATE) THROUGH DECEMBER 31, 2000. ** INCLUDES CAPITAL GAIN DISTRIBUTION OF LESS THAN $0.001. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 17 TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo CHAIRMAN OF THE BOARD Mitchell M. Merin PRESIDENT Ronald E. Robison EXECUTIVE VICE PRESIDENT AND PRINCIPAL EXECUTIVE OFFICER Joseph J. McAlinden VICE PRESIDENT Barry Fink VICE PRESIDENT Amy R. Doberman VICE PRESIDENT Carsten Otto CHIEF COMPLIANCE OFFICER Stefanie V. Chang VICE PRESIDENT Francis J. Smith TREASURER AND CHIEF FINANCIAL OFFICER Thomas F. Caloia VICE PRESIDENT Mary E. Mullin SECRETARY TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT 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 Portfolio 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 Portfolio. For more detailed information about the Portfolio, its fees and expenses and other pertinent information, please read its Prospectus. The Portfolio's Statement of Additional Information contains additional information about the Portfolio, 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 Portfolio 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) 2005 Morgan Stanley [MORGAN STANLEY LOGO] RA05-00651P-Y06/05 [GRAPHIC] MORGAN STANLEY FUNDS MORGAN STANLEY VARIABLE INVESTMENT SERIES -- MONEY MARKET PORTFOLIO SEMIANNUAL REPORT JUNE 30, 2005 [MORGAN STANLEY LOGO] WELCOME, SHAREHOLDER: IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY VARIABLE INVESTMENT SERIES -- S&P 500 INDEX PORTFOLIO 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 PORTFOLIO'S FINANCIAL STATEMENTS AND A LIST OF PORTFOLIO INVESTMENTS. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE PORTFOLIO BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE PORTFOLIO WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE PORTFOLIO IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE PORTFOLIO WILL DECLINE AND, THEREFORE, THE VALUE OF THE PORTFOLIO'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS PORTFOLIO. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT For the six months ended June 30, 2005 TOTAL RETURN FOR THE 6 MONTHS ENDED JUNE 30, 2005
CLASS X CLASS Y S&P 500(R) INDEX(1) -0.93% -1.07% -0.81%
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. SEE PERFORMANCE SUMMARY FOR PERFORMANCE INFORMATION AND INDEX DEFINITIONS. MARKET CONDITIONS Major factors driving the stock market during the Portfolio's six-month reporting period included oil prices, the interest rate environment and corporate earnings. Following a rally in the fourth quarter of 2004, the U.S. equity market retreated early in 2005. As oil prices soared to more than $60 per barrel by the close of the period, investors feared for the future pace of U.S. economic growth. The Federal Open Market Committee (the "Fed") continued to increase the federal funds target rate at each of its meetings. While short-term interest rates increased, long-term rates fell, and this flattening of the yield curve concerned some investors who believed it indicated trouble ahead. The period was not without its more optimistic signs. Although the technology sector reported weaker-than-expected earnings, corporate earnings overall were more positive than investors had anticipated. As mortgage rates fell along with long-term interest rates, consumer confidence strengthened. Moreover, in the final months of the period, investors were encouraged by signs that the Fed appeared to be nearing the end of its rate tightening cycle. PERFORMANCE ANALYSIS The Portfolio's best performing areas were energy and utilities. The backdrop continued to be very favorable for stocks in both sectors. With demand accelerating and the supply to meet such demand questionable, oil prices climbed sharply. These high prices particularly benefited energy companies that deal with crude oil, including those in the exploration and production, drilling equipment and services, and refining industries. Utilities companies, meanwhile, were buoyed by improving profit margins as they passed along higher energy costs to their customers. As long-term rates remained low, utilities were also rewarded by the market for their yield-oriented characteristics. Additionally, both the energy and utilities sectors were well positioned from investors' preference for "defensive" areas of the market, given the uncertainties of the rising interest rate and rising oil price environment. In contrast, the materials, consumer discretionary and technology sectors were the primary detractors from overall performance. Materials stocks lagged the overall market as rising commodity prices increased the production costs of papers, chemicals and metals. Unlike utilities companies, these companies must absorb the higher costs, eroding their profits. Within the consumer discretionary space, automobile and media stocks were among the worst performing industries in the market as a whole. The technology sector continued to struggle as corporate outlays for technology investment remained weak. From a broad market capitalization perspective, stocks from the middle of the index's market capitalization range outperformed both the largest companies and the smallest companies. However, because both the S&P 500(R) Index and the Portfolio are market cap weighted, the largest stocks' performance is amplified. The strong performance of the middle range companies was not enough to offset the lagging performance of the largest cap companies. THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM WELL OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE PORTFOLIO IN THE FUTURE. 2 TOP 10 HOLDINGS General Electric Co. 3.3% Exxon Mobil Corp. 3.3 Microsoft Corp. 2.3 Citigroup, Inc. 2.2 Pfizer, Inc. 1.9 Johnson & Johnson 1.8 Bank of America Corp. 1.7 Wal-Mart Stores, Inc. 1.5 Intel Corp. 1.5 American International Group, Inc. 1.4
TOP FIVE INDUSTRIES Pharmaceuticals: Major 6.7% Industrial Conglomerates 5.6 Integrated Oil 5.2 Major Banks 4.7 Financial Conglomerates 4.4
DATA AS OF JUNE 30, 2005. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES FOR TOP 10 HOLDINGS AND TOP FIVE INDUSTRIES ARE AS A PERCENTAGE OF NET ASSETS. 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. INVESTMENT STRATEGY THE PORTFOLIO WILL NORMALLY INVEST AT LEAST 80% OF ITS ASSETS IN COMMON STOCKS OF COMPANIES INCLUDED IN THE STANDARD &POOR'S 500(R) COMPOSITE STOCK PRICE INDEX ("S&P 500(R) INDEX"). THE "INVESTMENT ADVISER," MORGAN STANLEY INVESTMENT ADVISORS INC., "PASSIVELY" MANAGES THE PORTFOLIO'S ASSETS BY INVESTING IN STOCKS IN APPROXIMATELY THE SAME PROPORTION AS THEY ARE REPRESENTED IN THE S&P 500(R) INDEX. FOR EXAMPLE, IF THE COMMON STOCK OF A SPECIFIC COMPANY REPRESENTS FIVE PERCENT OF THE S&P 500(R) INDEX, THE INVESTMENT ADVISER TYPICALLY WILL INVEST THE SAME PERCENTAGE OF THE PORTFOLIO'S ASSETS IN THAT STOCK. THE S&P 500(R) INDEX IS A WELL-KNOWN STOCK MARKET INDEX THAT INCLUDES COMMON STOCKS OF 500 COMPANIES REPRESENTING A SIGNIFICANT PORTION OF THE MARKET VALUE OF ALL COMMON STOCKS PUBLICLY TRADED IN THE UNITED STATES. FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY PORTFOLIO PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE PORTFOLIO'S SECOND AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY PORTFOLIO 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 3 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 PORTFOLIO'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 PORTFOLIO VOTED PROXIES RELATING TO PORTFOLIO SECURITIES DURING THE MOST RECENT TWELVE-MONTH PERIOD ENDED JUNE 30 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. 4 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED JUNE 30, 2005
CLASS X SHARES CLASS Y SHARES (SINCE 05/18/98) (SINCE O6/05/00) 1 YEAR 6.12%(2) 5.82%(2) 5 YEARS (2.78)(2) (3.03)(2) SINCE INCEPTION 2.17(2) (3.16)(2)
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 THE 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 PORTFOLIO SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. THE PERFORMANCE OF THE PORTFOLIO'S TWO SHARE CLASSES VARIES BECAUSE EACH HAS DIFFERENT EXPENSES. THE PORTFOLIO'S TOTAL RETURN FIGURES ASSUME THE REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE IMPACT OF ANY CHARGES BY YOUR INSURANCE COMPANY. SUCH COSTS WOULD LOWER PERFORMANCE. (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) FIGURE ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS FOR THE UNDERLYING PORTFOLIO BASED ON NET ASSET VALUE (NAV). IT DOES NOT REFLECT THE DEDUCTION OF INSURANCE EXPENSES, AN ANNUAL CONTRACT MAINTENANCE FEE, OR SURRENDER CHARGES. 5 EXPENSE EXAMPLE As a shareholder of the Portfolio, you incur two types of costs: (1) insurance company charges; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Portfolio expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Portfolio 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 01/01/05 - 06/30/05. 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 Portfolio's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Portfolio'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 Portfolio 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 insurance company charges. 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 insurance company charges were included, your costs would have been higher.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD * --------------- --------------- --------------- 01/01/05 - 01/01/05 06/30/05 06/30/05 --------------- --------------- --------------- CLASS X Actual (-0.93% return) $ 1,000.00 $ 990.70 $ 1.33 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,023.46 $ 1.35 CLASS Y Actual (-1.07% return) $ 1,000.00 $ 989.30 $ 2.56 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,022.22 $ 2.61
- ---------- * EXPENSES ARE EQUAL TO THE PORTFOLIO'S ANNUALIZED EXPENSE RATIO OF 0.27% AND 0.52% 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 fixed income securities trading. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Portfolio's Administrator under the Administration Agreement, including accounting, clerical, bookkeeping, compliance, business management and planning, and the provision of supplies, office space and utilities. (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 administrative and investment advisory services to the Portfolio. 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 Portfolio. 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 The Board reviewed the Portfolio's performance for the one-, three- and five-year periods ended November 30, 2004, as shown in reports provided by Lipper (the "Lipper Reports"), compared to the performance of comparable funds selected by Lipper (the "performance peer group"), and noted that the Portfolio's performance was lower than its performance peer group average for the three- and five-year periods but better for the one-year period. The Board considered that the Portfolio's performance, relative to its performance peer group, has improved, as the gap between the Portfolio's performance and the average of its performance peer group narrowed from the five- to the three-year period and with the Portfolio outperforming its performance peer group average performance in the last year. The Board concluded that the Portfolio's performance was improving and was now competitive with its performance peer group. FEES RELATIVE TO OTHER FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT STRATEGIES The Board reviewed the advisory and administrative fees (together, the "management fee") paid by the Fund under the Management Agreement. The Board noted that the rate was comparable to the management fee rates charged by the Adviser to any other funds it manages with investment strategies comparable to those of the Portfolio. 7 FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS The Board reviewed the management fee rate and the total expense ratio of the Portfolio. The Board noted that: (i) the Portfolio's management fee rate was lower than the average management fee rate 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 for the Fund; and (ii) the Portfolio's total expense ratio was also lower than the average total expense ratio of the funds included in the Portfolio's expense peer group, and total expenses, other than brokerage and 12b-1 fees, were being capped at 0.40%. The Board concluded that the Portfolio's management fee 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 Portfolio's management fee schedule under the Management Agreement and noted that it does not include any breakpoints. The Board recommended that the Adviser consider incorporating breakpoints in the management fee schedule. The Adviser agreed to introduce a breakpoint which would reduce the management fee from 0.20% to 0.10% on assets above $2 billion. The Board concluded that the proposed new breakpoint in the management fee would reflect economies of scale as assets increase. PROFITABILITY OF ADVISER AND AFFILIATES The Board considered and reviewed information concerning the costs incurred and profits realized by the Adviser and its affiliates during the last two years from their relationship with the Portfolio and the Morgan Stanley Fund Complex and reviewed with the Controller of the Adviser the cost allocation methodology used to determine the Adviser's profitability. Based on their review of the information they received, the Board concluded that the profits earned by the Adviser and its affiliates were not excessive in light of the advisory, administrative and other services provided to the Portfolio. FALL-OUT BENEFITS The Board considered so-called "fall-out benefits" derived by the Adviser and its affiliates from their relationship with the Portfolio and the Morgan Stanley Fund Complex, such as "float" benefits derived from handling of checks for purchases and redemptions of Portfolio 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 Portfolio 12b-1 fees for distribution and shareholder services. The Board also considered that an affiliate of the Adviser, through a joint venture, receives revenue in connection with trading done on behalf of the Portfolio through an electronic trading system network ("ECN"). The Board concluded that the float benefits and the above-referenced ECN-related revenue were relatively small and that the 12b-1 fees were competitive with those of other broker-dealer affiliates of investment advisers of mutual funds. 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 Portfolio 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 Portfolio. The Adviser informed the Board that it does not use Portfolio 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 Portfolio and other funds in the Morgan Stanley Fund Complex. ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE PORTFOLIO'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 PORTFOLIO AND THE ADVISER The Board also reviewed and considered the historical relationship between the Portfolio and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Portfolio'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 Portfolio 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 Portfolio'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 Portfolio's business. GENERAL CONCLUSION After considering and weighing all of the above factors, the Board concluded it would be in the best interest of the Portfolio and its shareholders to approve renewal of the Management Agreement for another year. 9 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- S&P 500 INDEX PORTFOLIO PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ Common Stocks (98.9%) ADVERTISING/MARKETING SERVICES (0.2%) 10,545 Interpublic Group of Companies, Inc. (The)* $ 128,438 4,587 Omnicom Group, Inc. 366,318 ------------- 494,756 ------------- AEROSPACE & DEFENSE (1.5%) 20,671 Boeing Co. 1,364,286 5,012 General Dynamics Corp. 549,014 2,994 Goodrich Corp. 122,634 2,969 L-3 Communications Holdings, Inc. 227,366 10,107 Lockheed Martin Corp. 655,641 8,984 Northrop Grumman Corp. 496,366 11,299 Raytheon Co. 442,017 4,448 Rockwell Collins, Inc. 212,081 ------------- 4,069,405 ------------- AGRICULTURAL COMMODITIES/MILLING (0.1%) 15,603 Archer-Daniels-Midland Co. 333,592 ------------- AIR FREIGHT/COURIERS (0.9%) 7,556 FedEx Corp. 612,112 27,865 United Parcel Service, Inc. (Class B) 1,927,143 ------------- 2,539,255 ------------- AIRLINES (0.1%) 3,481 Delta Air Lines, Inc.* 13,089 18,453 Southwest Airlines Co. 257,050 ------------- 270,139 ------------- ALTERNATIVE POWER GENERATION (0.0%) 13,324 Calpine Corp.* 45,302 ------------- ALUMINUM (0.2%) 21,817 Alcoa, Inc. 570,078 ------------- APPAREL/FOOTWEAR (0.5%) 3,725 Cintas Corp. 143,785 9,434 Coach, Inc.* 316,699 3,017 Jones Apparel Group, Inc. $ 93,648 2,707 Liz Claiborne, Inc. 107,630 5,713 Nike, Inc. (Class B) 494,746 1,397 Reebok International Ltd. 58,437 2,493 V.F. Corp. 142,649 ------------- 1,357,594 ------------- APPAREL/FOOTWEAR RETAIL (0.4%) 18,956 Gap, Inc. (The) 374,381 9,527 Limited Brands, Inc. 204,068 3,074 Nordstrom, Inc. 208,940 11,768 TJX Companies, Inc. (The) 286,551 ------------- 1,073,940 ------------- AUTO PARTS: O.E.M. (0.2%) 3,744 Dana Corp. 56,197 13,994 Delphi Corp. 65,072 3,770 Eaton Corp. 225,823 4,804 Johnson Controls, Inc. 270,609 3,230 Visteon Corp.* 19,477 ------------- 637,178 ------------- AUTOMOTIVE AFTERMARKET (0.0%) 1,600 Cooper Tire & Rubber Co. 29,712 4,383 Goodyear Tire & Rubber Co. (The)* 65,307 ------------- 95,019 ------------- BEVERAGES: ALCOHOLIC (0.4%) 19,421 Anheuser-Busch Companies, Inc. 888,511 2,255 Brown-Forman Corp. (Class B) 136,337 1,964 Molson Coors Brewing Co. (Class B) 121,768 ------------- 1,146,616 ------------- BEVERAGES: NON-ALCOHOLIC (1.0%) 56,617 Coca-Cola Co. (The) 2,363,760 8,796 Coca-Cola Enterprises Inc. 193,600 4,930 Pepsi Bottling Group, Inc. (The) 141,047 ------------- 2,698,407 -------------
SEE NOTES TO FINANCIAL STATEMENTS 10
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ BIOTECHNOLOGY (1.2%) 30,956 Amgen Inc.* $ 1,871,600 8,621 Biogen Idec Inc.* 296,993 3,681 Chiron Corp.* 128,430 6,311 Genzyme Corp.* 379,228 11,302 Gilead Sciences, Inc.* 497,175 6,202 MedImmune, Inc.* 165,717 1,240 Millipore Corp.* 70,345 ------------- 3,409,488 ------------- BROADCASTING (0.2%) 12,756 Clear Channel Communications, Inc. 394,543 7,278 Univision Communications, Inc. (Class A)* 200,509 ------------- 595,052 ------------- BUILDING PRODUCTS (0.2%) 4,470 American Standard Companies, Inc. 187,382 10,849 Masco Corp. 344,564 ------------- 531,946 ------------- CABLE/SATELLITE TV (0.6%) 55,161 Comcast Corp. (Class A)* 1,693,443 ------------- CASINO/GAMING (0.2%) 4,543 Harrah's Entertainment, Inc. 327,414 8,604 International Game Technology 242,203 ------------- 569,617 ------------- CHEMICALS: AGRICULTURAL (0.1%) 6,708 Monsanto Co. 421,732 ------------- CHEMICALS: MAJOR DIVERSIFIED (1.0%) 24,046 Dow Chemical Co. (The) 1,070,768 24,917 Du Pont (E.I.) de Nemours & Co. 1,071,680 2,010 Eastman Chemical Co. 110,852 3,047 Engelhard Corp. 86,992 2,792 Hercules Inc.* 39,507 4,827 Rohm & Haas Co. 223,683 ------------- 2,603,482 ------------- CHEMICALS: SPECIALTY (0.3%) 5,735 Air Products & Chemicals, Inc. $ 345,820 1,283 Great Lakes Chemical Corp. 40,376 8,092 Praxair, Inc. 377,087 1,717 Sigma-Aldrich Corp. 96,221 ------------- 859,504 ------------- COMMERCIAL PRINTING/FORMS (0.1%) 5,336 Donnelley (R.R.) & Sons Co. 184,145 ------------- COMPUTER COMMUNICATIONS (1.2%) 11,970 Avaya Inc.* 99,590 159,863 Cisco Systems, Inc.* 3,054,982 2,290 QLogic Corp.* 70,692 ------------- 3,225,264 ------------- COMPUTER PERIPHERALS (0.5%) 60,105 EMC Corp.* 824,040 3,158 Lexmark International, Inc. (Class A)* 204,733 9,130 Network Appliance, Inc.* 258,105 ------------- 1,286,878 ------------- COMPUTER PROCESSING HARDWARE (1.9%) 20,611 Apple Computer, Inc.* 758,691 60,563 Dell, Inc.* 2,392,844 7,455 Gateway, Inc.* 24,602 72,204 Hewlett-Packard Co. 1,697,516 4,673 NCR Corp.* 164,116 85,202 Sun Microsystems, Inc.* 317,803 ------------- 5,355,572 ------------- CONSTRUCTION MATERIALS (0.1%) 1 Eagle Materials, Inc. 90 2,566 Vulcan Materials Co. 166,764 ------------- 166,854 ------------- CONTAINERS/PACKAGING (0.2%) 2,742 Ball Corp. 98,602 2,669 Bemis Company, Inc. 70,835 3,701 Pactiv Corp.* 79,868
SEE NOTES TO FINANCIAL STATEMENTS 11
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ 2,084 Sealed Air Corp.* $ 103,762 3,114 Temple-Inland Inc. 115,685 ------------- 468,752 ------------- CONTRACT DRILLING (0.3%) 3,721 Nabors Industries, Ltd. (Bermuda)* 225,567 3,398 Noble Corp. (Cayman Islands) 209,011 2,708 Rowan Companies, Inc.* 80,455 8,157 Transocean Inc. (Cayman Islands)* 440,233 ------------- 955,266 ------------- DATA PROCESSING SERVICES (0.9%) 3,159 Affiliated Computer Services, Inc. (Class A)* 161,425 14,592 Automatic Data Processing, Inc. 612,426 4,605 Computer Sciences Corp.* 201,239 3,544 Convergys Corp.* 50,396 19,478 First Data Corp. 781,847 4,785 Fiserv, Inc.* 205,516 8,868 Paychex, Inc. 288,565 7,260 SunGard Data Systems Inc.* 255,334 ------------- 2,556,748 ------------- DEPARTMENT STORES (0.5%) 1,761 Dillard's, Inc. (Class A) 41,243 4,263 Federated Department Stores, Inc. 312,393 8,161 Kohl's Corp.* 456,282 7,491 May Department Stores Co. 300,839 6,586 Penney (J.C.) Co., Inc. 346,292 ------------- 1,457,049 ------------- DISCOUNT STORES (2.3%) 2,814 Big Lots, Inc.* 37,257 11,949 Costco Wholesale Corp. 535,554 7,517 Dollar General Corp. 153,046 4,182 Family Dollar Stores, Inc. 109,150 2,558 Sears Holdings Corp.* 383,367 22,098 Target Corp. $ 1,202,352 83,691 Wal-Mart Stores, Inc. 4,033,906 ------------- 6,454,632 ------------- DRUGSTORE CHAINS (0.6%) 20,264 CVS Corp. 589,074 25,575 Walgreen Co. 1,176,194 ------------- 1,765,268 ------------- ELECTRIC UTILITIES (3.1%) 16,339 AES Corp. (The)* 267,633 4,042 Allegheny Energy, Inc.* 101,939 5,086 Ameren Corp. 281,256 9,606 American Electric Power Co., Inc. 354,173 7,215 CenterPoint Energy, Inc. 95,310 4,961 Cinergy Corp. 222,352 5,473 CMS Energy Corp.* 82,423 6,081 Consolidated Edison, Inc. 284,834 4,441 Constellation Energy Group, Inc. 256,201 8,518 Dominion Resources, Inc. 625,136 4,338 DTE Energy Co. 202,888 23,182 Duke Energy Corp. 689,201 8,125 Edison International 329,469 5,315 Entergy Corp. 401,548 16,738 Exelon Corp. 859,162 8,225 FirstEnergy Corp. 395,705 9,805 FPL Group, Inc. 412,398 9,258 PG&E Corp. 347,545 2,460 Pinnacle West Capital Corp. 109,347 4,747 PPL Corp. 281,877 6,221 Progress Energy, Inc. 281,438 5,972 Public Service Enterprise Group, Inc. 363,217 18,619 Southern Co. (The) 645,521 5,150 TECO Energy, Inc. 97,387 5,990 TXU Corp. 497,709 10,063 Xcel Energy, Inc. 196,430 ------------- 8,682,099 -------------
SEE NOTES TO FINANCIAL STATEMENTS 12
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ ELECTRICAL PRODUCTS (0.4%) 4,536 American Power Conversion Corp. $ 107,004 2,311 Cooper Industries Ltd. (Class A) (Bermuda) 147,673 10,424 Emerson Electric Co. 652,855 4,182 Molex Inc. 108,899 ------------- 1,016,431 ------------- ELECTRONIC COMPONENTS (0.1%) 4,577 Jabil Circuit, Inc.* 140,651 13,052 Sanmina-SCI Corp.* 71,394 24,215 Solectron Corp.* 91,775 ------------- 303,820 ------------- ELECTRONIC EQUIPMENT/INSTRUMENTS (0.4%) 10,778 Agilent Technologies, Inc.* 248,110 36,025 JDS Uniphase Corp.* 54,758 4,363 Rockwell Automation, Inc. 212,522 3,792 Scientific-Atlanta, Inc. 126,160 6,051 Symbol Technologies, Inc. 59,723 2,229 Tektronix, Inc. 51,869 4,032 Thermo Electron Corp.* 108,340 23,969 Xerox Corp.* 330,533 ------------- 1,192,015 ------------- ELECTRONIC PRODUCTION EQUIPMENT (0.4%) 41,123 Applied Materials, Inc. 665,370 4,925 KLA-Tencor Corp. 215,223 3,486 Novellus Systems, Inc.* 86,139 4,842 Teradyne, Inc.* 57,959 ------------- 1,024,691 ------------- ELECTRONICS/APPLIANCE STORES (0.2%) 7,468 Best Buy Co., Inc. 511,931 4,770 Circuit City Stores - Circuit City Group 82,473 3,894 RadioShack Corp. 90,224 ------------- 684,628 ------------- ELECTRONICS/APPLIANCES (0.1%) 7,149 Eastman Kodak Co. $ 191,951 1,983 Maytag Corp. 31,054 1,667 Whirlpool Corp. 116,873 ------------- 339,878 ------------- ENGINEERING & CONSTRUCTION (0.1%) 2,166 Fluor Corp. 124,740 ------------- ENVIRONMENTAL SERVICES (0.2%) 6,767 Allied Waste Industries, Inc.* 53,662 14,176 Waste Management, Inc. 401,748 ------------- 455,410 ------------- FINANCE/RENTAL/LEASING (2.0%) 6,307 Capital One Financial Corp. 504,623 5,258 CIT Group, Inc. 225,936 14,701 Countrywide Financial Corp. 567,606 24,212 Fannie Mae 1,413,981 17,275 Freddie Mac 1,126,848 31,711 MBNA Corp. 829,560 7,309 Providian Financial Corp.* 128,858 1,598 Ryder System, Inc. 58,487 10,495 SLM Corp. 533,146 ------------- 5,389,045 ------------- FINANCIAL CONGLOMERATES (4.4%) 29,296 American Express Co. 1,559,426 130,132 Citigroup, Inc. (Note 4) 6,016,002 88,020 JPMorgan Chase & Co. 3,108,866 7,349 Principal Financial Group, Inc. 307,923 13,067 Prudential Financial, Inc. 857,979 8,279 State Street Corp. 399,462 ------------- 12,249,658 ------------- FINANCIAL PUBLISHING/SERVICES (0.3%) 3,247 Equifax, Inc. 115,950 9,371 McGraw-Hill Companies, Inc. (The) 414,667 6,909 Moody's Corp. 310,629 ------------- 841,246 -------------
SEE NOTES TO FINANCIAL STATEMENTS 13
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ FOOD DISTRIBUTORS (0.2%) 15,836 SYSCO Corp. $ 573,105 ------------- FOOD RETAIL (0.3%) 9,178 Albertson's, Inc. 189,801 18,258 Kroger Co.* 347,450 11,212 Safeway Inc. 253,279 3,404 Supervalu, Inc. 111,004 ------------- 901,534 ------------- FOOD: MAJOR DIVERSIFIED (1.6%) 8,120 Campbell Soup Co. 249,852 12,955 ConAgra Foods Inc. 300,038 9,248 General Mills, Inc. 432,714 8,757 Heinz (H.J.) Co. 310,173 8,752 Kellogg Co. 388,939 41,889 PepsiCo, Inc. 2,259,074 19,683 Sara Lee Corp. 389,920 ------------- 4,330,710 ------------- FOOD: SPECIALTY/CANDY (0.3%) 5,439 Hershey Foods Corp. 337,762 3,386 McCormick & Co., Inc. (Non-Voting) 110,654 4,898 Wrigley (Wm.) Jr. Co. 337,178 ------------- 785,594 ------------- FOREST PRODUCTS (0.2%) 2,762 Louisiana-Pacific Corp. 67,890 6,126 Weyerhaeuser Co. 389,920 ------------- 457,810 ------------- GAS DISTRIBUTORS (0.3%) 8,258 Dynegy, Inc. (Class A)* 40,134 4,326 KeySpan Corp. 176,068 1,100 Nicor Inc. 45,287 6,764 NiSource, Inc. 167,274 945 Peoples Energy Corp. 41,070 5,985 Sempra Energy 247,240 ------------- 717,073 ------------- HOME BUILDING (0.2%) 3,200 Centex Corp. 226,144 2,084 KB Home 158,863 2,968 Pulte Homes, Inc. 250,054 ------------- 635,061 ------------- HOME FURNISHINGS (0.1%) 4,759 Leggett & Platt, Inc. $ 126,494 6,853 Newell Rubbermaid, Inc. 163,376 ------------- 289,870 ------------- HOME IMPROVEMENT CHAINS (1.2%) 53,691 Home Depot, Inc. (The) 2,088,580 19,323 Lowe's Companies, Inc. 1,124,985 3,131 Sherwin-Williams Co. 147,439 ------------- 3,361,004 ------------- HOSPITAL/NURSING MANAGEMENT (0.4%) 10,484 HCA, Inc. 594,128 6,167 Health Management Associates, Inc. (Class A) 161,452 2,149 Manor Care, Inc. 85,380 11,678 Tenet Healthcare Corp.* 142,939 ------------- 983,899 ------------- HOTELS/RESORTS/CRUISELINES (0.6%) 13,182 Carnival Corp. (Panama) 719,078 9,593 Hilton Hotels Corp. 228,793 4,965 Marriott International, Inc. (Class A) 338,712 5,406 Starwood Hotels & Resorts Worldwide, Inc. 316,629 ------------- 1,603,212 ------------- HOUSEHOLD/PERSONAL CARE (2.5%) 2,138 Alberto-Culver Co. 92,640 11,807 Avon Products, Inc. 446,895 3,856 Clorox Co. (The) 214,856 13,104 Colgate-Palmolive Co. 654,021 24,955 Gillette Co. (The) 1,263,472 2,209 International Flavors & Fragrances, Inc. 80,010 11,968 Kimberly-Clark Corp. 749,077 61,901 Procter & Gamble Co. (The) 3,265,278 ------------- 6,766,249 -------------
SEE NOTES TO FINANCIAL STATEMENTS 14
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ INDUSTRIAL CONGLOMERATES (5.6%) 19,261 3M Co. $ 1,392,570 6,884 Danaher Corp. 360,309 265,307 General Electric Co.** 9,192,888 21,339 Honeywell International, Inc. 781,648 4,217 Ingersoll-Rand Co. Ltd. (Class A) (Bermuda) 300,883 2,301 ITT Industries, Inc. 224,647 3,370 Textron, Inc. 255,615 50,519 Tyco International Ltd. (Bermuda) 1,475,155 25,606 United Technologies Corp. 1,314,868 ------------- 15,298,583 ------------- INDUSTRIAL MACHINERY (0.3%) 6,828 Illinois Tool Works Inc. 544,055 2,997 Parker-Hannifin Corp. 185,844 ------------- 729,899 ------------- INDUSTRIAL SPECIALTIES (0.1%) 5,506 Ecolab Inc. 178,174 4,294 PPG Industries, Inc. 269,491 ------------- 447,665 ------------- INFORMATION TECHNOLOGY SERVICES (1.2%) 4,226 Citrix Systems, Inc.* 91,535 12,980 Electronic Data Systems Corp. 249,865 40,357 International Business Machines Corp. 2,994,489 8,411 Unisys Corp.* 53,242 ------------- 3,389,131 ------------- INSURANCE BROKERS/SERVICES (0.2%) 7,950 AON Corp. 199,068 13,330 Marsh & McLennan Companies, Inc. 369,241 ------------- 568,309 ------------- INTEGRATED OIL (5.2%) 2,148 Amerada Hess Corp. 228,783 52,477 Chevron Corp. 2,934,514 34,828 ConocoPhillips $ 2,002,262 159,227 Exxon Mobil Corp. 9,150,776 ------------- 14,316,335 ------------- INTERNET SOFTWARE/SERVICES (0.4%) 12,837 Siebel Systems, Inc. 114,249 32,836 Yahoo!, Inc.* 1,137,767 ------------- 1,252,016 ------------- INVESTMENT BANKS/BROKERS (2.0%) 2,844 Bear Stearns Companies, Inc. (The) 295,605 9,242 E*TRADE Group, Inc.* 129,296 11,054 Goldman Sachs Group Inc. (The) 1,127,729 6,919 Lehman Brothers Holdings Inc. 686,918 23,648 Merrill Lynch & Co., Inc. 1,300,876 28,561 Morgan Stanley (Note 4) 1,498,596 28,504 Schwab (Charles) Corp. (The) 321,525 ------------- 5,360,545 ------------- INVESTMENT MANAGERS (0.4%) 2,372 Federated Investors, Inc. (Class B) 71,184 4,957 Franklin Resources, Inc. 381,590 5,675 Janus Capital Group, Inc. 85,352 10,567 Mellon Financial Corp. 303,167 3,086 Price (T.) Rowe Group, Inc. 193,184 ------------- 1,034,477 ------------- LIFE/HEALTH INSURANCE (0.7%) 12,550 AFLAC, Inc. 543,164 3,404 Jefferson-Pilot Corp. 171,630 4,348 Lincoln National Corp. 204,008 18,344 MetLife, Inc. (Note 4) 824,379 2,605 Torchmark Corp. 135,981 7,420 UnumProvident Corp. 135,934 ------------- 2,015,096 -------------
SEE NOTES TO FINANCIAL STATEMENTS 15
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ MAJOR BANKS (4.7%) 100,600 Bank of America Corp. $ 4,588,366 19,472 Bank of New York Co., Inc. (The) 560,404 13,676 BB&T Corp. 546,630 4,223 Comerica, Inc. 244,089 5,782 Huntington Bancshares, Inc. 139,577 10,198 KeyCorp 338,064 14,865 National City Corp. 507,194 7,048 PNC Financial Services Group 383,834 11,585 Regions Financial Corp. 392,500 8,500 SunTrust Banks, Inc. 614,040 39,434 Wachovia Corp. 1,955,926 42,209 Wells Fargo & Co. 2,599,230 ------------- 12,869,854 ------------- MAJOR TELECOMMUNICATIONS (2.7%) 8,182 ALLTEL Corp. 509,575 20,042 AT&T Corp. 381,600 45,803 BellSouth Corp. 1,216,986 82,627 SBC Communications, Inc. 1,962,391 37,016 Sprint Corp. 928,731 69,221 Verizon Communications Inc. 2,391,586 ------------- 7,390,869 ------------- MANAGED HEALTH CARE (1.6%) 7,266 Aetna, Inc. 601,770 11,347 Caremark Rx, Inc.* 505,168 3,280 CIGNA Corp. 351,058 4,048 Humana, Inc.* 160,868 31,673 UnitedHealth Group, Inc. 1,651,430 15,325 WellPoint Inc.* 1,067,233 ------------- 4,337,527 ------------- MEDIA CONGLOMERATES (2.1%) 51,054 Disney (Walt) Co. (The) 1,285,540 72,150 News Corp Inc. (Class A) 1,167,387 117,213 Time Warner, Inc.* 1,958,629 40,332 Viacom Inc. (Class B) (Non-Voting) 1,291,431 ------------- 5,702,987 ------------- MEDICAL DISTRIBUTORS (0.4%) 2,628 AmerisourceBergen Corp. $ 181,726 10,713 Cardinal Health, Inc. 616,855 7,361 McKesson Corp. 329,699 ------------- 1,128,280 ------------- MEDICAL SPECIALTIES (2.2%) 4,896 Applera Corp. - Applied Biosystems Group 96,304 2,629 Bard (C.R.), Inc. 174,855 1,338 Bausch & Lomb, Inc. 111,054 15,528 Baxter International, Inc. 576,089 6,307 Becton, Dickinson & Co. 330,928 6,301 Biomet, Inc. 218,267 18,757 Boston Scientific Corp.* 506,439 3,005 Fisher Scientific International, Inc.* 195,025 8,130 Guidant Corp. 547,149 3,954 Hospira, Inc.* 154,206 30,256 Medtronic, Inc. 1,566,958 3,092 Pall Corp. 93,873 3,230 PerkinElmer, Inc. 61,047 9,063 St. Jude Medical, Inc.* 395,237 9,378 Stryker Corp. 446,018 2,937 Waters Corp.* 109,168 6,178 Zimmer Holdings, Inc.* 470,578 ------------- 6,053,195 ------------- MISCELLANEOUS COMMERCIAL SERVICES (0.0%) 3,280 Sabre Holdings Corp. (Class A) 65,436 ------------- MISCELLANEOUS MANUFACTURING (0.1%) 5,079 Dover Corp. 184,774 ------------- MOTOR VEHICLES (0.5%) 46,036 Ford Motor Co. 471,409 14,145 General Motors Corp. 480,930 7,121 Harley-Davidson, Inc. 353,202 ------------- 1,305,541 -------------
SEE NOTES TO FINANCIAL STATEMENTS 16
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ MULTI-LINE INSURANCE (1.8%) 64,912 American International Group, Inc. $ 3,771,387 7,420 Hartford Financial Services Group, Inc. (The) 554,868 3,994 Loews Corp. 309,535 3,171 Safeco Corp. 172,312 ------------- 4,808,102 ------------- OFFICE EQUIPMENT/SUPPLIES (0.1%) 2,534 Avery Dennison Corp. 134,201 5,756 Pitney Bowes, Inc. 250,674 ------------- 384,875 ------------- OIL & GAS PIPELINES (0.3%) 16,039 El Paso Corp. 184,769 2,715 Kinder Morgan, Inc. 225,888 14,279 Williams Companies, Inc. (The) 271,301 ------------- 681,958 ------------- OIL & GAS PRODUCTION (1.5%) 5,906 Anadarko Petroleum Corp. 485,178 8,210 Apache Corp. 530,366 9,648 Burlington Resources, Inc. 532,956 11,850 Devon Energy Corp. 600,558 5,985 EOG Resources, Inc. 339,948 2,914 Kerr-McGee Corp. 222,367 9,962 Occidental Petroleum Corp. 766,377 6,799 Unocal Corp. 442,275 9,029 XTO Energy Inc. 306,896 ------------- 4,226,921 ------------- OIL REFINING/MARKETING (0.5%) 1,677 Ashland, Inc. 120,526 8,702 Marathon Oil Corp. 464,426 1,730 Sunoco, Inc. 196,666 6,422 Valero Energy Corp. 508,044 ------------- 1,289,662 ------------- OILFIELD SERVICES/EQUIPMENT (0.9%) 8,475 Baker Hughes Inc. 433,581 4,051 BJ Services Co. 212,596 12,651 Halliburton Co. $ 604,971 4,304 National-Oilwell, Inc.* 204,612 14,738 Schlumberger Ltd. (Netherlands Antilles) 1,119,204 ------------- 2,574,964 ------------- OTHER CONSUMER SERVICES (0.8%) 4,089 Apollo Group, Inc. (Class A)* 319,842 4,121 Block (H.&R.), Inc. 240,460 26,312 Cendant Corp. 588,599 30,388 eBay Inc.* 1,003,108 ------------- 2,152,009 ------------- OTHER CONSUMER SPECIALTIES (0.1%) 3,638 Fortune Brands, Inc. 323,054 ------------- OTHER METALS/MINERALS (0.1%) 2,424 Phelps Dodge Corp. 224,220 ------------- PACKAGED SOFTWARE (3.6%) 12,232 Adobe Systems, Inc. 350,080 5,723 Autodesk, Inc. 196,700 5,524 BMC Software, Inc.* 99,156 13,314 Computer Associates International, Inc. 365,869 9,659 Compuware Corp.* 69,448 4,624 Intuit Inc.* 208,589 2,166 Mercury Interactive Corp.* 83,088 251,352 Microsoft Corp. 6,243,584 9,450 Novell, Inc.* 58,590 110,606 Oracle Corp.* 1,459,999 6,745 Parametric Technology Corp.* 43,033 17,794 Symantec Corp.* 386,842 10,692 VERITAS Software Corp.* 260,885 ------------- 9,825,863 ------------- PERSONNEL SERVICES (0.1%) 3,010 Monster Worldwide, Inc.* 86,327 4,014 Robert Half International, Inc. 100,230 ------------- 186,557 -------------
SEE NOTES TO FINANCIAL STATEMENTS 17
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ PHARMACEUTICALS: GENERIC DRUGS (0.1%) 6,714 Mylan Laboratories, Inc. $ 129,177 2,731 Watson Pharmaceuticals, Inc.* 80,728 ------------- 209,905 ------------- PHARMACEUTICALS: MAJOR (6.7%) 38,790 Abbott Laboratories 1,901,098 48,886 Bristol-Myers Squibb Co. 1,221,172 74,383 Johnson & Johnson 4,834,895 28,344 Lilly (Eli) & Co. 1,579,044 55,111 Merck & Co., Inc. 1,697,419 185,995 Pfizer, Inc. 5,129,742 36,899 Schering-Plough Corp. 703,295 33,482 Wyeth 1,489,949 ------------- 18,556,614 ------------- PHARMACEUTICALS: OTHER (0.2%) 3,263 Allergan, Inc. 278,138 8,517 Forest Laboratories, Inc.* 330,885 6,024 King Pharmaceuticals, Inc.* 62,770 ------------- 671,793 ------------- PRECIOUS METALS (0.2%) 4,495 Freeport-McMoRan Copper & Gold, Inc. (Class B) 168,293 11,155 Newmont Mining Corp. 435,380 ------------- 603,673 ------------- PROPERTY - CASUALTY INSURERS (1.2%) 7,191 ACE Ltd. (Cayman Islands) 322,516 16,716 Allstate Corp. (The) (Note 4) 998,781 4,886 Chubb Corp. (The) 418,290 4,160 Cincinnati Financial Corp. 164,570 4,973 Progressive Corp. (The) 491,382 16,854 St. Paul Travelers Companies, Inc. (The) 666,239 3,505 XL Capital Ltd. (Class A) (Cayman Islands) 260,842 ------------- 3,322,620 ------------- PUBLISHING: BOOKS/MAGAZINES (0.0%) 1,134 Meredith Corp. $ 55,634 ------------- PUBLISHING: NEWSPAPERS (0.4%) 1,760 Dow Jones & Co., Inc. 62,392 6,213 Gannett Co., Inc. 441,931 1,861 Knight-Ridder, Inc. 114,154 3,635 New York Times Co. (The) (Class A) 113,230 7,438 Tribune Co. 261,669 ------------- 993,376 ------------- PULP & PAPER (0.3%) 6,479 Georgia-Pacific Corp. 206,032 12,270 International Paper Co. 370,677 4,663 MeadWestvaco Corp. 130,751 ------------- 707,460 ------------- RAILROADS (0.5%) 9,435 Burlington Northern Santa Fe Corp. 444,200 5,417 CSX Corp. 231,089 10,113 Norfolk Southern Corp. 313,098 6,579 Union Pacific Corp. 426,319 ------------- 1,414,706 ------------- REAL ESTATE INVESTMENT TRUSTS (0.6%) 2,385 Apartment Investment & Management Co. (Class A) 97,594 4,982 Archstone-Smith Trust 192,405 10,195 Equity Office Properties Trust 337,455 7,170 Equity Residential 263,999 4,583 Plum Creek Timber Co., Inc. 166,363 4,669 ProLogis 187,881 5,495 Simon Property Group, Inc. 398,333 ------------- 1,644,030 ------------- RECREATIONAL PRODUCTS (0.3%) 2,416 Brunswick Corp. 104,661 7,679 Electronic Arts, Inc.* 434,708 4,162 Hasbro, Inc. 86,528 10,297 Mattel, Inc. 188,435 ------------- 814,332 -------------
SEE NOTES TO FINANCIAL STATEMENTS 18
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ REGIONAL BANKS (1.4%) 8,855 AmSouth Bancorporation $ 230,230 3,081 Compass Bancshares, Inc. 138,645 13,051 Fifth Third Bancorp 537,832 3,105 First Horizon National Corp. 131,031 2,452 M&T Bank Corp. 257,852 5,326 Marshall & Ilsley Corp. 236,741 11,947 North Fork Bancorporation, Inc. 335,591 5,072 Northern Trust Corp. 231,232 7,752 Synovus Financial Corp. 222,250 45,846 U.S. Bancorp 1,338,703 2,241 Zions Bancorporation 164,781 ------------- 3,824,888 ------------- RESTAURANTS (0.7%) 3,645 Darden Restaurants, Inc. 120,212 31,722 McDonald's Corp. 880,286 9,751 Starbucks Corp.* 503,737 2,875 Wendy's International, Inc. 136,994 7,266 Yum! Brands, Inc. 378,413 ------------- 2,019,642 ------------- SAVINGS BANKS (0.6%) 7,071 Golden West Financial Corp. 455,231 9,122 Sovereign Bancorp, Inc. 203,785 21,944 Washington Mutual, Inc. 892,901 ------------- 1,551,917 ------------- SEMICONDUCTORS (2.8%) 9,824 Advanced Micro Devices, Inc.* 170,348 9,284 Altera Corp.* 184,009 9,256 Analog Devices, Inc. 345,341 7,682 Applied Micro Circuits Corp.* 19,666 7,321 Broadcom Corp. (Class A)* 259,969 10,013 Freescale Semiconductor Inc. (Class B)* 212,075 154,418 Intel Corp. 4,024,133 7,657 Linear Technology Corp. 280,935 9,599 LSI Logic Corp.* 81,496 8,204 Maxim Integrated Products, Inc. 313,475 15,307 Micron Technology, Inc.* $ 156,284 8,732 National Semiconductor Corp. 192,366 4,226 NVIDIA Corp.* 112,919 4,483 PMC - Sierra, Inc.* 41,826 41,579 Texas Instruments Inc. 1,167,123 8,776 Xilinx, Inc. 223,788 ------------- 7,785,753 ------------- SERVICES TO THE HEALTH INDUSTRY (0.4%) 3,712 Express Scripts, Inc.* 185,526 5,668 IMS Health Inc. 140,396 3,368 Laboratory Corp. of America Holdings* 168,063 6,933 Medco Health Solutions Inc.* 369,945 4,552 Quest Diagnostics Inc. 242,485 ------------- 1,106,415 ------------- SPECIALTY INSURANCE (0.2%) 2,710 Ambac Financial Group, Inc. 189,050 3,387 MBIA Inc. 200,883 2,361 MGIC Investment Corp. 153,984 ------------- 543,917 ------------- SPECIALTY STORES (0.5%) 5,631 AutoNation, Inc.* 115,548 1,642 AutoZone, Inc.* 151,819 7,390 Bed Bath & Beyond Inc.* 308,754 7,901 Office Depot, Inc.* 180,459 1,767 OfficeMax Inc. 52,604 18,427 Staples, Inc. 392,864 3,594 Tiffany & Co. 117,739 5,541 Toys 'R' Us, Inc.* 146,726 ------------- 1,466,513 ------------- SPECIALTY TELECOMMUNICATIONS (0.1%) 3,284 CenturyTel, Inc. 113,725 8,520 Citizens Communications Co. 114,509 41,676 Qwest Communications International, Inc.* 154,618 ------------- 382,852 -------------
SEE NOTES TO FINANCIAL STATEMENTS 19
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------ STEEL (0.1%) 2,232 Allegheny Technologies Inc. $ 49,238 4,007 Nucor Corp. 182,799 2,847 United States Steel Corp. 97,851 ------------- 329,888 ------------- TELECOMMUNICATION EQUIPMENT (1.4%) 2,888 ADC Telecommunications, Inc.* 62,872 4,015 Andrew Corp.* 51,231 14,270 CIENA Corp.* 29,824 5,010 Comverse Technology, Inc.* 118,487 36,253 Corning, Inc.* 602,525 110,492 Lucent Technologies Inc.* 321,532 61,342 Motorola, Inc. 1,120,105 40,864 QUALCOMM Inc. 1,348,921 11,214 Tellabs, Inc.* 97,562 ------------- 3,753,059 ------------- TOBACCO (1.4%) 51,805 Altria Group, Inc. 3,349,711 2,904 Reynolds American, Inc. 228,835 4,122 UST, Inc. 188,211 ------------- 3,766,757 ------------- TOOLS/HARDWARE (0.1%) 2,000 Black & Decker Corp. 179,700 1,445 Snap-On, Inc. 49,564 1,875 Stanley Works (The) 85,388 ------------- 314,652 ------------- TRUCKS/CONSTRUCTION/FARM MACHINERY (0.6%) 8,552 Caterpillar Inc. 815,091 1,090 Cummins Inc. 81,325 6,156 Deere & Co. 403,156 1,640 Navistar International Corp.* 52,480 4,349 PACCAR, Inc. 295,732 ------------- 1,647,784 ------------- WHOLESALE DISTRIBUTORS (0.1%) 4,357 Genuine Parts Co. 179,029 2,080 Grainger (W.W.), Inc. 113,963 ------------- 292,992 ------------- WIRELESS TELECOMMUNICATIONS (0.3%) 28,151 Nextel Communications, Inc. (Class A)* $ 909,559 ------------- Total Common Stocks (COST $252,142,000) 272,420,190 ------------- PRINCIPAL AMOUNT IN THOUSANDS - ------------- SHORT-TERM INVESTMENT (1.0%) REPURCHASE AGREEMENT $ 2,767 The Bank of New York 3.125% due 07/01/05 (dated 06/30/05; proceeds $2,767,472) (a) (COST $2,767,232) 2,767,232 ------------- TOTAL INVESTMENTS (COST $254,909,232) (b)(c) 99.9% 275,187,422 OTHER ASSETS IN EXCESS OF LIABILITIES 0.1 186,423 ----- ------------- NET ASSETS 100.0% $ 275,373,845 ===== =============
- ---------- * NON-INCOME PRODUCING SECURITY. ** A PORTION OF THIS SECURITY IS SEGREGATED IN CONNECTION WITH OPEN FUTURES CONTRACTS IN THE AMOUNT OF $157,500. (a) COLLATERALIZED BY FEDERAL NATIONAL MORTGAGE ASSOC. 4.126% DUE 07/01/18 VALUED AT $2,822,577. (b) SECURITIES HAVE BEEN DESIGNATED AS COLLATERAL IN AN AMOUNT EQUAL TO $2,860,173 IN CONNECTION WITH OPEN FUTURES CONTRACTS. (c) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES APPROXIMATES THE AGGREGATE COST FOR BOOK PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION IS $55,932,582 AND THE AGGREGATE GROSS UNREALIZED DEPRECIATION IS $35,654,392, RESULTING IN NET UNREALIZED APPRECIATION OF $20,278,190. SEE NOTES TO FINANCIAL STATEMENTS 20 FUTURES CONTRACTS OPEN AT JUNE 30, 2005:
NUMBER OF DESCRIPTION, DELIVERY UNDERLYING FACE UNREALIZED CONTRACTS LONG/SHORT MONTH AND YEAR AMOUNT AT VALUE DEPRECIATION - -------------------------------------------------------------------------------- 10 Long S&P 500 Index $ 2,988,750 $ (28,973) September 2005
SUMMARY OF INVESTMENTS
PERCENT OF SECTOR VALUE NET ASSETS - -------------------------------------------------------------------------------- Finance $ 55,182,458 20.0% Health Technology 28,900,995 10.5 Electronic Technology 27,996,457 10.2 Consumer Non-Durables 20,851,927 7.6 Producer Manufacturing 20,431,470 7.4 Energy Minerals 19,832,918 7.2 Retail Trade 17,164,568 6.2 Technology Services 17,023,758 6.2 Consumer Services 15,384,972 5.6 Utilities 9,444,474 3.4 Communications 8,683,280 3.2 Health Services 6,427,841 2.3 Process Industries 5,842,187 2.1 Industrial Services 4,792,338 1.8 Transportation 4,224,100 1.5 Consumer Durables 4,117,407 1.5 Repurchase Agreement 2,767,232 1.0 Non-Energy Minerals 2,352,523 0.9 Distribution Services 1,994,377 0.7 Commercial Services 1,772,140 0.6 --------------- ---- $ 275,187,422* 99.9% =============== ====
- ---------- * DOES NOT INCLUDE OUTSTANDING LONG FUTURES CONTRACTS WITH AN UNDERLYING FACE AMOUNT OF $2,988,750 WITH UNREALIZED DEPRECIATION OF $28,973. SEE NOTES TO FINANCIAL STATEMENTS 21 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- S&P 500 INDEX PORTFOLIO FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 2005 (UNAUDITED) ASSETS: Investments in securities, at value (cost $247,083,128) $ 265,849,664 Investments in affiliates, at value (cost $7,826,104) 9,337,758 Dividends receivable 327,058 Prepaid expenses and other assets 12,844 ------------- TOTAL ASSETS 275,527,324 ------------- LIABILITIES: Payable for: Distribution fee 33,568 Investment advisory fee 27,503 Shares of beneficial interest redeemed 22,987 Variation margin 18,362 Administration fee 18,335 Accrued expenses and other payables 32,724 ------------- TOTAL LIABILITIES 153,479 ------------- NET ASSETS $ 275,373,845 ============= COMPOSITION OF NET ASSETS: Paid-in-capital $ 286,589,565 Net unrealized appreciation 20,249,217 Accumulated undistributed net investment income 2,003,927 Accumulated net realized loss (33,468,864) ------------- NET ASSETS $ 275,373,845 ============= CLASS X SHARES: Net Assets $ 113,112,943 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 10,423,740 NET ASSET VALUE PER SHARE $ 10.85 ============= CLASS Y SHARES: NET ASSETS $ 162,260,902 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 15,045,512 NET ASSET VALUE PER SHARE $ 10.78 =============
SEE NOTES TO FINANCIAL STATEMENTS 22 STATEMENT OF OPERATIONS For the six months ended June 30, 2005 (unaudited) NET INVESTMENT INCOME: INCOME Dividends $ 2,378,227 Dividends from affiliates 143,525 Interest 48,263 --------------- TOTAL INCOME 2,570,015 --------------- EXPENSES Distribution fee (Class Y shares) 200,317 Investment advisory fee 168,015 Administration fee 112,010 Custodian fees 42,162 Professional fees 16,091 Shareholder reports and notices 14,707 Trustees' fees and expenses 2,307 Transfer agent fees and expenses 248 Other 19,067 --------------- TOTAL EXPENSES 574,924 --------------- NET INVESTMENT INCOME 1,995,091 --------------- NET REALIZED AND UNREALIZED GAIN (LOSS): NET REALIZED LOSS ON: Investments (8,002,742) Futures contracts (533) --------------- NET REALIZED LOSS (8,003,275) --------------- NET CHANGE IN UNREALIZED APPRECIATION ON: Investments 3,092,420 Futures contracts (179,754) --------------- NET APPRECIATION 2,912,666 --------------- NET LOSS (5,090,609) --------------- NET DECREASE $ (3,095,518) ===============
SEE NOTES TO FINANCIAL STATEMENTS 23 STATEMENT OF CHANGES IN NET ASSETS
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 --------------- -------------------- (UNAUDITED) INCREASE (DECREASE) IN NET ASSETS: OPERATIONS: Net investment income $ 1,995,091 $ 4,327,549 Net realized loss (8,003,275) (3,798,059) Net change in unrealized appreciation 2,912,666 27,016,342 --------------- -------------------- NET INCREASE (DECREASE) (3,095,518) 27,545,832 --------------- -------------------- DIVIDENDS TO SHAREHOLDERS FROM NET INVESTMENT INCOME: Class X shares (1,907,197) (1,276,097) Class Y shares (2,393,740) (1,201,805) --------------- -------------------- TOTAL DIVIDENDS (4,300,937) (2,477,902) --------------- -------------------- Net increase (decrease) from transactions in shares of beneficial interest (14,258,690) 3,050,041 --------------- -------------------- NET INCREASE (DECREASE) (21,655,145) 28,117,971 NET ASSETS: Beginning of period 297,028,990 268,911,019 --------------- -------------------- END OF PERIOD (INCLUDING ACCUMULATED UNDISTRIBUTED NET INVESTMENT INCOME OF $2,003,927 AND $4,309,773, RESPECTIVELY) $ 275,373,845 $ 297,028,990 =============== ====================
SEE NOTES TO FINANCIAL STATEMENTS 24 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- S&P 500 INDEX PORTFOLIO NOTES TO FINANCIAL STATEMENTS JUNE 30, 2005 (UNAUDITED) 1. ORGANIZATION AND ACCOUNTING POLICIES Morgan Stanley Variable Investment Series (the "Fund") -- S&P 500 Index Portfolio (the "Portfolio"), one of 15 separate portfolios, is registered under the Investment Company Act of 1940, as amended (the "Act"), as a diversified, open-end management investment company. The Fund is offered exclusively to life insurance companies in connection with particular life insurance and/or annuity contracts they offer. The Portfolio's investment objective is to provide investment results that, before expenses, correspond to the total return of the Standard & Poor's 500 Composite Stock Price Index. The Fund was organized as a Massachusetts business trust on February 25, 1983 and the Portfolio commenced operations on May 18, 1998. On June 5, 2000, the Portfolio commenced offering one additional class of shares (Class Y). The Portfolio offers Class X shares and Class Y shares. The two are identical except that Class Y shares incur distribution expenses. Class X shares are generally available to holders of contracts offered by Metropolitan Life Insurance Company (formerly Paragon Life Insurance Company) and other contracts offered before May 1, 2000. Class Y shares are available to holders of contracts offered on or after June 5, 2000. 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) futures are valued at the latest price published by the commodities exchange on which they trade; (6) when market quotations are not readily available or Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") determines that the latest sale price, the bid price or the mean between the last reported bid and asked price do not reflect a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees. Occasionally, developments affecting the closing prices of securities and other assets may occur between the times at which valuations of such securities are determined (that is, close of the foreign market on which the securities trade) and the close of business on the NYSE. If developments occur during such periods that are 25 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; and (7) 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 -- The Fund may 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. 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 Portfolio 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 Portfolio 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 Portfolio as unrealized gains and losses. Upon closing of the contract, the Portfolio 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. F. 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. G. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- Dividends and distributions to shareholders are recorded on the ex-dividend date. 26 H. EXPENSES -- Direct expenses are charged to the Portfolio and general Fund expenses are allocated on the basis of relative net assets or equally among the Portfolios. I. 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 Effective June 1, 2005, pursuant to an Investment Advisory Agreement, the Portfolio pays the Investment Adviser an advisory fee, accrued daily and payable monthly, by applying the following annual rates to the net assets of the Portfolio determined at the close of each business day: 0.12% to the portion of the daily net assets not exceeding $2 billion and 0.10% to the portion of the daily net assets exceeding $2 billion. (Prior to June 1, 2005, 0.12%) Pursuant to an Administration Agreement with Morgan Stanley Services Company Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Portfolio pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.08% to the Portfolio's daily net assets. The Investment Adviser has agreed to assume all operating expenses (except for distribution fees) and to waive its compensation to the extent that such expenses and compensation on an annualized basis exceed 0.40% of the 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 Class Y shares of the Portfolio will pay a distribution fee which is accrued daily and paid monthly at the annual rate of 0.25% of the average daily net assets of the class. 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 June 30, 2005 were $6,148,124 and $20,306,026, respectively. 27 The Fund had transactions with the following affiliates:
REALIZED ISSUER PURCHASES SALES GAIN/LOSS INCOME VALUE - ----------------------------------- --------------- --------------- --------------- --------------- --------------- Allstate Corp $ 619,358 $ 62,560 $ 13,050 $ 11,046 $ 998,781 MetLife Inc 661,579 39,673 2,656 -- 824,379 Morgan Stanley 1,473,146 40,847 (10,475) 15,344 1,498,596 Citigroup Inc. 5,072,021 339,818 (11,598) 117,135 6,016,002 --------------- --------------- --------------- --------------- --------------- $ 7,826,104 $ 482,898 $ (6,367) $ 143,525 $ 9,337,758 --------------- --------------- --------------- --------------- ---------------
Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and Distributor, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and compensation. Aggregate pension costs for the six months ended June 30, 2005 included in Trustees' fees and expenses in the Statement of Operations amounted to $228. At June 30, 2005, the Portfolio had an accrued pension liability of $304 which is included in accrued expenses in the Statement of Assets and Liabilities. On December 2, 2003, the Trustees voted to close the plan to new participants and eliminate the future benefits growth due to increases to compensation after July 31, 2003. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 5. PURPOSES OF AND RISKS RELATING TO CERTAIN FINANCIAL INSTRUMENTS The Portfolio may purchase and sell stock index futures ("futures contracts") for the following reasons: to simulate full investment in the S&P 500 Index while retaining a cash balance for portfolio management purposes; to facilitate trading; to reduce transaction costs; or to seek higher investment returns when a futures contract is priced more attractively than stocks comprising the S&P 500 Index. These futures contracts involve elements of market risk in excess of the amount reflected in the Statement of Assets and Liabilities. The Portfolio bears the risk of an unfavorable change in the value of 28 the underlying securities. Risks may also arise upon entering into these contracts from the potential inability of the counterparties to meet the terms of their contracts. 6. SHARES OF BENEFICIAL INTEREST Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 ---------------------------------- ---------------------------------- (UNAUDITED) SHARES AMOUNT SHARES AMOUNT --------------- --------------- --------------- --------------- CLASS X SHARES Sold 823,429 $ 9,036,184 4,952,549 $ 51,673,870 Reinvestment of dividends 175,779 1,907,197 122,702 1,276,097 Redeemed (2,331,756) (25,547,083) (6,666,531) (69,220,355) --------------- --------------- --------------- --------------- Net decrease -- Class X (1,332,548) (14,603,702) (1,591,280) (16,270,388) --------------- --------------- --------------- --------------- CLASS Y SHARES Sold 1,650,699 17,957,829 4,035,180 41,876,646 Reinvestment of dividends 222,054 2,393,740 116,229 1,201,806 Redeemed (1,844,419) (20,006,557) (2,303,112) (23,758,023) --------------- --------------- --------------- --------------- Net increase -- Class Y 28,334 345,012 1,848,297 19,320,429 --------------- --------------- --------------- --------------- Net increase (decrease) in Portfolio (1,304,214) $ (14,258,690) 257,017 $ 3,050,041 =============== =============== =============== ===============
7. 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 December 31, 2004, the Portfolio had a net capital loss carryforward of approximately $24,372,000 of which $6,878,000 will expire on December 31, 2009, $14,114,000 will expire on December 31, 2010, and $3,380,000 will expire on December 31, 2012 to offset future capital gains to the extent provided by regulations. As of December 31, 2004, the Portfolio had temporary book/tax differences primarily attributable to capital gain from the mark-to-market of futures contracts and capital loss deferrals on wash sales. 29 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- S&P 500 INDEX PORTFOLIO FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ---------------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ---------- ---------- ---------- ---------- ---------- (UNAUDITED) CLASS X SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 11.14 $ 10.17 $ 8.04 $ 10.48 $ 12.05 $ 13.43 ------------- ---------- ---------- ---------- ---------- ---------- Income (loss) from investment operations: Net investment income++ 0.09 0.17 0.12 0.10 0.10 0.12 Net realized and unrealized gain (loss) (0.19) 0.90 2.11 (2.45) (1.57) (1.37) ------------- ---------- ---------- ---------- ---------- ---------- Total income (loss) from investment operations (0.10) 1.07 2.23 (2.35) (1.47) (1.25) ------------- ---------- ---------- ---------- ---------- ---------- Less dividends and distributions from: Net investment income (0.19) (0.10) (0.10) (0.09) (0.10) (0.07) Net realized gain -- -- -- -- -- (0.06) ------------- ---------- ---------- ---------- ---------- ---------- Total dividends and distributions (0.19) (0.10) (0.10) (0.09) (0.10) (0.13) ------------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period $ 10.85 $ 11.14 $ 10.17 $ 8.04 $ 10.48 $ 12.05 ============= ========== ========== ========== ========== ========== Total Return+ (0.93)%(2) 10.59% 27.85% (22.48)% (12.23)% (9.38)% RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.27%(3) 0.33% 0.46% 0.46% 0.46% 0.45% Net investment income 1.57%(3) 1.69% 1.31% 1.15% 0.95% 0.88% SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 113,113 $ 130,944 $ 135,767 $ 110,789 $ 165,465 $ 210,530 Portfolio turnover rate 2%(2) 4% 0% 5% 4% 3%
- ---------- * PRIOR TO JUNE 5, 2000, THE PORTFOLIO ISSUED ONE CLASS OF SHARES. ALL SHARES OF THE PORTFOLIO HELD PRIOR TO MAY 1, 2000 HAVE BEEN DESIGNATED CLASS X SHARES. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 30
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ---------------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ---------- ---------- ---------- ---------- ---------- (UNAUDITED) CLASS Y SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 11.06 $ 10.11 $ 8.00 $ 10.44 $ 12.04 $ 13.47 ------------- ---------- ---------- ---------- ---------- ------- Income (loss) from investment operations: Net investment income++ 0.07 0.15 0.09 0.08 0.08 0.04 Net realized and unrealized gain (loss) (0.19) 0.88 2.10 (2.44) (1.58) (1.34) ------------- ---------- ---------- ---------- ---------- ------- Total income (loss) from investment operations (0.12) 1.03 2.19 (2.36) (1.50) (1.30) ------------- ---------- ---------- ---------- ---------- ------- Less dividends and distributions from: Net investment income (0.16) (0.08) (0.08) (0.08) (0.10) (0.07) Net realized gain -- -- -- -- -- (0.06) ------------- ---------- ---------- ---------- ---------- ------- Total dividends and distributions (0.16) (0.08) (0.08) (0.08) (0.10) (0.13) ------------- ---------- ---------- ---------- ---------- ------- Net asset value, end of period $ 10.78 $ 11.06 $ 10.11 $ 8.00 $ 10.44 $ 12.04 ============= ========== ========== ========== ========== ======= TOTAL RETURN+ (1.07)%(2) 10.29% 27.54% (22.67)% (12.53)% (9.73)%(2) RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.52%(3) 0.58% 0.71% 0.71% 0.71% 0.71%(3) Net investment income 1.32%(3) 1.44% 1.06% 0.90% 0.70% 0.60%(3) SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 162,261 $ 166,085 $ 133,144 $ 62,977 $ 46,134 $ 12,724 Portfolio turnover rate 2%(2) 4% 0% 5% 4% 3%
- ---------- * FOR THE PERIOD JUNE 5, 2000 (ISSUED DATE) THROUGH DECEMBER 31, 2000. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 31 TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo CHAIRMAN OF THE BOARD Mitchell M. Merin PRESIDENT Ronald E. Robison EXECUTIVE VICE PRESIDENT and PRINCIPAL EXECUTIVE OFFICER Joseph J. McAlinden VICE PRESIDENT Barry Fink VICE PRESIDENT Amy R. Doberman VICE PRESIDENT Carsten Otto CHIEF COMPLIANCE OFFICER Stefanie V. Chang VICE PRESIDENT Francis J. Smith TREASURER and CHIEF FINANCIAL OFFICER Thomas F. Caloia VICE PRESIDENT Mary E. Mullin SECRETARY TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT 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 Portfolio 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 Portfolio. For more detailed information about the Portfolio, its fees and expenses and other pertinent information, please read its Prospectus. The Portfolio's Statement of Additional Information contains additional information about the Portfolio, 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 Portfolio 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) 2005 Morgan Stanley [MORGAN STANLEY LOGO] RA05-00658P-Y06/05 [GRAPHIC] MORGAN STANLEY FUNDS MORGAN STANLEY VARIABLE INVESTMENT SERIES -- S&P 500 INDEX PORTFOLIO SEMIANNUAL REPORT JUNE 30, 2005 [MORGAN STANLEY LOGO] WELCOME, SHAREHOLDER: IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY VARIABLE INVESTMENT SERIES -- STRATEGIST PORTFOLIO 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 PORTFOLIO'S FINANCIAL STATEMENTS AND A LIST OF PORTFOLIO INVESTMENTS. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE PORTFOLIO BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE PORTFOLIO WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE PORTFOLIO IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE PORTFOLIO WILL DECLINE AND, THEREFORE, THE VALUE OF THE PORTFOLIO'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS PORTFOLIO. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT For the six months ended June 30, 2005 TOTAL RETURN FOR THE 6 MONTHS ENDED JUNE 30, 2005
LEHMAN BROTHERS S&P 500(R) U.S. GOVERNMENT/ CLASS X CLASS Y INDEX(1) CREDIT INDEX(2) 1.51% 1.38% -0.81% 2.75%
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. SEE PERFORMANCE SUMMARY FOR PERFORMANCE INFORMATION AND INDEX DEFINITIONS. MARKET CONDITIONS The six-month period ended June 30, 2005 was characterized by continued high oil prices, mixed economic data, inflationary pressures and a flattening yield curve. The Federal Open Market Committee (the Fed), continued to raise the federal funds target rate at a "measured" pace, through four increases of 25 basis points each. Compared with the brisk rally seen in the final months of 2004, the U.S. equity markets proceeded at a much more tempered pace during the first half of 2005. As the year began, stocks retreated amid profit taking and flagging sentiment. Investors were concerned about the pace and the sustainability of economic growth, high energy costs and the intentions of the Fed. Inflationary concerns also cast a shadow. The climate improved in the final months of the reporting period, however. An upward revision of first-quarter gross domestic product, as well as encouraging payroll and retail data were among the factors that buoyed the stock market, and affirmed the prospects for continued moderate economic growth. Against the backdrop of rising commodity prices, energy and utilities stocks performed with particular strength. Large-cap stocks generally trailed their smaller counterparts. As investors sought greater stability and income, bonds generally posted stronger gains than stocks. Although the yields of short- and intermediate-term bonds moved higher in response to the Fed's increases to the federal funds target rate, the yields of long-term bonds did not move upward. Seemingly undeterred by the prospect of inflation, buyers fuelled a rally in the long end of the U.S. Treasury market, which drove long-term bond yields down (bond prices and yields move in opposite directions). As a result, the yield curve (the difference between the yields of short-term and long-term bonds) continued to flatten. PERFORMANCE ANALYSIS The Strategist Portfolio outperformed the S&P 500(R) Index (an all stock benchmark) and underperformed the Lehman Brothers U.S. Government/Credit Index (a fixed income benchmark) for the six months ended June 30, 2005. As the result of our investment discipline, the Portfolio was more heavily allocated toward stocks throughout the reporting period, as it has been since July of 2003. However, the Portfolio did shift to a more defensive blend in April. Targeted equity exposure was reduced from 70 percent of assets to 65 percent, while targeted fixed income exposure was reduced from 30 percent to 25 percent. Cash and cash equivalents were increased from zero percent to 10 percent. This target allocation represents an overweight stance in equities (65 percent versus an average balanced fund weight of 55 percent), a more significant fixed income underweight (25 percent versus an average weight of 35 percent), and a cash position in line with the peer group average. 2 Several factors led to the initiation of a cash reserve and to an overall more defensive tone toward the fixed income markets. In response to general economic weakness seen at the end of the first quarter, U.S. Treasury markets rallied. Against this backdrop, we reduced the Portfolio's exposure to bonds with longer maturities, capturing what we considered to be attractive valuation levels. The reduction in the equity allocation also reflected profit-taking activity, as a number of sectors benefited from strong first-quarter earnings reports. Moreover, the reduced exposure reflected our concerns about profit expectations for the remainder of 2005. One overriding concern, however, outweighed any asset class-specific rationale for the Portfolio's changed target. For the first time in this economic cycle, inflationary pressures finally began to manifest themselves in consumer goods and services. After facing spiking commodity prices for three years, companies seemed to have finally reached their limits in terms of absorbing higher costs. Price increases for both goods and services were seen across the spectrum of consumer goods, a trend that concerned us in light of the Fed's policy of "measured" increases to the federal funds target rate. Our analysis was that the Fed could grow more vigilant in its attempts to corral inflationary pressures, even if economic growth appeared a bit less robust than last year. The Portfolio's positioning at the end of the period reflected our view of the likelihood of moderate macroeconomic recovery through early 2006 and strength in cyclical industries (such as hardware and equipment, chemicals and metals, and industrials). The Portfolio maintained a bias toward information technology, its largest overweighting by far versus the S&P 500(R) Index. Other significantly overweighted exposures included basic materials and consumer staples; energy exposure was slightly overweighted. Sectors which could be negatively impacted by a steepening yield curve (such as financials and utilities) were significantly underweighted versus the S&P 500(R) Index. In fact, the Portfolio held zero exposure to utilities stocks. Weightings in consumer discretionary and telecommunications services were also below that of the S&P 500(R) Index. Throughout the period, the fixed-income portion of the portfolio emphasized high-quality securities. As of the end of the period, the average credit quality was AA+. The Portfolio's fixed income holdings were allocated as follows: U.S. government securities (36.7 percent), U.S. government agency securities (3.5 percent), mortgage-backed securities (0.2 percent), corporate bonds (38.7 percent) and cash equivalents (21.1 percent). Average yield-to-maturity stood at 3.99 percent and effective duration* was 4.43 years. THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM WELL OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE PORTFOLIO IN THE FUTURE. * A MEASURE OF THE SENSITIVITY OF A BOND'S PRICE TO CHANGES IN INTEREST RATES, EXPRESSED IN YEARS. EACH YEAR OF DURATION REPRESENTS AN EXPECTED 1 PERCENT CHANGE IN THE PRICE OF A BOND FOR EVERY 1 PERCENT CHANGE IN INTEREST RATES. THE LONGER A BOND'S DURATION, THE GREATER THE EFFECT OF INTEREST-RATE MOVEMENTS ON ITS PRICE. TYPICALLY, FUNDS WITH SHORTER DURATIONS PERFORM BETTER IN RISING-INTEREST-RATE ENVIRONMENTS, WHILE FUNDS WITH LONGER DURATIONS PERFORM BETTER WHEN RATES DECLINE. 3 TOP 10 HOLDINGS Fed Home Ln Mtge Corp 10.9% U.S. Treasury Securities 9.9 Citigroup Inc. 1.5 Bank of America Corp. 1.4 Corning Inc. 1.4 American Express Co. 1.4 Coca-Cola Co. 1.4 General Electric Co. 1.4 JPMorgan Chase & Co. 1.3 Fisher Scientific International Inc. 1.3
PORTFOLIO COMPOSITION* Common Stocks 68.4% U.S. Government Agencies & Obligations 11.3 Short-Term Paper 10.5 Corp Notes/Bonds 5.6 Asset-Backed 4.0 Foreign Government Bonds 0.2
DATA AS OF JUNE 30, 2005. 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. * DOES NOT INCLUDE OUTSTANDING SHORT FUTURES CONTRACTS WITH AN UNDERLYING FACE AMOUNT OF $22,001,970 WITH NET UNREALIZED APPRECIATION OF $1,441. INVESTMENT STRATEGY THE PORTFOLIO'S "INVESTMENT ADVISER," MORGAN STANLEY INVESTMENT ADVISORS INC., ACTIVELY ALLOCATES THE PORTFOLIO'S ASSETS AMONG THE MAJOR ASSET CATEGORIES OF EQUITY SECURITIES (INCLUDING DEPOSITARY RECEIPTS), FIXED-INCOME SECURITIES AND MONEY MARKET INSTRUMENTS. IN DETERMINING WHICH SECURITIES TO BUY, HOLD OR SELL FOR THE PORTFOLIO, THE INVESTMENT ADVISER ALLOCATES THE PORTFOLIO'S ASSETS BASED ON, AMONG OTHER THINGS, ITS ASSESSMENT OF THE EFFECTS OF ECONOMIC AND MARKET TRENDS ON DIFFERENT SECTORS OF THE MARKET. THERE IS NO LIMIT AS TO THE PERCENTAGE OF ASSETS THAT MAY BE ALLOCATED TO ANY ONE ASSET CLASS. FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY PORTFOLIO PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE PORTFOLIO'S SECOND AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY PORTFOLIO 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 4 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 POLICIES AND PROCEDURES AND PROXY VOTING RECORD YOU MAY OBTAIN A COPY OF THE PORTFOLIO'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 PORTFOLIO VOTED PROXIES RELATING TO PORTFOLIO SECURITIES DURING THE MOST RECENT TWELVE-MONTH PERIOD ENDED JUNE 30 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. 5 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED JUNE 30, 2005
CLASS X SHARES CLASS Y SHARES (SINCE 03/01/87) (SINCE 06/05/00) 1 YEAR 8.46%(3) 8.14%(3) 5 YEARS 2.92(3) 2.67(3) 10 YEARS 9.12(3) -- SINCE INCEPTION 9.18(3) 2.47(3)
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 THE 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 PORTFOLIO SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. THE PERFORMANCE OF THE PORTFOLIO'S TWO SHARE CLASSES VARIES BECAUSE EACH HAS DIFFERENT EXPENSES. THE PORTFOLIO'S TOTAL RETURN FIGURES ASSUME THE REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE IMPACT OF ANY CHARGES BY YOUR INSURANCE COMPANY. SUCH COSTS WOULD LOWER PERFORMANCE. (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. GOVERNMENT/CREDIT INDEX TRACKS THE PERFORMANCE OF GOVERNMENT AND CORPORATE OBLIGATIONS, INCLUDING U.S. GOVERNMENT AGENCY AND TREASURY SECURITIES AND CORPORATE AND YANKEE BONDS. 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) FIGURE ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS FOR THE UNDERLYING PORTFOLIO BASED ON NET ASSET VALUE (NAV). IT DOES NOT REFLECT THE DEDUCTION OF INSURANCE EXPENSES, AN ANNUAL CONTRACT MAINTENANCE FEE, OR SURRENDER charges. 6 EXPENSE EXAMPLE As a shareholder of the Portfolio, you incur two types of costs: (1) insurance company charges; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Portfolio expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Portfolio 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 01/01/05 - 06/30/05. 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 Portfolio's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Portfolio'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 Portfolio 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 insurance company charges. 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 insurance company charges were included, your costs would have been higher.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD * ------------- ------------- --------------- 01/01/05 - 01/01/05 06/30/05 06/30/05 ------------- ------------- --------------- CLASS X Actual (1.51% return) $ 1,000.00 $ 1,015.10 $ 2.65 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,022.17 $ 2.66 CLASS Y Actual (1.38% return) $ 1,000.00 $ 1,013.80 $ 3.89 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,020.93 $ 3.91
- ---------- * EXPENSES ARE EQUAL TO THE PORTFOLIO'S ANNUALIZED EXPENSE RATIO OF 0.53% AND 0.78% RESPECTIVELY, MULTIPLIED BY THE AVERAGE ACCOUNT VALUE OVER THE PERIOD, MULTIPLIED BY 181/365 (TO REFLECT THE ONE-HALF YEAR PERIOD). 7 INVESTMENT ADVISORY AGREEMENT APPROVAL NATURE, EXTENT AND QUALITY OF SERVICES The Board reviewed and considered the nature and extent of the investment advisory services provided by the Investment Adviser under the Advisory Agreement, including portfolio management, investment research and fixed income securities trading. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Portfolio's Administrator under the Administration Agreement, including accounting, clerical, bookkeeping, compliance, business management and planning, and the provision of supplies, office space and utilities. (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 administrative and investment advisory services to the Portfolio. 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 Portfolio. 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 The Board reviewed the Portfolio's performance for the one-, three- and five-year periods ended November 30, 2004, as shown in reports provided by Lipper (the "Lipper Reports"), compared to the performance of comparable funds selected by Lipper (the "performance peer group"), and noted that the Portfolio's performance was lower than its performance peer group average for the five-year period but better for the one- and three-year periods. The Board concluded that the Portfolio's overall performance was competitive with its performance peer group. FEES RELATIVE TO OTHER FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT STRATEGIES The Board reviewed the advisory and administrative fees (together, the "management fee") paid by the Fund under the Management Agreement. The Board noted that the rate was comparable to the management fee rates charged by the Adviser to any other funds it manages with investment strategies comparable to those of the Portfolio. FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS The Board reviewed the management fee rate and the total expense ratio of the Portfolio. The Board noted that: (i) the Portfolio's management fee rate was lower than the average management fee rate for funds, selected by Lipper (the "expense peer group"), managed by other advisers with investment strategies comparable to those of 8 the Portfolio, as shown in the Lipper Report for the Portfolio; and (ii) the Portfolio's total expense ratio was also lower than the average total expense ratio of the funds included in the Portfolio's expense peer group. The Board concluded that the Portfolio's management fee 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 Portfolio's management fee schedule under the Management Agreement and noted that it includes a breakpoint. The Board also reviewed the level of the Portfolio's management fee and noted that the fee, as a percentage of the Portfolio's net assets, would decrease as net assets increase because the management fee includes a breakpoint. The Board concluded that the Portfolio's management fee would reflect economies of scale as assets increase. PROFITABILITY OF ADVISER AND AFFILIATES The Board considered and reviewed information concerning the costs incurred and profits realized by the Adviser and its affiliates during the last two years from their relationship with the Portfolio and the Morgan Stanley Fund Complex and reviewed with the Controller of the Adviser the cost allocation methodology used to determine the Adviser's profitability. Based on their review of the information they received, the Board concluded that the profits earned by the Adviser and its affiliates were not excessive in light of the advisory, administrative and other services provided to the Portfolio. FALL-OUT BENEFITS The Board considered so-called "fall-out benefits" derived by the Adviser and its affiliates from their relationship with the Portfolio and the Morgan Stanley Fund Complex, such as "float" benefits derived from handling of checks for purchases and redemptions of Portfolio 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 Portfolio 12b-1 fees for distribution and shareholder services. The Board also considered that an affiliate of the Adviser, through a joint venture, receives revenue in connection with trading done on behalf of the Portfolio through an electronic trading system network ("ECN"). The Board concluded that the float benefits and the above-referenced ECN-related revenue were relatively small and that the 12b-1 fees were competitive with those of other broker-dealer affiliates of investment advisers of mutual funds. 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 Portfolio and/or other funds managed by the Adviser would be used to pay for research that a securities broker obtains 9 from third parties, or to pay for both research and execution services from securities brokers who effect transactions for the Portfolio. The Adviser informed the Board that it does not use Portfolio 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 Portfolio and other funds in the Morgan Stanley Fund Complex. ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE PORTFOLIO'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 PORTFOLIO AND THE ADVISER The Board also reviewed and considered the historical relationship between the Portfolio and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Portfolio'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 Portfolio 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 Portfolio'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 Portfolio's business. GENERAL CONCLUSION After considering and weighing all of the above factors, the Board concluded it would be in the best interest of the Portfolio and its shareholders to approve renewal of the Management Agreement for another year. 10 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- STRATEGIST PORTFOLIO PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
NUMBER OF SHARES VALUE - --------------------------------------------------------------------------------------------- COMMON STOCKS (68.7%) ADVERTISING/MARKETING SERVICES (1.1%) 53,600 Lamar Advertising Co. (Class A)* $ 2,292,472 26,490 Omnicom Group, Inc. 2,115,491 ------------ 4,407,963 ------------ AEROSPACE & DEFENSE (1.5%) 70,850 Northrop Grumman Corp. 3,914,463 57,560 Raytheon Co. 2,251,747 ------------ 6,166,210 ------------ AGRICULTURAL COMMODITIES/MILLING (1.1%) 215,940 Archer-Daniels-Midland Co. 4,616,797 ------------ APPAREL/FOOTWEAR RETAIL (1.0%) 189,200 Gap, Inc. (The) 3,736,700 ------------ BEVERAGES: NON-ALCOHOLIC (1.4%) 134,530 Coca-Cola Co. (The) 5,616,628 ------------ BIOTECHNOLOGY (2.1%) 106,595 Celgene Corp.* 4,345,878 97,950 Gilead Sciences, Inc.* 4,308,821 ------------ 8,654,699 ------------ CHEMICALS: AGRICULTURAL (0.6%) 39,555 Monsanto Co. 2,486,823 ------------ CHEMICALS: MAJOR DIVERSIFIED (1.1%) 55,070 Dow Chemical Co. (The) 2,452,267 63,900 Engelhard Corp. 1,824,345 ------------ 4,276,612 ------------ COMPUTER COMMUNICATIONS (1.3%) 266,400 Cisco Systems, Inc.* 5,090,904 ------------ COMPUTER PERIPHERALS (0.7%) 222,800 EMC Corp.* 3,054,588 ------------ COMPUTER PROCESSING HARDWARE (2.3%) 136,010 Apple Computer, Inc.* 5,006,528 109,200 Dell, Inc.* 4,314,492 ------------ 9,321,020 ------------ CONTAINERS/PACKAGING (0.3%) 139,120 Smurfit-Stone Container Corp.* 1,414,850 ------------ CONTRACT DRILLING (0.7%) 53,225 Diamond Offshore Drilling, Inc. 2,843,812 ------------
SEE NOTES TO FINANCIAL STATEMENTS 11
NUMBER OF SHARES VALUE - --------------------------------------------------------------------------------------------- DEPARTMENT STORES (1.1%) 78,920 Kohl's Corp.* $ 4,412,417 ------------ DISCOUNT STORES (1.3%) 113,840 Costco Wholesale Corp. 5,102,309 ------------ ELECTRICAL PRODUCTS (1.7%) 70,790 Emerson Electric Co. 4,433,578 75,040 Spectrum Brands Inc.* 2,476,320 ------------ 6,909,898 ------------ ELECTRONIC COMPONENTS (0.5%) 144,860 Flextronics International Ltd. (Singapore)* 1,913,601 ------------ ELECTRONIC PRODUCTION EQUIPMENT (0.6%) 162,160 Applied Materials, Inc. 2,623,749 ------------ ENVIRONMENTAL SERVICES (1.0%) 143,650 Waste Management, Inc. 4,071,041 ------------ FINANCIAL CONGLOMERATES (4.0%) 106,500 American Express Co. 5,668,995 118,600 Citigroup, Inc. 5,482,878 140,160 JPMorgan Chase & Co. 4,950,451 ------------ 16,102,324 ------------ FOOD: MAJOR DIVERSIFIED (1.2%) 95,000 Kellogg Co. 4,221,800 24,514 TreeHouse Foods, Inc.* 698,894 ------------ 4,920,694 ------------ FOOD: MEAT/FISH/DAIRY (1.1%) 122,570 Dean Foods Co.* 4,319,367 ------------ HOUSEHOLD/PERSONAL CARE (1.3%) 48,320 Colgate-Palmolive Co. 2,411,651 54,570 Gillette Co. (The) 2,762,879 ------------ 5,174,530 ------------ INDUSTRIAL CONGLOMERATES (1.4%) 158,150 General Electric Co. 5,479,898 ------------ INFORMATION TECHNOLOGY SERVICES (1.1%) 59,010 International Business Machines Corp. 4,378,542 ------------ INTEGRATED OIL (2.0%) 47,390 BP PLC (ADR) (United Kingdom) 2,956,188 53,280 Exxon Mobil Corp. 3,062,002 35,240 Royal Dutch Petroleum Co. (NY Registered Shares) (Netherlands) 2,287,076 ------------ 8,305,266 ------------
SEE NOTES TO FINANCIAL STATEMENTS 12
NUMBER OF SHARES VALUE - --------------------------------------------------------------------------------------------- INTERNET SOFTWARE/SERVICES (0.8%) 165,500 Siebel Systems, Inc. $ 1,472,950 52,280 Yahoo!, Inc.* 1,811,502 ------------ 3,284,452 ------------ INVESTMENT BANKS/BROKERS (0.7%) 161,550 Ameritrade Holding Corp.* 3,003,215 ------------ MAJOR BANKS (2.8%) 126,940 Bank of America Corp. 5,789,733 88,375 KeyCorp 2,929,631 45,470 Wells Fargo & Co. 2,800,043 ------------ 11,519,407 ------------ MAJOR TELECOMMUNICATIONS (1.0%) 132,870 AT&T Corp. 2,529,845 66,800 SBC Communications, Inc. 1,586,500 ------------ 4,116,345 ------------ MEDIA CONGLOMERATES (1.3%) 310,030 Time Warner, Inc.* 5,180,601 ------------ MEDICAL SPECIALTIES (3.7%) 75,380 Bard (C.R.), Inc. 5,013,524 80,130 Fisher Scientific International, Inc.* 5,200,437 74,330 Hospira, Inc.* 2,898,870 37,970 Medtronic, Inc. 1,966,466 ------------ 15,079,297 ------------ MOTOR VEHICLES (1.1%) 179,460 Honda Motor Co., Ltd. (ADR) (Japan) 4,416,511 ------------ OIL & GAS PRODUCTION (0.8%) 59,990 Burlington Resources, Inc. 3,313,848 ------------ OIL REFINING/MARKETING (0.7%) 41,220 Ashland, Inc. 2,962,481 ------------ OILFIELD SERVICES/EQUIPMENT (1.8%) 77,530 Halliburton Co. 3,707,485 55,150 Smith International, Inc. 3,513,055 ------------ 7,220,540 ------------ PACKAGED SOFTWARE (2.7%) 163,830 Microsoft Corp. 4,069,537 330,400 Oracle Corp.* 4,361,280 141,240 Sybase, Inc.* 2,591,754 ------------ 11,022,571 ------------
SEE NOTES TO FINANCIAL STATEMENTS 13
NUMBER OF SHARES VALUE - --------------------------------------------------------------------------------------------- PHARMACEUTICALS: MAJOR (4.2%) 73,695 Johnson & Johnson $ 4,790,175 64,550 Lilly (Eli) & Co. 3,596,081 167,860 Pfizer, Inc. 4,629,579 88,720 Wyeth 3,948,040 ------------ 16,963,875 ------------ PROPERTY - CASUALTY INSURERS (1.1%) 73,420 Allstate Corp. (The) (Note 4) 4,386,845 ------------ RAILROADS (1.6%) 29,040 Burlington Northern Santa Fe Corp. 1,367,203 57,600 CSX Corp. 2,457,216 42,970 Union Pacific Corp. 2,784,456 ------------ 6,608,875 ------------ REGIONAL BANKS (0.4%) 68,340 AmSouth Bancorporation 1,776,840 ------------ SEMICONDUCTORS (2.2%) 107,510 Freescale Semiconductor Inc. (Class B)* 2,277,061 112,310 Intel Corp. 2,926,799 190,390 Micron Technology, Inc.* 1,943,882 185,190 Taiwan Semiconductor Manufacturing Co. Ltd. (ADR) (Taiwan) 1,688,933 ------------ 8,836,675 ------------ SPECIALTY STORES (0.9%) 87,980 Bed Bath & Beyond Inc.* 3,675,804 ------------ SPECIALTY TELECOMMUNICATIONS (0.8%) 240,000 Citizens Communications Co. 3,225,600 ------------ STEEL (0.6%) 49,820 Nucor Corp. 2,272,788 ------------ TELECOMMUNICATION EQUIPMENT (3.9%) 341,540 Corning Inc.* 5,676,394 277,500 Motorola, Inc. 5,067,150 302,700 Nokia Corp. (ADR) (Finland) 5,036,927 ------------ 15,780,471 ------------ TOBACCO (0.8%) 53,560 Altria Group, Inc. 3,463,190 ------------ TRUCKS/CONSTRUCTION/FARM MACHINERY (1.3%) 53,550 Caterpillar Inc. 5,103,850 ------------ TOTAL COMMON STOCKS (Cost $214,657,688) 278,615,323 ------------
SEE NOTES TO FINANCIAL STATEMENTS 14
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - --------------------------------------------------------------------------------------------- CORPORATE BONDS (5.6%) ADVERTISING/MARKETING SERVICES (0.0%) $ 150 WPP Finance (UK) Corp. (United Kingdom) 5.875% 06/15/14 $ 158,866 ------------ AEROSPACE & DEFENSE (0.2%) 150 Northrop Grumman Corp. 4.079 11/16/06 149,616 74 Raytheon Co. 6.15 11/01/08 78,142 20 Raytheon Co. 8.30 03/01/10 23,201 312 Systems 2001 Asset Trust LLC - 144A** (Cayman Islands) 6.664 09/15/13 340,702 ------------ 591,661 ------------ AIR FREIGHT/COURIERS (0.0%) 140 Fedex Corp. 2.65 04/01/07 136,409 ------------ AIRLINES (0.1%) 355 America West Airlines, Inc. (Series 01-1) 7.10 04/02/21 376,558 125 Southwest Airlines Co. (Series 01-1) 5.496 11/01/06 127,198 ------------ 503,756 ------------ BEVERAGES: ALCOHOLIC (0.1%) 205 FBG Finance Ltd. - 144A** (Australia) 5.125 06/15/15 206,199 215 Miller Brewing Co. - 144A** 4.25 08/15/08 214,217 ------------ 420,416 ------------ CABLE/SATELLITE TV (0.2%) 30 Comcast Cable Communications Inc. 6.75 01/30/11 33,136 30 Comcast Corp. 5.30 01/15/14 30,893 90 Comcast Corp. 6.50 01/15/15 100,499 25 Lenfest Communications 7.625 02/15/08 26,867 180 Cox Communications, Inc. 4.625 01/15/10 179,706 190 TCI Communications, Inc. 7.875 02/15/26 237,967 ------------ 609,068 ------------ CASINO/GAMING (0.0%) 115 Harrahs Operating Co. Inc. - 144A** 5.625 06/01/15 117,354 ------------ CHEMICALS: MAJOR DIVERSIFIED (0.0%) 105 ICI Wilmington Inc. 4.375 12/01/08 104,284 ------------ CONTAINERS/PACKAGING (0.1%) 240 Sealed Air Corp. - 144A** 5.625 07/15/13 247,015 ------------ DEPARTMENT STORES (0.1%) 275 May Department Stores Co., Inc. 5.95 11/01/08 287,400 ------------
SEE NOTES TO FINANCIAL STATEMENTS 15
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - --------------------------------------------------------------------------------------------- DRUGSTORE CHAINS (0.1%) $ 455 CVS Corp. 5.625% 03/15/06 $ 459,781 ------------ ELECTRIC UTILITIES (0.6%) 210 Arizona Public Service Co. 5.80 06/30/14 225,986 185 Carolina Power & Light Co. 5.125 09/15/13 191,312 115 CC Funding Trust I 6.90 02/16/07 119,828 90 Cincinnati Gas & Electric Co. 5.70 09/15/12 96,344 130 Consolidated Natural Gas Co. (Series A) 5.00 12/01/14 131,756 25 Consolidated Natural Gas Co. (Series A) 5.00 03/01/14 25,404 170 Consolidated Natural Gas Co. (Series C) 6.25 11/01/11 185,714 125 Consumers Energy Co. (Series H) 4.80 02/17/09 126,661 55 Detroit Edison Co. (The) 6.125 10/01/10 59,424 155 Detroit Edison Co. (The) - 144A** 4.80 02/15/15 156,192 85 Entergy Gulf States, Inc. 3.60 06/01/08 83,266 130 Entergy Gulf States, Inc. 3.73++ 12/01/09 130,432 110 Exelon Corp. 6.75 05/01/11 122,307 260 FPL Group Capital Inc. 3.25 04/11/06 258,749 185 Pacific Gas & Electric Co. 6.05 03/01/34 204,614 45 Panhandle Eastern Pipe Line Co. (Series B) 2.75 03/15/07 43,843 125 Public Service Electric & Gas Co. (Series MTNB) 5.00 01/01/13 129,183 60 South Carolina Electric & Gas Co. 5.30 05/15/33 62,557 40 Texas Eastern Transmission, LP 7.00 07/15/32 49,076 75 Wisconsin Electric Power Co. 3.50 12/01/07 73,877 ------------ 2,476,525 ------------ ELECTRICAL PRODUCTS (0.1%) 215 Cooper Industries Inc. 5.25 07/01/07 219,032 ------------ ELECTRONICS/APPLIANCES (0.0%) 110 LG Electronics Inc. - 144A** (South Korea) 5.00 06/17/10 110,417 ------------ FINANCE/RENTAL/LEASING (0.5%) 150 CIT Group, Inc. 2.875 09/29/06 147,935 280 Countrywide Home Loans, Inc. (Series MTNL) 3.25 05/21/08 272,054 180 Ford Motor Credit Co. 7.375 10/28/09 176,053 255 MBNA Corp. (Series MTNF) 3.64++ 05/05/08 256,704 310 MBNA Corp. 6.125 03/01/13 338,334 270 Nationwide Building Society - 144A** (United Kingdom) 4.25 02/01/10 269,604 190 Residential Capital Corp. - 144A** 6.375 06/30/10 191,116 170 SLM Corp. (Series MTNA) 4.00 01/15/10 168,106 215 SLM Corp. (Series MTNA) 5.00 10/01/13 220,600 ------------ 2,040,506 ------------
SEE NOTES TO FINANCIAL STATEMENTS 16
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - --------------------------------------------------------------------------------------------- FINANCIAL CONGLOMERATES (0.4%) $ 360 JPMorgan Chase & Co. 6.00% 02/15/09 $ 380,849 105 Citicorp 6.75 08/15/05 105,369 270 Citigroup Inc. 5.625 08/27/12 288,820 225 Citigroup Inc. 5.75 05/10/06 228,416 205 Citigroup Inc. 6.00 02/21/12 224,171 125 General Electric Capital Corp. (Series MTNA) 4.25 12/01/10 124,683 300 General Electric Capital Corp. (Series MTNA) 6.75 03/15/32 371,466 50 General Motors Acceptance Corp. 4.50 07/15/06 49,328 ------------ 1,773,102 ------------ FOOD RETAIL (0.1%) 260 Albertson's Inc. 7.45 08/01/29 296,955 115 Safeway Inc. 7.25 02/01/31 133,583 ------------ 430,538 ------------ FOOD: MAJOR DIVERSIFIED (0.1%) 155 Kraft Foods Inc. 5.625 11/01/11 164,646 ------------ FOREST PRODUCTS (0.0%) 90 Weyerhaeuser Co. 6.00 08/01/06 91,627 ------------ GAS DISTRIBUTORS (0.1%) 130 Nisource Finance Corp. 3.854++ 11/23/09 130,639 46 Ras Laffan Liquid Natural Gas Co. Ltd. - 144A** (Qatar) 7.628 09/15/06 47,685 135 Ras Laffan Liquid Natural Gas Co. Ltd. - 144A** (Qatar) 8.294 03/15/14 161,379 80 Sempra Energy 4.621 05/17/07 80,414 ------------ 420,117 ------------ HOME FURNISHINGS (0.0%) 115 Mohawk Industries, Inc. (Series D) 7.20 04/15/12 131,616 ------------ HOTELS/RESORTS/CRUISELINES (0.1%) 170 Hyatt Equities LLC - 144A** 6.875 06/15/07 175,499 315 Marriott International, Inc. (Series E) 7.00 01/15/08 334,933 ------------ 510,432 ------------ HOUSEHOLD/PERSONAL CARE (0.1%) 240 Clorox Co. (The) 3.525++ 12/14/07 240,486 ------------
SEE NOTES TO FINANCIAL STATEMENTS 17
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - --------------------------------------------------------------------------------------------- INDUSTRIAL CONGLOMERATES (0.1%) $ 100 Hutchison Whampoa International Ltd. - 144A** (Cayman Islands) 5.45% 11/24/10 $ 103,468 125 Hutchison Whampoa International Ltd. - 144A** (Cayman Islands) 6.50 02/13/13 135,956 135 Textron Financial Corp. (Series MTNE) 4.125 03/03/08 134,920 ------------ 374,344 ------------ INSURANCE BROKERS/SERVICES (0.2%) 500 Farmers Exchange Capital - 144A** 7.05 07/15/28 542,295 315 Marsh & McLennan Companies, Inc. 5.375 07/15/14 314,327 ------------ 856,622 ------------ INVESTMENT BANKS/BROKERS (0.1%) 95 Goldman Sachs Group Inc. (The) 5.25 10/15/13 98,195 210 Goldman Sachs Group Inc. (The) 6.60 01/15/12 233,709 ------------ 331,904 ------------ MAJOR BANKS (0.1%) 75 Bank of New York Co., Inc. (The) 5.20 07/01/07 76,464 185 FleetBoston Financial Corp. 7.25 09/15/05 186,309 115 HSBC Finance Corp. 6.75 05/15/11 127,800 ------------ 390,573 ------------ MAJOR TELECOMMUNICATIONS (0.3%) 90 New Cingular Wireless Services Inc. 8.75 03/01/31 126,537 215 Deutsche Telekom International Finance NV (Netherlands) 8.25 06/15/30 292,010 210 France Telecom S.A. (France) 8.50 03/01/31 293,701 60 Sprint Capital Corp. 8.75 03/15/32 83,728 165 Telecom Italia Capital SpA - 144A** (Luxembourg) 4.00 01/15/10 160,490 130 Telecom Italia Capital SpA (Luxembourg) 4.00 11/15/08 128,136 ------------ 1,084,602 ------------ MANAGED HEALTH CARE (0.2%) 345 Aetna, Inc. 7.875 03/01/11 403,171 150 WellPoint Health Networks Inc. 6.375 06/15/06 153,256 40 WellPoint Inc. 3.75 12/14/07 39,508 ------------ 595,935 ------------ MEDIA CONGLOMERATES (0.1%) 95 Time Warner, Inc. 6.625 05/15/29 106,188 75 Time Warner, Inc. 7.70 05/01/32 95,183 ------------ 201,371 ------------
SEE NOTES TO FINANCIAL STATEMENTS 18
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - --------------------------------------------------------------------------------------------- MISCELLANEOUS (0.0%) $ 50 Arizona Public Service Co. 6.75% 11/15/06 $ 51,700 ------------ MOTOR VEHICLES (0.1%) 220 DaimlerChrysler North American Holdings Co. 8.50 01/18/31 279,549 105 Ford Motor Co. 7.45 07/16/31 87,880 155 General Motors Corp. 8.375 07/15/33 130,200 ------------ 497,629 ------------ MULTI-LINE INSURANCE (0.3%) 490 AIG Sun America Global Finance VI - 144A** 6.30 05/10/11 534,705 290 American General Finance Corp. (Series MTNF) 5.875 07/14/06 295,088 325 AXA Financial Inc. 6.50 04/01/08 344,350 25 Hartford Financial Services Group, Inc. (The) 2.375 06/01/06 24,559 45 International Lease Finance Corp. 3.75 08/01/07 44,634 125 Two-Rock Pass Through - 144A** (Bahamas)@ 4.19++ 12/31/49 124,070 ------------ 1,367,406 ------------ OIL & GAS PRODUCTION (0.2%) 185 Pemex Project Funding Master Trust 7.375 12/15/14 207,940 40 Pemex Project Funding Master Trust 8.00 11/15/11 45,540 210 Pemex Project Funding Master Trust 8.625 02/01/22 259,350 75 Pemex Project Funding Master Trust 9.125 10/13/10 88,013 ------------ 600,843 ------------ OTHER METALS/MINERALS (0.0%) 120 Brascan Corp. (Canada) 7.125 06/15/12 135,178 ------------ PROPERTY - CASUALTY INSURERS (0.1%) 300 Mantis Reef Ltd. - 144A** (Australia) 4.692 11/14/08 301,138 210 St. Paul Travelers 5.01 08/16/07 212,723 ------------ 513,861 ------------ PULP & PAPER (0.0%) 140 Sappi Papier Holding AG - 144A** (Austria) 6.75 06/15/12 149,821 ------------ RAILROADS (0.1%) 125 Burlington North Santa Fe Railway Co. 4.575 01/15/21 126,116 120 Norfolk Southern Corp. 7.35 05/15/07 126,714 100 Union Pacific Corp. - 144A** (Series 2004-2) 5.214 09/30/14 103,239 75 Union Pacific Corp. 6.65 01/15/11 83,534 60 Union Pacific Corp. (Series MTNE) 6.79 11/09/07 63,527 ------------ 503,130 ------------
SEE NOTES TO FINANCIAL STATEMENTS 19
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - --------------------------------------------------------------------------------------------- REAL ESTATE DEVELOPMENT (0.1%) $ 517 World Financial Properties - 144A** (Series 1996 WFP - B) 6.91% 09/01/13 $ 560,697 ------------ REAL ESTATE INVESTMENT TRUSTS (0.1%) 260 EOP Operating L.P. 6.763 06/15/07 271,642 ------------ REGIONAL BANKS (0.1%) 350 Marshall & Ilsley Bank (Series BKNT) 3.80 02/08/08 347,426 ------------ SAVINGS BANKS (0.2%) 170 Household Finance Corp. 4.125 12/15/08 169,043 160 Household Finance Corp. 5.875 02/01/09 168,087 75 Household Finance Corp. 6.375 10/15/11 82,107 100 Household Finance Corp. 6.40 06/17/08 105,984 100 Sovereign Bank (Series CD) 4.00 02/01/08 99,170 165 Washington Mutual Bank 5.50 01/15/13 173,055 120 Washington Mutual Inc. 8.25 04/01/10 137,954 ------------ 935,400 ------------ TOBACCO (0.1%) 120 Altria Group, Inc. 7.00 11/04/13 134,507 140 Altria Group, Inc. 7.75 01/15/27 168,596 ------------ 303,103 ------------ TRUCKS/CONSTRUCTION/FARM MACHINERY (0.1%) 270 Caterpillar Financial Services Corp. (Series MTNF) 3.35++ 08/20/07 270,468 55 Caterpillar Financial Services Corp. (Series MTNF) 3.625 11/15/07 54,340 ------------ 324,808 ------------ TOTAL CORPORATE BONDS (Cost $21,751,787) 22,643,049 ------------ U.S. GOVERNMENT OBLIGATIONS (9.9%) 2,250 U.S. Treasury Bond 6.125 08/15/29 2,873,586 500 U.S. Treasury Bond 6.375 08/15/27 648,418 2,875 U.S. Treasury Bond 8.125 08/15/19 4,074,864 3,100 U.S. Treasury Bond 8.125 08/15/21 4,501,300 10,250 U.S. Treasury Note 3.625 05/15/13 10,122,685 5,000 U.S. Treasury Note 3.875 02/15/13 5,007,620 5,300 U.S. Treasury Note 4.25 08/15/13 5,434,159 500 U.S. Treasury Note 4.375 08/15/12 518,711 1,000 U.S. Treasury Note 6.50 02/15/10 1,116,290 2,900 U.S. Treasury Note 6.625 05/15/07 3,056,104
SEE NOTES TO FINANCIAL STATEMENTS 20
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - --------------------------------------------------------------------------------------------- $ 4,750 U.S. Treasury Strip 0.00% 02/15/25 $ 2,029,861 445 U.S. Treasury Strip 0.00 02/15/25 188,711 1,250 U.S. Treasury Strip 0.00 02/15/27 490,872 ------------ TOTAL U.S. GOVERNMENT OBLIGATIONS (Cost $37,679,322) 40,063,181 ------------ ASSET-BACKED SECURITIES (4.0%) FINANCE/RENTAL/LEASING 700 American Express Credit Account Master Trust 2001-2 A 5.53 10/15/08 708,565 500 American Express Credit Account Master Trust 2002-3 A 3.33++ 12/15/09 501,298 850 American Express Credit Account Master Trust 2003-3 A 3.33++ 11/15/10 852,719 408 Asset Backed Funding Certificates 2005-WF1 A2A 3.39 01/25/35 407,917 77 Asset Backed Funding Certificates 2004-HE1 A1 3.444++ 06/25/22 77,513 500 Bank of America Securities Auto Trust 2005 WFI-A3 (DD) 3.99 08/18/09 500,156 149 Capital Auto Receivables Asset Trust 2003-2 A3A 1.44 02/15/07 147,907 350 Capital Auto Receivables Asset Trust 2003-3 A3B 3.30++ 01/15/08 350,499 500 Capital Auto Receivables Asset Trust 2005-1 A4 4.05 07/15/09 500,936 425 Caterpillar Financial Asset Trust 2005-A A3 3.90 02/25/09 424,576 915 Chase Credit Card Master Trust 2001-4 A 5.50 11/17/08 930,623 200 CIT Equipment Collateral 2004-EF1 A3 3.50 09/20/08 197,643 600 Citibank Credit Card Issuance Trust 2000-A1 A1 6.90 10/15/07 605,866 325 CNH Equipment Trust 2005-A A3 4.02 04/15/09 325,199 375 Daimler Chrysler Auto Trust 2005-B A3 4.04 09/08/09 375,624 407 Equifirst Mortgage Loan Trust 2005-1 A1 3.37++ 04/25/35 407,057 325 Ford Credit Auto Owner Trust 2005-B A3 4.17 01/15/09 325,980 400 GE Capital Credit Card Master Note Trust 2004-2 A 3.26++ 09/15/10 400,644 350 GE Dealer Floorplan Master Note Trust 2004-1 A 3.31++ 07/20/08 350,218
SEE NOTES TO FINANCIAL STATEMENTS 21
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ----------------------------------------------------------------------------------------------------------- $ 600 Harley-Davidson Motorcycle Trust 2005-1 A2 3.76% 12/17/12 $ 596,732 350 Harley-Davidson Motorcycle Trust 2005-2 A2 4.07 02/15/12 350,499 250 Honda Auto Receivables Owner Trust 2005-2 A3 3.93 01/15/09 249,928 425 Honda Auto Receivables Owner Trust 2005-3 A3 3.87 04/20/09 424,660 300 Hyundai Auto Receivables Trust 2005-A A3 (DD) 3.98 11/16/09 299,820 575 MBNA Credit Card Master Note Trust 2003-A3 3.34++ 08/16/10 576,990 525 Merrill Auto Trust Securitization 2005-1 A3 4.10 08/25/09 525,328 375 National City Auto Receivables Trust 2004-A A4 2.88 05/15/11 366,384 550 Nissan Auto Receivables Owner Trust 2005-B A3 3.99 07/15/09 550,421 564 Novastar Home Equity Loan Ser 2005-1 A2A 3.43++ 06/25/35 563,978 246 Residential Asset Securities Corp. 2004-KS8 AI1 3.47++ 10/25/22 246,103 125 TXU Electric Delivery Transition Bond Co. LLC 2004-1 A2 4.81 11/17/14 128,229 650 USAA Auto Owner Trust 2004-2 A4 3.58 02/15/11 644,673 600 USAA Auto Owner Trust 2004-3 A3 3.16 02/17/09 593,933 375 USAA Auto Owner Trust 2005-1 A3 3.90 07/15/09 374,710 350 Volkswagen Auto Lease Trust 2005-A A3 3.82 05/20/08 349,527 317 Wachovia Auto Owner Trust 2004-B A2 2.40 05/21/07 315,680 200 Wachovia Auto Owner Trust 2004-B A3 2.91 04/20/09 197,487 250 Wachovia Auto Owner Trust 2005-A A3 4.06 09/21/09 250,519 200 World Omni Auto Receivables Trust 2004-A A3 3.29 11/12/08 198,422 ------------- TOTAL ASSET-BACKED SECURITIES (Cost $16,193,564) 16,194,963 ------------- U.S. GOVERNMENT AGENCY-MORTGAGE-BACKED SECURITIES (1.5%) Federal Home Loan Mortgage Corp. PC Gold 15 6.50 05/01/29 - 12/01/31 15,498 52 7.50 08/01/32 55,437 349 8.00 01/01/30 - 11/01/30 375,989
SEE NOTES TO FINANCIAL STATEMENTS 22
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ----------------------------------------------------------------------------------------------------------- Federal Home Loan Mortgage Corp. $ 790 5.125% 11/07/13 $ 793,074 158 7.50 01/01/30 - 04/01/31 169,086 Federal National Mortgage Assoc. 2,070 (DD) 4.25 05/15/09 2,092,940 5 6.50 11/01/29 5,484 172 7.00 10/01/27 - 07/01/31 181,929 150 7.50 + 160,266 941 7.50 09/01/29 - 10/01/32 846,076 1,318 8.00 11/01/29 - 05/01/31 1,418,428 ------------- TOTAL U.S. GOVERNMENT AGENCY-MORTGAGE-BACKED SECURITIES (Cost $6,036,911) 6,114,207 ------------- FOREIGN GOVERNMENT OBLIGATIONS (0.2%) 105 United Mexican States (Mexico) 8.375 01/14/11 122,483 270 United Mexican States (Mexico) (Series MTN) 8.30 08/15/31 336,825 345 United Mexican States (Mexico) (Series MTNA) 8.00 09/24/22 423,487 ------------- TOTAL FOREIGN GOVERNMENT OBLIGATIONS (Cost $771,598) 882,795 ------------- SHORT-TERM INVESTMENTS (a) (10.6%) U.S. GOVERNMENT AGENCIES & OBLIGATIONS 42,700 Federal Home Mortgage Corp. 2.60 07/01/05 42,700,000 100 U.S. Treasury Bills*** 2.82 07/14/05 99,898 ------------- TOTAL SHORT-TERM INVESTMENTS (Cost $42,799,898) 42,799,898 ------------- TOTAL INVESTMENTS (Cost $339,890,768) (b) (c) 100.5% 407,313,416 LIABILIITIES IN EXCESS OF OTHER ASSETS (0.5) (1,853,432) ----- ------------- NET ASSETS 100.0% $ 405,459,984 ===== =============
SEE NOTES TO FINANCIAL STATEMENTS 23 - ---------- ADR AMERICAN DEPOSITARY RECEIPT. * NON-INCOME PRODUCING SECURITY. ** RESALE IS RESTRICTED TO QUALIFIED INSTITUTIONAL INVESTORS. *** A PORTION OF THIS SECURITY HAS BEEN PHYSICALLY SEGREGATED IN CONNECTION WITH OPEN FUTURES CONTRACTS AN THE AMOUNT EQUAL TO $66,000. + SECURITY WAS PURCHASED ON A FORWARD COMMITMENT BASIS WITH AN APPROXIMATE PRINCIPAL AMOUNT AND NO DEFINITE MATURITY DATE; THE ACTUAL PRINCIPAL AMOUNT AND MATURITY DATE WILL BE DETERMINED UPON SETTLEMENT. @ FOREIGN ISSUED SECURITY WITH PERPETUAL MATURITY. ++ FLOATING RATE SECURITY; RATE SHOWN IS THE RATE IN EFFECT AT JUNE 30, 2005. DD SECURITY PURCHASED ON A DELAYED DELIVERY BASIS. (a) PURCHASED ON A DISCOUNT BASIS. THE INTEREST RATE SHOWN HAS BEEN ADJUSTED TO REFLECT A MONEY MARKET EQUIVALENT YIELD. (b) SECURITIES HAVE BEEN DESIGNATED AS COLLATERAL IN AN AMOUNT EQUAL TO $25,002,710 IN CONNECTION WITH SECURITIES PURCHASED ON A FORWARD COMMITMENT BASIS, A DELAYED DELIVERY BASIS AND OPEN FUTURES CONTRACTS. (c) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES APPROXIMATES THE AGGREGATE COST FOR BOOK PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION IS $75,993,260 AND THE AGGREGATE GROSS UNREALIZED DEPRECIATION IS $8,570,612, RESULTING IN NET UNREALIZED APPRECIATION OF $67,422,648. FUTURES CONTRACTS OPEN AT JUNE 30, 2005:
UNREALIZED NUMBER OF DESCRIPTION, DELIVERY UNDERLYING FACE APPRECIATION/ CONTRACTS LONG/SHORT MONTH, AND YEAR AMOUNT AT VALUE (DEPRECIATION) - ------------------------------------------------------------------------------------------ 47 Short U.S. Treasury Notes 5 Year, September 2005 $ (5,110,276) $ (7,713) 79 Short U.S. Treasury Notes 2 Year, September 2005 (16,421,921) 14,392 4 Short U.S. Treasury Bond 20 Year, September 2005 (469,773) (5,238) -------------- Net unrealized appreciation $ 1,441 ==============
SEE NOTES TO FINANCIAL STATEMENTS 24 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- STRATEGIST PORTFOLIO FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 2005 (UNAUDITED) ASSETS: Investments in securities, at value (cost $338,228,140) $ 402,926,571 Investment in affiliates (cost $1,662,628) 4,386,845 Cash 77,634 Receivable for: Interest 912,844 Dividends 348,447 Investments sold 228,142 Prepaid expenses and other assets 11,692 --------------- TOTAL ASSETS 408,892,175 --------------- LIABILITIES: Payable for: Investments purchased 3,174,293 Investment advisory fee 142,049 Administration fee 27,057 Distribution fee 20,107 Variation margin 9,719 Shares of beneficial interest redeemed 366 Accrued expenses and other payables 58,600 --------------- TOTAL LIABILITIES 3,432,191 --------------- NET ASSETS $ 405,459,984 =============== COMPOSITION OF NET ASSETS: Paid-in-capital $ 333,020,829 Net unrealized appreciation 67,424,089 Accumulated net investment loss (930,829) Accumulated undistributed net realized gain 5,945,895 --------------- NET ASSETS $ 405,459,984 =============== CLASS X SHARES: Net Assets $ 308,553,399 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 20,308,840 NET ASSET VALUE PER SHARE $ 15.19 =============== CLASS Y SHARES: Net Assets $ 96,906,585 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 6,386,170 NET ASSET VALUE PER SHARE $ 15.17 ===============
SEE NOTES TO FINANCIAL STATEMENTS 25 STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2005 (UNAUDITED) NET INVESTMENT INCOME: INCOME Interest $ 2,569,120 Dividends (net of $43,697 foreign withholding tax) 2,250,084 Dividends from affiliates 45,434 --------------- TOTAL INCOME 4,864,638 --------------- EXPENSES Investment advisory fee 876,396 Administration fee 166,933 Distribution fee (Class Y shares) 120,577 Custodian fees 19,285 Professional fees 16,452 Shareholder reports and notices 11,929 Trustees' fees and expenses 2,957 Transfer agent fees and expenses 250 Other 15,463 --------------- TOTAL EXPENSES 1,230,242 --------------- NET INVESTMENT INCOME 3,634,396 --------------- NET REALIZED AND UNREALIZED GAIN (LOSS): NET REALIZED GAIN/LOSS ON: Investments 6,780,452 Futures contracts (42,400) --------------- NET REALIZED GAIN 6,738,052 --------------- NET CHANGE IN UNREALIZED APPRECIATION/DEPRECIATION ON: Investments (4,464,621) Futures contracts (11,326) --------------- NET DEPRECIATION (4,475,947) --------------- NET GAIN 2,262,105 --------------- NET INCREASE $ 5,896,501 ===============
SEE NOTES TO FINANCIAL STATEMENTS 26 STATEMENT OF CHANGES IN NET ASSETS
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 --------------- ----------------- (UNAUDITED) INCREASE (DECREASE) IN NET ASSETS: OPERATIONS: Net investment income $ 3,634,396 $ 7,861,763 Net realized gain 6,738,052 52,305,382 Net change in unrealized depreciation (4,475,947) (16,595,347) --------------- ----------------- NET INCREASE 5,896,501 43,571,798 --------------- ----------------- DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS FROM: Net investment income Class X shares (3,154,592) (6,959,864) Class Y shares (852,026) (1,638,766) Net realized gain Class X shares (27,439,402) (43,203) Class Y shares (8,632,691) (10,173) --------------- ----------------- TOTAL DIVIDENDS AND DISTRIBUTIONS (40,078,711) (8,652,006) --------------- ----------------- Net decrease from transactions in shares of beneficial interest (4,738,373) (68,830,403) --------------- ----------------- NET DECREASE (38,920,583) (33,910,611) NET ASSETS: Beginning of period 444,380,567 478,291,178 --------------- ----------------- END OF PERIOD (INCLUDING ACCUMULATED NET INVESTMENT LOSSES OF $930,829 AND $558,607, RESPECTIVELY) $ 405,459,984 $ 444,380,567 =============== =================
SEE NOTES TO FINANCIAL STATEMENTS 27 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- STRATEGIST PORTFOLIO NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) 1. ORGANIZATION AND ACCOUNTING POLICIES Morgan Stanley Variable Investment Series (the "Fund") -- Strategist Portfolio (the "Portfolio"), one of 15 separate portfolios, is registered under the Investment Company Act of 1940, as amended (the "Act"), as a diversified, open-end management investment company. The Fund is offered exclusively to life insurance companies in connection with particular life insurance and/or annuity contracts they offer. The Portfolio's investment objective is to maximize the total return of its investments. The Fund was organized as a Massachusetts business trust on February 25, 1983 and the Portfolio commenced operations on March 1, 1987. On June 5, 2000, the Portfolio commenced offering one additional class of shares (Class Y) The Portfolio offers Class X shares and Class Y shares. The two classes are identical except that Class Y shares incur distribution expenses. Class X shares are generally available to holders of contracts offered by Metropolitan Life Insurance Company (formerly Paragon Life Insurance Company) and other contracts offered before May 1, 2000. Class Y shares are available to holders of contracts offered on or after June 5, 2000. 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) futures are valued at the latest price published by the commodities exchange on which they trade; (6) when market quotations are not readily available or Morgan Stanley Investment Advisors Inc. (the "Investment Adviser"), determines that the latest sale price, the bid price or the mean between the last reported bid and asked price do not reflect a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees. Occasionally, developments affecting the closing prices of securities and other assets may occur between the times at which valuations of such securities are determined (that is, close of the foreign market on which the securities trade) and the close of business on the NYSE. If developments occur during such periods that are expected to materially affect the value of such securities, such valuations may be adjusted to reflect 28 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; (7) certain portfolio securities may be valued by an outside pricing service approved by the Fund's Trustees; and (8) 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 -- The Fund may 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. 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 Portfolio 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 Portfolio 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 Portfolio as unrealized gains and losses. Upon closing of the contract, the Portfolio 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. F. 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. G. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- Dividends and distributions to shareholders are recorded on the ex-dividend date. 29 H. EXPENSES -- Direct expenses are charged to the Portfolio and general Fund expenses are allocated on the basis of relative net assets or equally among the Portfolios. I. 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, the Portfolio pays the Investment Adviser an advisory fee, accrued daily and payable monthly, by applying the annual rates to the net assets of the Portfolio determined as of the close of each business day: 0.42% to the portion of the daily net assets not exceeding $1.5 billion; and 0.395% to the portion of the daily net assets in excess of $1.5 billion. Pursuant to an Administration Agreement with Morgan Stanley Services Company Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Portfolio pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.08% to the Portfolio'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 Class Y shares of the Portfolio will pay a distribution fee which is accrued daily and paid monthly at the annual rate of 0.25% of the average daily net assets of the class. 4. SECURITY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES The cost of purchases and proceeds from maturity/sales/prepayments of portfolio securities, excluding short-term investments, for the six months ended June 30, 2005 were $72,872,985 and $140,599,516, respectively. Included in the aforementioned are purchases and maturity/sales/prepayments of U.S. Government securities of $32,458,400 and $75,106,953, respectively. Included in the aforementioned are purchases of $281,009, including an income of $45,434, and a value of $4,386,845 with Allstate Corp, an affiliate of the Fund. For the six months ended June 30, 2005, the Portfolio incurred brokerage commissions of $28,689 with Morgan Stanley & Co., Inc. an affiliate of the Investment Adviser, Administrator and Distributor, for transactions executed on behalf of the Portfolio. 30 Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator, and Distributor, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and compensation. Aggregate pension costs for the six months ended June 30, 2005 included in Trustees' fees and expenses in the Statement of Operations amounted to $300. At June 30, 2005, the Portfolio had an accrued pension liability of $8,746 which is included in accrued expenses in the Statement of Assets and Liabilities. On December 2, 2003, the Trustees voted to close the plan to new participants and eliminate the future benefits growth due to increases to compensation after July 31, 2003. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 5. SHARES OF BENEFICIAL INTEREST Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 ------------------------------ ------------------------------ (UNAUDITED) SHARES AMOUNT SHARES AMOUNT ------------- ------------- ------------- ------------- CLASS X SHARES Sold 773,739 $ 12,759,248 1,641,246 $ 25,739,857 Reinvestment of dividends and distributions 2,007,248 30,593,995 440,705 7,003,067 Redeemed (3,271,991) (53,961,754) (6,604,570) (103,360,189) ------------- ------------- ------------- ------------- Net decrease -- Class X (491,004) (10,608,511) (4,522,619) (70,617,265) ------------- ------------- ------------- ------------- CLASS Y SHARES Sold 409,592 6,729,237 990,748 15,538,779 Reinvestment of dividends and distributions 623,422 9,484,717 103,744 1,648,939 Redeemed (628,325) (10,343,816) (983,210) (15,400,856) ------------- ------------- ------------- ------------- Net increase -- Class Y 404,689 5,870,138 111,282 1,786,862 ------------- ------------- ------------- ------------- Net decrease in Portfolio (86,315) $ (4,738,373) (4,411,337) $ (68,830,403) ============= ============= ============= =============
31 6. 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 December 31, 2004, the Portfolio had temporary book/tax differences primarily attributable to capital gain from mark-to-market of future contracts, capital loss deferrals on straddles and wash sales and book amortization of premiums on debt securities. 7. PURPOSES OF AND RISKS RELATING TO CERTAIN FINANCIAL INSTRUMENTS To hedge against adverse interest rate and market risks on portfolio positions or anticipated positions in U.S. Government Securities, the Portfolio may enter into interest rate futures contracts ("future contracts"). Futures contracts involve elements of market risk in excess of the amount reflected in the Statement and Assets and Liabilities. The Portfolio bears the risk of an unfavorable change in the value of the underlying securities. Risk may also arise upon entering into contracts from the potential inability of counterparts to meet the terms of their contacts 32 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- STRATEGIST FUND PORTFOLIO FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED --------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ---------- ---------- ---------- ---------- ---------- (UNAUDITED) CLASS X SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 16.60 $ 15.34 $ 12.36 $ 13.94 $ 16.66 $ 19.10 ------------- ---------- ---------- ---------- ---------- ---------- Income (loss) from investment operations: Net investment income@ 0.15 0.28 0.18 0.19 0.38 0.50 Net realized and unrealized gain (loss) 0.10 1.30 3.03 (1.56) (2.05) (0.20) ------------- ---------- ---------- ---------- ---------- ---------- Total income (loss) from investment operations 0.25 1.58 3.21 (1.37) (1.67) 0.30 ------------- ---------- ---------- ---------- ---------- ---------- Less dividends and distributions from: Net investment income (0.17) (0.32)@@ (0.23) (0.21) (0.39) (0.48) Net realized gain (1.49) - - - (0.66) (2.26) ------------- ---------- ---------- ---------- ---------- ---------- Total dividends and distributions (1.66) (0.32) (0.23) (0.21) (1.05) (2.74) ------------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period $ 15.19 $ 16.60 $ 15.34 $ 12.36 $ 13.94 $ 16.66 ============= ========== ========== ========== ========== ========== TOTAL RETURN+ 1.51%(2) 10.37% 26.24% (9.89)% (10.18)% 1.64% RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.53%(3) 0.53% 0.52% 0.52% 0.52% 0.52% Net investment income 1.80%(3) 1.79% 1.31% 1.47% 2.53% 2.68% SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 308,553 $ 345,215 $ 388,356 $ 372,254 $ 522,655 $ 701,294 Portfolio turnover rate 19%(2) 55% 93% 124% 124% 126%
- ---------- * PRIOR TO JUNE 5, 2000, THE PORTFOLIO ISSUED ONE CLASS OF SHARES. ALL SHARES OF THE PORTFOLIO HELD PRIOR TO MAY 1, 2000 HAVE BEEN DESIGNATED CLASS X SHARES. @ 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. @@ INCLUDES DISTRIBUTIONS FROM NET REALIZED GAIN OF $0.002. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 33
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED --------------------------------------------------------------- JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ---------- ---------- ---------- ---------- ---------- (UNAUDITED) Class Y Shares SELECTED PER SHARE DATA: NET ASSET VALUE, BEGINNING OF PERIOD $ 16.58 $ 15.32 $ 12.35 $ 13.93 $ 16.65 $ 19.29 ------------- ---------- ---------- ---------- ---------- ---------- Income (loss) from investment operations: Net investment income@ 0.13 0.24 0.14 0.16 0.32 0.49 Net realized and unrealized gain (loss) 0.10 1.30 3.03 (1.56) (2.03) (0.51) ------------- ---------- ---------- ---------- ---------- ---------- Total income (loss) from investment operations 0.23 1.54 3.17 (1.40) (1.71) (0.02) ------------- ---------- ---------- ---------- ---------- ---------- Less dividends and distributions from: Net investment income (0.15) (0.28)@@ (0.20) (0.18) (0.35) (0.36) Net realized gain (1.49) - - - (0.66) (2.26) ------------- ---------- ---------- ---------- ---------- ---------- Total dividends and distributions (1.64) (0.28) (0.20) (0.18) (1.01) (2.62) ------------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period $ 15.17 $ 16.58 $ 15.32 $ 12.35 $ 13.93 $ 16.65 ============= ========== ========== ========== ========== ========== TOTAL RETURN+ 1.38%(2) 10.12% 25.88% (10.11)% (10.40)% (0.02)%(2) RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.78%(3) 0.78% 0.77% 0.77% 0.77% 0.77%(3) Net investment income 1.55%(3) 1.54% 1.06% 1.22% 2.28% 2.77%(3) SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 96,907 $ 99,165 $ 89,935 $ 57,651 $ 47,886 $ 23,375 Portfolio turnover rate 19%(2) 55% 93% 124% 124% 126%(2)
- ---------- * FOR THE PERIOD JUNE 5, 2000 (ISSUED DATE) THROUGH DECEMBER 31, 2000. @ 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. @@ INCLUDES DISTRIBUTIONS FROM NET REALIZED GAIN OF $0.002. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 34 TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo CHAIRMAN OF THE BOARD Mitchell M. Merin PRESIDENT Ronald E. Robison EXECUTIVE VICE PRESIDENT AND PRINCIPAL EXECUTIVE OFFICER Joseph J. McAlinden VICE PRESIDENT Barry Fink VICE PRESIDENT Amy R. Doberman VICE PRESIDENT Carsten Otto CHIEF COMPLIANCE OFFICER Stefanie V. Chang VICE PRESIDENT Francis J. Smith TREASURER AND CHIEF FINANCIAL OFFICER Thomas F. Caloia VICE PRESIDENT Mary E. Mullin SECRETARY TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT 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 Portfolio 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 Portfolio. For more detailed information about the Portfolio, its fees and expenses and other pertinent information, please read its Prospectus. The Portfolio's Statement of Additional Information contains additional information about the Portfolio, 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 Portfolio 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) 2005 Morgan Stanley [MORGAN STANLEY LOGO] RA05-00686P-Y06/05 [GRAPHIC] MORGAN STANLEY FUNDS MORGAN STANLEY VARIABLE INVESTMENT SERIES-- STRATEGIST PORTFOLIO SEMIANNUAL REPORT JUNE 30, 2005 [MORGAN STANLEY LOGO] WELCOME, SHAREHOLDER: IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY VARIABLE INVESTMENT SERIES -- UTILITIES PORTFOLIO 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 PORTFOLIO'S FINANCIAL STATEMENTS AND A LIST OF PORTFOLIO INVESTMENTS. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE PORTFOLIO BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE PORTFOLIO WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE PORTFOLIO IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE PORTFOLIO WILL DECLINE AND, THEREFORE, THE VALUE OF THE PORTFOLIO'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS PORTFOLIO. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT For the six months ended June 30, 2005 TOTAL RETURN FOR THE 6 MONTHS ENDED JUNE 30, 2005
S&P 500(R) CLASS X CLASS Y INDEX(1) 10.87% 10.75% -0.81%
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. SEE PERFORMANCE SUMMARY FOR PERFORMANCE INFORMATION AND INDEX DEFINITIONS. MARKET CONDITIONS As in 2003 and 2004, utilities stocks performed with strength during the six-month reporting period, both in absolute terms and relative to other areas of the U.S. equity market. Although the Federal Open Market Committee continued increasing the federal funds target rate throughout the reporting period, interest rates remained at historically low levels. Against this backdrop, investors were drawn to the yield and dividend potential of utilities stocks. Additionally, utilities companies' increased focus on basic services and decreased dependence on comparatively higher risk diversification efforts resulted in cleaner balance sheets and enhanced earnings predictability. Merger and acquisition activity further bolstered the appeal of the sector overall. Investor sentiment also improved due to legislative activity, specifically, the realistic prospect of the passage of an energy bill that contained elements deemed favorable to the sector overall and electric energy stocks in particular. Within the utilities sector, electric utilities and natural gas stocks were the dominant performers, while telecommunications generated mixed results. Higher commodity prices helped selective electric utilities companies, most notably those with relatively low costs as well as excess coal and nuclear generation. Exceptionally strong oil and natural gas prices supported the significant upside of natural gas companies with exploration and production affiliations. While telecommunication operating companies (Regional Bells) were stagnant amid the threat of competition and regulatory uncertainty, the wireless industry provided stronger performance, propelled by consolidation trends. Wireless-related industries, such as tower companies, posted particularly robust gains. PERFORMANCE ANALYSIS The Utilities Portfolio outperformed the S&P 500(R) Index for the six-month period ended June 30, 2005. The Portfolio participated in the broad strength of the utilities sector. Among the more specific factors driving performance, the Portfolio held electric utilities companies that benefited from high commodity prices. Additionally, company-specific events, such as restructurings and turnarounds, proved advantageous for select electric utilities holdings with the Portfolio. Within its natural gas stake, the Portfolio reaped above-average gains from companies with exploration and production operations. Telecommunications stocks were mixed: the large-cap legacy Regional Bell companies lagged while selective wireless stocks provided contributed gains. Unlike the Regional Bells where growth is slow at best, the wireless area has attractive organic growth prospects as well as the benefit of synergies from current and future consolidation. Consequently, the Portfolio's incremental investment in telecommunications has focused on the wireless arena. THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM WELL OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE PORTFOLIO IN THE FUTURE. 2 TOP 10 HOLDINGS Exelon Corp. 3.7% Entergy Corp. 3.5 Edison International 3.5 Questar Corp. 3.5 PPL Corp. 3.3 Sprint Corp. 3.2 SCANA Corp. 3.1 Constellation Energy Group 3.1 PG&E Corp. 3.0 TXU Corp. 3.0
LARGEST INDUSTRIES Electric Utilities 54.9% Energy 21.4 Telecommunications 20.9 Electric Products 0.6
DATA AS OF JUNE 30, 2005. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES FOR TOP 10 HOLDINGS AND LARGEST INDUSTRIES ARE AS A PERCENTAGE OF NET ASSETS. 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. INVESTMENT STRATEGY THE PORTFOLIO WILL NORMALLY INVEST AT LEAST 80 PERCENT OF ITS ASSETS IN COMMON STOCK AND OTHER EQUITY SECURITIES OF COMPANIES THAT ARE ENGAGED IN THE UTILITIES INDUSTRY. A COMPANY WILL BE CONSIDERED TO BE IN THE UTILITIES INDUSTRY IF IT DERIVES AT LEAST 50 PERCENT OF ITS REVENUES OR EARNINGS FROM THE UTILITIES INDUSTRY OR DEVOTES AT LEAST 50 PERCENT OF ITS ASSETS TO ACTIVITIES IN THAT INDUSTRY. THESE MAY INCLUDE COMPANIES INVOLVED IN, AMONG OTHER AREAS: TELECOMMUNICATIONS, COMPUTERS AND OTHER NEW OR EMERGING TECHNOLOGIES, GAS AND ELECTRIC ENERGY, WATER DISTRIBUTION, THE INTERNET AND INTERNET RELATED SERVICES. THE COMPANIES MAY INCLUDE TRADITIONALLY REGULATED PUBLIC UTILITIES OR FULLY OR PARTIALLY DEREGULATED UTILITY COMPANIES AS WELL AS UNREGULATED UTILITY COMPANIES. THE PORTFOLIO MAY INVEST UP TO 25 PERCENT OF ITS NET ASSETS IN FOREIGN SECURITIES. THIS PERCENTAGE LIMITATION DOES NOT APPLY TO SECURITIES OF FOREIGN COMPANIES THAT ARE LISTED IN THE UNITED STATES ON A NATIONAL SECURITIES EXCHANGE. FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY PORTFOLIO PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE PORTFOLIO'S SECOND AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY PORTFOLIO 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 3 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 PORTFOLIO'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 PORTFOLIO VOTED PROXIES RELATING TO PORTFOLIO SECURITIES DURING THE MOST RECENT TWELVE-MONTH PERIOD ENDED JUNE 30 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. 4 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS -- PERIOD ENDED JUNE 30, 2005
CLASS X SHARES CLASS Y SHARES (SINCE 03/01/90) (SINCE 06/05/00) 1 YEAR 29.92%(2) 29.63%(2) 5 YEARS (1.50)(2) (1.75)(2) 10 YEARS 7.43(2) -- SINCE INCEPTION 8.38(2) (1.91)(2)
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 THE 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 PORTFOLIO SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. THE PERFORMANCE OF THE PORTFOLIO'S TWO SHARE CLASSES VARIES BECAUSE EACH HAS DIFFERENT EXPENSES. THE PORTFOLIO'S TOTAL RETURN FIGURES ASSUME THE REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE IMPACT OF ANY CHARGES BY YOUR INSURANCE COMPANY. SUCH COSTS WOULD LOWER PERFORMANCE. (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) FIGURE ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS FOR THE UNDERLYING PORTFOLIO BASED ON NET ASSET VALUE (NAV). IT DOES NOT REFLECT THE DEDUCTION OF INSURANCE EXPENSES, AN ANNUAL CONTRACT MAINTENANCE FEE, OR SURRENDER CHARGES. 5 EXPENSE EXAMPLE As a shareholder of the Portfolio, you incur two types of costs: (1) insurance company charges; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Portfolio expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Portfolio 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 01/01/05 - 06/30/05. 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 Portfolio's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Portfolio'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 Portfolio 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 insurance company charges. 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 insurance company charges were included, your costs would have been higher.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD * ------------- ------------- --------------- 01/01/05 - 01/01/05 06/30/05 06/30/05 ------------- ------------- --------------- CLASS X Actual (10.87% return) $ 1,000.00 $ 1,108.70 $ 3.61 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,021.37 $ 3.46 CLASS Y Actual (10.75% return) $ 1,000.00 $ 1,107.50 $ 4.91 Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,020.13 $ 4.71
- ---------- * EXPENSES ARE EQUAL TO THE PORTFOLIO'S ANNUALIZED EXPENSE RATIO OF 0.69% AND 0.94% 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 fixed income securities trading. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Portfolio's Administrator under the Administration Agreement, including accounting, clerical, bookkeeping, compliance, business management and planning, and the provision of supplies, office space and utilities. (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 administrative and investment advisory services to the Portfolio. 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 Portfolio. 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 The Board reviewed the Portfolio's performance for the one-, three- and five-year periods ended November 30, 2004, as shown in reports provided by Lipper (the "Lipper Reports"), compared to the performance of comparable funds selected by Lipper (the "performance peer group"), and noted that the Portfolio's performance was better than its performance peer group average for all three periods. The Board concluded that the Portfolio's performance was satisfactory. FEES RELATIVE TO OTHER FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT STRATEGIES The Board reviewed the advisory and administrative fees (together, the "management fee") paid by the Portfolio under the Management Agreement. The Board noted that the rate was comparable to the management fee rates charged by the Adviser to any other funds it manages with investment strategies comparable to those of the Portfolio. FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS The Board reviewed the management fee rate and the total expense ratio of the Portfolio. The Board noted that: (i) the Portfolio's management fee rate was lower than the average management fee rate for funds, selected by 7 Lipper (the "expense peer group"), managed by other advisers with investment strategies comparable to those of the Portfolio, as shown in the Lipper Report for the Portfolio; and (ii) the Portfolio's total expense ratio was also lower than the average total expense ratio of the funds included in the Portfolio's expense peer group. The Board concluded that the Portfolio's management fee 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 Portfolio's management fee schedule under the Management Agreement and noted that it includes breakpoints. The Board also reviewed the level of the Portfolio's management fee and noted that the fee, as a percentage of the Portfolio's net assets, would decrease as net assets increase because the management fee includes breakpoints. The Board concluded that the Portfolio's management fee would reflect economies of scale as assets increase. PROFITABILITY OF ADVISER AND AFFILIATES The Board considered and reviewed information concerning the costs incurred and profits realized by the Adviser and its affiliates during the last two years from their relationship with the Portfolio and the Morgan Stanley Fund Complex and reviewed with the Controller of the Adviser the cost allocation methodology used to determine the Adviser's profitability. Based on their review of the information they received, the Board concluded that the profits earned by the Adviser and its affiliates were not excessive in light of the advisory, administrative and other services provided to the Portfolio. FALL-OUT BENEFITS The Board considered so-called "fall-out benefits" derived by the Adviser and its affiliates from their relationship with the Portfolio and the Morgan Stanley Fund Complex, such as "float" benefits derived from handling of checks for purchases and redemptions of Portfolio 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 Portfolio 12b-1 fees for distribution and shareholder services. The Board also considered that an affiliate of the Adviser, through a joint venture, receives revenue in connection with trading done on behalf of the Portfolio through an electronic trading system network ("ECN"). The Board concluded that the float benefits and the above-referenced ECN-related revenue were relatively small and that the 12b-1 fees were competitive with those of other broker-dealer affiliates of investment advisers of mutual funds. 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 Portfolio 8 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 Portfolio. The Adviser informed the Board that it does not use Portfolio 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 Portfolio and other funds in the Morgan Stanley Fund Complex. ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE PORTFOLIO'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 PORTFOLIO AND THE ADVISER The Board also reviewed and considered the historical relationship between the Portfolio and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Portfolio'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 Portfolio 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 Portfolio'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 Portfolio's business. GENERAL CONCLUSION After considering and weighing all of the above factors, the Board concluded it would be in the best interest of the Portfolio and its shareholders to approve renewal of the Management Agreement for another year. 9 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- UTILITIES PORTFOLIO PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------------------------------------------- COMMON STOCKS (95.6%) ELECTRIC UTILITIES (53.8%) 240,000 AES Corp. (The)* $ 3,931,200 50,000 Allegheny Energy, Inc.* 1,261,000 93,865 Cinergy Corp. 4,207,029 50,000 Consolidated Edison, Inc. 2,342,000 110,000 Constellation Energy Group, Inc. 6,345,900 77,000 Dominion Resources, Inc. 5,651,030 70,000 DTE Energy Co. 3,273,900 110,432 Duke Energy Corp. 3,283,143 175,000 Edison International 7,096,250 148,000 Energy East Corp. 4,289,040 95,000 Entergy Corp. 7,177,250 145,000 Exelon Corp. 7,442,850 140,000 FPL Group, Inc. 5,888,400 163,000 PG&E Corp. 6,119,020 90,000 Pinnacle West Capital Corp. 4,000,500 100,000 PNM Resources Inc. 2,881,000 115,000 PPL Corp. 6,828,700 100,000 Reliant Energy, Inc.* 1,238,000 150,000 SCANA Corp. 6,406,500 60,000 Sempra Energy 2,478,600 150,000 Southern Co. (The) 5,200,500 72,000 TXU Corp. 5,982,480 127,000 Wisconsin Energy Corp. 4,953,000 85,000 Xcel Energy, Inc. 1,659,200 --------------- 109,936,492 --------------- ELECTRICAL PRODUCTS (0.6%) 190,000 Active Power, Inc.* 617,500 65,000 FuelCell Energy, Inc.* 663,650 --------------- 1,281,150 --------------- ENERGY (21.4%) 97,000 AGL Resources, Inc. 3,749,050 50,000 Burlington Resources, Inc. 2,762,000 75,000 Equitable Resources, Inc. 5,100,000 95,000 KeySpan Corp. 3,866,500 58,000 Kinder Morgan, Inc. 4,825,600 65,000 MDU Resources Group, Inc. 1,831,050 118,000 New Jersey Resources Corp. 5,693,500 90,000 NRG Energy Inc.* 3,384,000
SEE NOTES TO FINANCIAL STATEMENTS 10
NUMBER OF SHARES VALUE - ------------------------------------------------------------------------------------------------------------- 107,000 Questar Corp. $ 7,051,300 285,000 Williams Companies, Inc. (The) 5,415,000 --------------- 43,678,000 --------------- TELECOMMUNICATIONS (19.8%) 90,000 Alaska Communications Systems Holdings, Inc. 891,900 70,932 ALLTEL Corp. 4,417,645 150,000 BellSouth Corp. 3,985,500 76,750 CenturyTel, Inc. 2,657,853 90,000 Crown Castle International Corp.* 1,828,800 130,000 Nextel Communications, Inc. (Class A)* 4,200,300 184,946 SBC Communications, Inc. 4,392,468 260,000 Sprint Corp. (Fon Group) 6,523,400 54,860 Telefonica de Epana S.A. (ADR) (Spain) 2,682,654 134,000 Telefonos de Mexico S.A. (Series L) (ADR) (Mexico) 2,531,260 85,120 Verizon Communications Inc. 2,940,896 135,000 Vodafone Group PLC (ADR) (United Kingdom) 3,283,200 --------------- 40,335,876 --------------- TOTAL COMMON STOCKS (COST $109,775,999) 195,231,518 --------------- PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE - ------------- ------------ ------------ CORPORATE BONDS (2.2%) ELECTRIC UTILITIES (1.1%) $ 100 Appalachian Power Co. (Series G) 3.60% 05/15/08 98,230 70 Carolina Power & Light Co. 5.125 09/15/13 72,388 120 Cleco Power LLC 5.375 05/01/13 123,877 160 Commonwealth Edison Co. (Series 98) 6.15 03/15/12 177,150 400 Consumers Energy Co. 6.875 03/01/18 464,793 90 Duquesne Light Co. (Series O) 6.70 04/15/12 101,338 25 Entergy Gulf States, Inc. 3.60 06/01/08 24,490 35 Entergy Gulf States, Inc. 3.73+ 12/01/09 35,116 100 Exelon Corp. 6.75 05/01/11 111,189 70 FirstEnergy Corp. (Series B) 6.45 11/15/11 76,584 40 Indianapolis Power & Light Co. - 144A** 6.30 07/01/13 43,612 155 Jersey Central Power & Light Co. (Series MTN) 6.45 05/15/06 158,110
SEE NOTES TO FINANCIAL STATEMENTS 11
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------------------------------- $ 55 Pacific Gas & Electric Co. 6.05% 03/01/34 $ 60,831 160 Pinnacle West Capital Corp. 6.40 04/01/06 162,186 145 Public Service Co. of New Mexico (Series B) 7.50 08/01/18 172,899 145 Public Service Electric & Gas Co. (Series MTNB) 5.00 01/01/13 149,852 85 Texas-New Mexico Power Co. 6.25 01/15/09 89,608 45 TXU Energy Co. 7.00 03/15/13 50,261 ------------ 2,172,514 ------------ ENERGY (0.0%) 35 Panhandle Eastern Pipe Line Co. 4.80 08/15/08 35,459 25 Panhandle Eastern Pipe Line Co. (Series B) 2.75 03/15/07 24,357 ------------ 59,816 ------------ TELECOMMUNICATIONS (1.1%) 27 AT&T Corp. 9.05 11/15/11 31,253 160 AT&T Wireless Services, Inc. 7.875 03/01/11 186,163 90 AT&T Wireless Services, Inc. 8.75 03/01/31 126,537 160 Bellsouth Corp. 4.20 09/15/09 159,584 75 British Telecommunications PLC (United Kingdom) 8.375 12/15/10 88,898 180 Deutsche Telekom International Finance NV (Netherlands) 8.75 06/15/30 244,473 155 France Telecom S.A. (France) 8.75 03/01/31 216,779 520 GTE Corp. 7.90 02/01/27 563,546 20 SBC Communications, Inc. 5.75 05/02/06 20,289 55 SBC Communications, Inc. 6.45 06/15/34 62,053 90 Sprint Capital Corp. 8.375 03/15/12 108,397 90 Sprint Capital Corp. 8.75 03/15/32 125,592 125 Telecom Italia Capital SpA (Luxembourg) 4.00 11/15/08 123,208 90 Vodafone Airtouch PLC (United Kingdom) 7.75 02/15/10 102,862 ------------ 2,159,634 ------------ TOTAL CORPORATE BONDS (COST $4,069,149) 4,391,964 ------------ U.S. GOVERNMENT OBLIGATION (0.0%) 30 U.S. Treasury Bond (Cost $37,275) 6.375 08/15/27 38,905 ------------
SEE NOTES TO FINANCIAL STATEMENTS 12
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------------------------------- SHORT-TERM INVESTMENT (2.0%) REPURCHASE AGREEMENT $ 4,101 The Bank of New York (dated 06/30/05; proceeds $4,101,056) (a) (COST 4,100,700) 3.125% 07/01/05 $ 4,100,700 -------------- TOTAL INVESTMENTS (COST $117,983,123) (b) 99.8% 203,763,087 OTHER ASSETS IN EXCESS OF LIABILITIES 0.2 442,767 -------- -------------- NET ASSETS 100.0% $ 204,205,854 ======== ==============
- ---------- ADR AMERICAN DEPOSITARY RECEIPT. * NON-INCOME PRODUCING SECURITY. ** RESALE IS RESTRICTED TO QUALIFIED INSTITUTIONAL INVESTORS. + FLOATING RATE SECURITY. RATE SHOWN IS THE RATE IN EFFECT AT JUNE 30, 2005. (a) COLLATERALIZED BY FEDERAL NATIONAL MORTGAGE ASSOCIATION 4.126% DUE 07/01/18 VALUED AT $2,522,899 AND 4.182% DUE 03/01/34 VALUED AT $1,659,815. (b) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES APPROXIMATES THE AGGREGATE COST FOR BOOK PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION IS $85,837,185 AND THE AGGREGATE GROSS UNREALIZED DEPRECIATION IS $57,221, RESULTING IN NET UNREALIZED APPRECIATION OF $85,779,964. SUMMARY OF INVESTMENTS
PERCENT OF INDUSTRY VALUE NET ASSETS - ------------------------------------------------------------------------------------ Electric Utilities $ 112,109,006 54.9% Energy 43,737,816 21.4 Telecommunications 42,495,510 20.9 Repurchase Agreement 4,100,700 2.0 Electrical Products 1,281,150 0.6 U.S. Government Obligation 38,905 0.0 --------------- ---- $ 203,763,087 99.8% =============== ====
SEE NOTES TO FINANCIAL STATEMENTS 13 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- UTILITIES PORTFOLIO FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 2005 (UNAUDITED) ASSETS: Investments in securities, at value (cost $117,983,123) $ 203,763,087 Receivable for: Dividends 511,647 Interest 77,011 Prepaid expenses and other assets 6,763 --------------- TOTAL ASSETS 204,358,508 --------------- LIABILITIES: Payable for: Investment advisory fee 94,330 Administration fee 13,239 Distribution fee 7,061 Shares of beneficial interest redeemed 61 Accrued expenses and other payables 37,963 --------------- TOTAL LIABILITIES 152,654 --------------- NET ASSETS $ 204,205,854 =============== COMPOSITION OF NET ASSETS: Paid-in-capital $ 141,878,656 Net unrealized appreciation 85,779,964 Accumulated net investment loss (18,663) Accumulated net realized loss (23,434,103) --------------- NET ASSETS $ 204,205,854 =============== CLASS X SHARES: Net Assets $ 169,307,691 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 10,499,556 NET ASSET VALUE PER SHARE $ 16.13 =============== CLASS Y SHARES: Net Assets $ 34,898,163 Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 2,165,420 NET ASSET VALUE PER SHARE $ 16.12 ===============
SEE NOTES TO FINANCIAL STATEMENTS 14 STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2005 (UNAUDITED) NET INVESTMENT INCOME: INCOME Dividends (net of $6,869 foreign withholding tax) $ 2,950,830 Interest 190,605 --------------- TOTAL INCOME 3,141,435 --------------- EXPENSES Investment advisory fee 555,217 Administration fee 77,925 Distribution fee (Class Y shares) 39,441 Professional fees 16,485 Shareholder reports and notices 9,130 Custodian fees 6,281 Trustees' fees and expenses 1,285 Transfer agent fees and expenses 250 Other 5,336 --------------- TOTAL EXPENSES 711,350 --------------- NET INVESTMENT INCOME 2,430,085 --------------- NET REALIZED AND UNREALIZED GAIN: Net realized gain 8,688,575 Net change in unrealized appreciation 9,207,181 --------------- NET GAIN 17,895,756 --------------- NET INCREASE $ 20,325,841 ===============
SEE NOTES TO FINANCIAL STATEMENTS 15 STATEMENT OF CHANGES IN NET ASSETS
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 --------------- ----------------- (UNAUDITED) INCREASE (DECREASE) IN NET ASSETS: OPERATIONS: Net investment income $ 2,430,085 $ 4,909,797 Net realized gain 8,688,575 9,357,798 Net change in unrealized appreciation 9,207,182 21,441,584 --------------- ----------------- NET INCREASE 20,325,842 35,709,179 --------------- ----------------- DIVIDENDS TO SHAREHOLDERS FROM NET INVESTMENT INCOME: Class X shares (2,064,444) (4,273,816) Class Y shares (372,253) (654,117) --------------- ----------------- TOTAL DIVIDENDS (2,436,697) (4,927,933) --------------- ----------------- Net decrease from transactions in shares of beneficial interest (12,119,829) (33,468,158) --------------- ----------------- NET INCREASE (DECREASE) 5,769,316 (2,686,912) NET ASSETS: Beginning of period 198,436,539 201,123,451 --------------- ----------------- END OF PERIOD (INCLUDING ACCUMULATED NET INVESTMENT LOSSES OF $18,663 AND $12,051, RESPECTIVELY) $ 204,205,855 $ 198,436,539 =============== =================
SEE NOTES TO FINANCIAL STATEMENTS 16 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- UTILITIES PORTFOLIO NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) 1. ORGANIZATION AND ACCOUNTING POLICIES Morgan Stanley Variable Investment Series (the "Fund") - Utilities Portfolio (the "Portfolio"), one of 15 separate portfolios, is registered under the Investment Company Act of 1940, as amended (the "Act"), as a diversified, open-end management investment company. The Fund is offered exclusively to life insurance companies in connection with particular life insurance and/or annuity contracts they offer. The Portfolio's investment objective is both capital appreciation and current income. The Fund was organized as a Massachusetts business trust on February 25, 1983 and the Portfolio commenced operations on March 1, 1990. On June 5, 2000, the Portfolio commenced offering one additional class of shares (Class Y). The Portfolio offers Class X shares and Class Y shares. The two are identical except that Class Y shares incur distribution expenses. Class X shares are generally available to holders of contracts offered by Metropolitan Life Insurance Company (formerly Paragon Life Insurance Company) and other contract offered before May 1, 2000. Class Y shares are available to holders of contracts offered on or after June 5, 2000. 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) when market quotations are not readily available or Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") determines that the latest sale price, the bid price or the mean between the last reported bid and asked price do not reflect a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees. Occasionally, developments affecting the closing prices of securities and other assets may occur between the times at which valuations of such securities are determined (that is, close of the foreign market on which the securities trade) and the close of business on the NYSE. If developments occur during such periods that are expected to materially affect the value of such securities, such valuations may be adjusted to reflect the estimated fair value of such securities as of the close of the NYSE, as determined in good faith by the Fund's Trustees or by the Investment Adviser using a pricing service and/or procedures approved 17 by the Trustees of the Fund; (6) certain portfolio securities may be valued by an outside pricing service approved by the Fund's Trustees; and (7) 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 -- The Fund may 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. FEDERAL INCOME TAX POLICY -- It is the Fund's policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute substantially all of its taxable income to its shareholders. Accordingly, no federal income tax provision is required. F. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- Dividends and distributions to shareholders are recorded on the ex-dividend date. G. EXPENSES -- Direct expenses are charged to the Portfolio and general Fund expenses are allocated on the basis of relative net assets or equally among Portfolios. H. 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; the Portfolio pays the Investment Adviser an advisory fee, accrued daily and payable monthly, by applying the annual rates to the Portfolio's net assets determined at the close of each business day: 0.57% to the portion of the daily net assets not exceeding $500 million; 0.47% to the portion of the daily net assets exceeding $500 million but not exceeding $1 billion; 0.445% to the portion of the daily net assets exceeding $1 billion but not exceeding $1.5 billion; 0.42% to the portion of the daily net assets exceeding $1.5 billion but not exceeding $2.5 billion; 0.395% 18 to the portion of the daily net assets exceeding $2.5 billion but not exceeding $3.5 billion; 0.37% to the portion of the daily net assets exceeding $3.5 billion but not exceeding $5 billion; and 0.345% to the portion of the daily net assets in excess of $5 billion. Pursuant to an Investment Administration Agreement with Morgan Stanley Services Company Inc. (the "Administrator"); an affiliate of the Investment Adviser, the Portfolio pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.08% to the Portfolio'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. Under the Plan, Class Y shares of the Portfolio will pay a distribution fee which is accrued daily and paid monthly at the annual rate of 0.25% of the average daily net assets of the class. 4. SECURITY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES The cost of purchases and proceeds from sales portfolio securities, excluding short-term investments, for the six months ended June 30, 2005 aggregated $19,391,767 and $31,614,760, respectively. Included in the aforementioned are purchases and sales of U.S. Government securities of $98,470 and $59,351, respectively. Also, included in the aforementioned is a purchase with another Morgan Stanley fund of $255,312. For the six months ended June 30, 2005, the Portfolio incurred brokerage commissions of $14,585, with Morgan Stanley & Co., Inc., an affiliate of the Investment Adviser, Administrator and Distributor, for portfolio transactions executed on behalf of the Portfolio. Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and Distributor, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and compensation. Aggregate pension costs for the six months ended June 30, 2005 included in Trustees' fees and expenses in the Statement of Operations amounted to $161. At June 30, 2005, the Portfolio had an accrued pension liability of $6,017 which is included in accrued expenses in the Statement of Assets and Liabilities. On December 2, 2003, the Trustees voted to close the plan to new participants and eliminate the future benefits growth due to increases to compensation after July 31, 2003. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the 19 Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 5. SHARES OF BENEFICIAL INTEREST Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED JUNE 30, 2005 DECEMBER 31, 2004 ---------------------------------- ---------------------------------- (UNAUDITED) SHARES AMOUNT SHARES AMOUNT --------------- --------------- --------------- --------------- CLASS X SHARES Sold 576,784 $ 8,730,770 831,180 $ 11,021,168 Reinvestment of dividends 132,733 2,064,444 320,048 4,273,816 Redeemed (1,624,485) (24,547,163) (3,713,526) (48,645,585) --------------- --------------- --------------- --------------- Net decrease -- Class X (914,968) (13,751,949) (2,562,298) (33,350,601) --------------- --------------- --------------- --------------- CLASS Y SHARES Sold 301,524 4,560,460 340,027 4,493,355 Reinvestment of dividends 23,922 372,253 48,895 654,117 Redeemed (217,164) (3,300,593) (401,598) (5,265,029) --------------- --------------- --------------- --------------- Net increase (decrease) -- Class Y 108,282 1,632,120 (12,676) (117,557) --------------- --------------- --------------- --------------- Net decrease in Portfolio (806,686) $ (12,119,829) (2,574,974) $ (33,468,158) =============== =============== =============== ===============
6. 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 December 31, 2004, the Portfolio had a net capital loss carryforward of approximately $28,685,000 which will expire on December 30, 2010, to offset future capital gains to the extent provided by regulations. As of December 31, 2004, the Portfolio had temporary book/tax differences primarily attributable to capital loss deferrals on wash sales and book amortization of premiums on debt securities. 20 MORGAN STANLEY VARIABLE INVESTMENT SERIES -- UTILITIES PORTFOLIO FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ------------------------------------------------------------ JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ---------- ---------- ---------- ---------- ---------- (UNAUDITED) CLASS X SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 14.73 $ 12.53 $ 11.00 $ 14.73 $ 21.69 $ 22.90 ------------- ---------- ---------- ---------- ---------- ---------- Income (loss) from investment operations: Net investment income++ 0.19 0.34 0.34 0.37 0.39 0.49 Net realized and unrealized gain (loss) 1.40 2.21 1.54 (3.72) (5.74) 0.17 ------------- ---------- ---------- ---------- ---------- ---------- Total income (loss) from investment operations 1.59 2.55 1.88 (3.35) (5.35) 0.66 ------------- ---------- ---------- ---------- ---------- ---------- Less dividends and distributions from: Net investment income (0.19) (0.35) (0.35) (0.38) (0.41) (0.49) Net realized gain - - - - (1.20) (1.38) ------------- ---------- ---------- ---------- ---------- ---------- Total dividends and distributions (0.19) (0.35) (0.35) (0.38) (1.61) (1.87) ------------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period $ 16.13 $ 14.73 $ 12.53 $ 11.00 $ 14.73 $ 21.69 ============= ========== ========== ========== ========== ========== TOTAL RETURN+ 10.87%(2) 20.66% 17.34% (22.87)% (25.75)% 3.03% RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.69%(3) 0.69% 0.70% 0.68% 0.67% 0.66% Net investment income 2.54%(3) 2.59% 2.94% 2.99% 2.19% 2.16% SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 169,308 $ 168,148 $ 175,191 $ 189,936 $ 327,749 $ 551,734 Portfolio turnover rate 10%(2) 13% 35% 51% 32% 13%
- ---------- * PRIOR TO JUNE 5, 2000, THE PORTFOLIO ISSUED ONE CLASS OF SHARES. ALL SHARES OF THE PORTFOLIO HELD PRIOR TO MAY 1, 2000 HAVE BEEN DESIGNATED CLASS X SHARES. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 21
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31, MONTHS ENDED ------------------------------------------------------------ JUNE 30, 2005 2004 2003 2002 2001 2000* ------------- ---------- ---------- ---------- ---------- ---------- (UNAUDITED) CLASS Y SHARES SELECTED PER SHARE DATA: Net asset value, beginning of period $ 14.72 $ 12.53 $ 10.99 $ 14.72 $ 21.68 $ 22.98 ------------- ---------- ---------- ---------- ---------- ---------- Income (loss) from investment operations: Net investment income++ 0.17 0.31 0.31 0.34 0.35 0.24 Net realized and unrealized gain (loss) 1.41 2.20 1.55 (3.72) (5.74) 0.19 ------------- ---------- ---------- ---------- ---------- ---------- Total income (loss) from investment operations 1.58 2.51 1.86 (3.38) (5.39) 0.43 ------------- ---------- ---------- ---------- ---------- ---------- Less dividends and distributions from: Net investment income (0.18) (0.32) (0.32) (0.35) (0.37) (0.35) Net realized gain - - - - (1.20) (1.38) ------------- ---------- ---------- ---------- ---------- ---------- Total dividends and distributions (0.18) (0.32) (0.32) (0.35) (1.57) (1.73) ------------- ---------- ---------- ---------- ---------- ---------- Net asset value, end of period $ 16.12 $ 14.72 $ 12.53 $ 10.99 $ 14.72 $ 21.68 ============= ========== ========== ========== ========== ========== TOTAL RETURN+ 10.75%(2) 20.28% 17.17% (23.08)% (25.98)% 2.07%(2) RATIOS TO AVERAGE NET ASSETS(1): Expenses 0.94%(3) 0.94% 0.95% 0.93% 0.92% 0.91%(3) Net investment income 2.29%(3) 2.34% 2.69% 2.74% 0.94% 1.93%(3) SUPPLEMENTAL DATA: Net assets, end of period, in thousands $ 34,898 $ 30,289 $ 25,933 $ 20,157 $ 24,550 $ 19,069 Portfolio turnover rate 10%(2) 13% 35% 51% 32% 13%
- ---------- * FOR THE PERIOD JUNE 5, 2000 (ISSUED DATE) THROUGH DECEMBER 31, 2000. ++ THE PER SHARE AMOUNTS WERE COMPUTED USING AN AVERAGE NUMBER OF SHARES OUTSTANDING DURING THE PERIOD. + CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD. (1) REFLECTS OVERALL PORTFOLIO RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC EXPENSES. (2) NOT ANNUALIZED. (3) ANNUALIZED. SEE NOTES TO FINANCIAL STATEMENTS 22 (This page has been left blank intentionally.) TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo Chairman of the Board Mitchell M. Merin PRESIDENT Ronald E. Robison EXECUTIVE VICE PRESIDENT AND PRINCIPAL EXECUTIVE OFFICER Joseph J. McAlinden VICE PRESIDENT Barry Fink VICE PRESIDENT Amy R. Doberman VICE PRESIDENT Carsten Otto CHIEF COMPLIANCE OFFICER Stefanie V. Chang VICE PRESIDENT Francis J. Smith TREASURER AND CHIEF FINANCIAL OFFICER Thomas F. Caloia VICE PRESIDENT Mary E. Mullin SECRETARY TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT 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 Portfolio 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 Portfolio. For more detailed information about the Portfolio, its fees and expenses and other pertinent information, please read its Prospectus. The Portfolio's Statement of Additional Information contains additional information about the Portfolio, 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 Portfolio 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) 2005 Morgan Stanley [MORGAN STANLEY LOGO] RA05-00685P-Y06/05 [GRAPHIC] MORGAN STANLEY FUNDS MORGAN STANLEY VARIABLE INVESTMENT SERIES -- UTILITIES PORTFOLIO SEMIANNUAL REPORT JUNE 30, 2005 [MORGAN STANLEY LOGO] 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 registrant's most recent fiscal half-year (the registrant's second fiscal half-year in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. Item 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 Variable Investment Series /s/ Ronald E. Robison Ronald E. Robison Principal Executive Officer August 23, 2005 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 August 23, 2005 /s/ Francis Smith Francis Smith Principal Financial Officer August 23, 2005 EX-99.CERT 2 a2161677zex-99_cert.txt EXHIBIT-99.CERT EXHIBIT 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 Variable Investment Series; 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: August 23, 2005 /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 Variable Investment Series; 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: August 23, 2005 /s/ Francis Smith Francis Smith Principal Financial Officer EX-99.906CERT 3 a2161677zex-99_906cert.txt EXHIBIT-99.906CERT EXHIBIT 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 Variable Investment Series In connection with the Report on Form N-CSR (the "Report") of the above-named issuer for the period ended June 30, 2005 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: August 23, 2005 /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 Variable Investment Series and will be retained by Morgan Stanley Variable Investment Series 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 Variable Investment Series In connection with the Report on Form N-CSR (the "Report") of the above-named issuer for the period ended June 30, 2005 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: August 23, 2005 /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 Variable Investment Series and will be retained by Morgan Stanley Variable Investment Series and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----