N-CSRS 1 y26881nvcsrs.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: 811-07117 Morgan Stanley Limited Duration Fund (Exact name of registrant as specified in charter) 1221 Avenue of the Americas, New York, New York 10020 (Address of principal executive offices) (Zip code) Ronald E. Robison 1221 Avenue of the Americas, New York, New York 10020 (Name and address of agent for service) Registrant's telephone number, including area code: 212-762-4000 Date of fiscal year end: April 30, 2007 Date of reporting period: October 31, 2006 Item 1 - Report to Shareholders Welcome, Shareholder: In this report, you'll learn about how your investment in Morgan Stanley Limited Duration Fund performed during the semiannual period. We will provide an overview of the market conditions, and discuss some of the factors that affected performance during the reporting period. In addition, this report includes the Fund's financial statements and a list of Fund investments. THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE FUND BEING OFFERED. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE FUND WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE FUND IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE FUND WILL DECLINE AND, THEREFORE, THE VALUE OF THE FUND'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS FUND. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE INFORMATION ON INVESTMENT RISKS. FUND REPORT For the six months ended October 31, 2006 TOTAL RETURN FOR THE 6 MONTHS ENDED OCTOBER 31, 2006
MORGAN STANLEY LEHMAN BROTHERS LIPPER SHORT LIMITED DURATION U.S. CREDIT INDEX INVESTMENT GRADE FUND (1-5 YEAR)(1) BOND FUNDS INDEX(2) 2.28% 3.56% 2.81%
The Fund's total return assumes the reinvestment of all distributions. See Performance Summary for standardized performance and benchmark information. MARKET CONDITIONS The Federal Open Market Committee (the "Fed") raised the federal funds target rate by 25 basis points at both the May and June meetings, but then chose to pause at the following three meetings. Comments made by Fed members after their May and June meetings indicated that they will rely heavily on economic data in making future decisions concerning the direction of interest rates. In fact, based on these comments it appears that the Fed will be driven by the weight of the economic data more so now than perhaps at anytime over the past few years. At first glance, the third quarter gross domestic product (GDP) report was disappointing, with the real economy expanding at a 1.6 percent annualized rate during the period -- its weakest showing in three years. A further analysis, however, suggests a more favorable view of the economy. Most observers expected that housing would be a drag on GDP, and it certainly was to the tune of approximately one full percentage point during the period. However, this is far from a crushing blow to an economy that had been growing at or above its long-term potential growth rate for the past few years. There is also evidence that home sellers are responding to the housing market correction by either withdrawing inventory from the market or by adjusting asking prices -- both of which may tend to limit the severity and longevity of the housing correction. Moreover, the so-called negative wealth effect caused by lower home prices is open to debate. Empirical evidence shows that the assumed relationships between mortgage equity withdrawals and consumer spending are unstable in both the short run and the long run. A further analysis of the third quarter GDP report also revealed strong gains in both non-residential real restate and in real equipment spending. We are not suggesting that investors ignore the relatively weak headline GDP number; instead, we are suggesting that there is more to the report than meets the eye, especially when evaluated within the context of other economic barometers. Where does all of this leave the Fed? With inflation above 2 percent and expectations for strong growth, we believe there is little support in any of the recent data to justify a more accommodative monetary policy. If anything, there is cause for concern on the inflation front, especially with tight labor markets. Accordingly, a higher federal funds rate may well be necessary to control the level of inflation and, accordingly, nominal economic growth rates. Within the government sector, U.S. Treasuries underperformed over the six-month period because of 2 their high sensitivity to fluctuating interest rates and their relatively low yields. Yield spreads (a measure of market risk) of agency debentures and mortgages remained tight relative to Treasuries. As is typical during periods of declining interest rates, prepayment speeds on mortgages rose, causing lower-coupon mortgages to outperform. Within the investment-grade portion of the corporate sector, lower-rated issues (BBB- and A-rated) outpaced higher-rated issues (AA-rated and above). Industrials posted the highest returns, followed by utilities and financials. Overall for the period, longer dated corporate issues underperformed shorter-dated issues. PERFORMANCE ANALYSIS Morgan Stanley Limited Duration Fund underperformed the Lehman Brothers U.S. Credit Index (1-5 Year) and the Lipper Short Investment Grade Bond Funds Index for the six months ended October 31, 2006, assuming no deduction of applicable sales charges. During the period, we kept the Fund's overall duration* modestly below that of the relevant indices. This posture was beneficial as interest rates rose across the market, especially in the short- and intermediate-portions of the yield curve. The portfolio had a small exposure to higher-coupon mortgage backed securities which benefited performance. Additionally, the portfolio had significant exposure to adjustable rate mortgages which enhanced performance. Within the credit section of the Portfolio, we employed a defensive strategy with a focus on higher-quality securities, which detracted from relative performance. However, strong security selection contributed positively to performance for the period. There is no guarantee that any sectors mentioned will continue to perform as discussed herein or that securities in such sectors will be held by the Fund in the future. *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
PORTFOLIO COMPOSITION** Corporate Bonds 43.3% Private Issues -- CMOs 23.4 Mortgage-Backed Securities 17.9 Asset-Backed Securities 8.2 U.S. Government Agencies -- CMOs 2.8 Short-Term Investments 4.4
LONG-TERM CREDIT ANALYSIS Aaa/AAA 53.6% Aa/AA 12.4 A/A 18.4 Baa/BBB 15.6
** Does not include open long futures contracts with an underlying face amount of $34,544,658 with unrealized appreciation of $56,537 and open short futures contracts with an underlying face amount of $11,717,438 and unrealized depreciation of $69,189. Data as of October 31, 2006. Subject to change daily. All percentages for portfolio composition are as a percentage of total investments 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. INVESTMENT STRATEGY The Fund 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 Fund's portfolio of three years or less. FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS Each Morgan Stanley fund provides a complete schedule of portfolio holdings in its semiannual and annual reports within 60 days of the end of the fund's second and fourth fiscal quarters. The semiannual reports and the annual reports are filed electronically with the Securities and Exchange Commission (SEC) on Form N-CSRS and Form N-CSR, respectively. Morgan Stanley also delivers the semiannual and annual reports to fund shareholders and makes these reports available on its public web site, www.morganstanley.com. Each Morgan Stanley fund also files a complete schedule of portfolio holdings with the SEC for the fund's first and third fiscal quarters on Form N-Q. Morgan Stanley does not deliver the reports for the first and third fiscal 4 quarters to shareholders, nor are the reports posted to the Morgan Stanley public web site. You may, however, obtain the Form N-Q filings (as well as the Form N-CSR and N-CSRS filings) by accessing the SEC's web site, http://www.sec.gov. You may also review and copy them at the SEC's public reference room in Washington, DC. Information on the operation of the SEC's public reference room may be obtained by calling the SEC at (800) SEC-0330. You can also request copies of these materials, upon payment of a duplicating fee, by electronic request at the SEC's e-mail address (publicinfo@sec.gov) or by writing the public reference section of the SEC, Washington, DC 20549-0102. PROXY VOTING POLICY AND PROCEDURES AND PROXY VOTING RECORD You may obtain a copy of the Fund's Proxy Voting Policy and Procedures without charge, upon request, by calling toll free (800) 869-NEWS or by visiting the Mutual Fund Center on our Web site at www.morganstanley.com. It is also available on the Securities and Exchange Commission's Web site at http://www.sec.gov. You may obtain information regarding how the Fund voted proxies relating to portfolio securities during the most recent twelve-month period ended June 30 without charge by visiting the Mutual Fund Center on our Web site at www.morganstanley.com. This information is also available on the Securities and Exchange Commission's Web site at http://www.sec.gov. HOUSEHOLDING NOTICE To reduce printing and mailing costs, the Fund attempts to eliminate duplicate mailings to the same address. The Fund delivers a single copy of certain shareholder documents, including shareholder reports, prospectuses and proxy materials, to investors with the same last name who reside at the same address. Your participation in this program will continue for an unlimited period of time unless you instruct us otherwise. You can request multiple copies of these documents by calling (800) 350-6414, 8:00 a.m. to 8:00 p.m., ET. Once our Customer Service Center has received your instructions, we will begin sending individual copies for each account within 30 days. 5 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS -- PERIOD ENDED OCTOBER 31, 2006
(since 01/10/94) SYMBOL MSLDX 1 YEAR 3.93%(3) 5 YEARS 2.31(3) 10 YEARS 4.35(3) SINCE INCEPTION 4.44(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 most recent month-end performance figures, please visit www.morganstanley.com or speak with your Financial Advisor. Investment returns and principal value will fluctuate and fund shares, when redeemed, may be worth more or less than their original cost. The table does not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares. (1) The Lehman Brothers U.S. Credit Index (1-5 Year) includes U.S. corporate and specified foreign debentures and secured notes with maturities of one to five years. Indexes are unmanaged and their returns do not include any sales charges or fees. Such costs would lower performance. It is not possible to invest directly in an index. (2) The Lipper Short Investment Grade Bond Funds Index is an equally weighted performance index of the largest qualifying funds (based on net assets) in the Lipper Short Investment Grade Bond Funds classification. The Index, which is adjusted for capital gains distributions and income dividends, is unmanaged and should not be considered an investment. There are currently 30 funds represented in this Index. (3) Figure shown assumes reinvestment of all distributions. There are no sales charges. 6 EXPENSE EXAMPLE As a shareholder of the Fund, you incur two types of costs: (1) transaction costs, including redemption fees; and (2) ongoing costs, including advisory fees and other Fund expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other mutual funds. The example is based on an investment of $1,000 invested at the beginning of the period and held for the entire period 05/01/06 - 10/31/06. ACTUAL EXPENSES The first line of the table below provides information about actual account values and actual expenses. You may use the information in this line, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the first line under the heading entitled "Expenses Paid During Period" to estimate the expenses you paid on your account during this period. HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES The second line of the table below provides information about hypothetical expenses based on the Fund's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Fund's actual return. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. You may use this information to compare the ongoing cost of investing in the Fund and other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the other funds. Please note that the expenses shown in the table are meant to highlight your ongoing costs only. 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 that have transactional costs, such as sales charges (loads), redemption fees or exchange fees.
BEGINNING ENDING EXPENSES PAID ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD * ------------- ------------- --------------- 05/01/06 - 05/01/06 10/31/06 10/31/06 ------------- ------------- --------------- Actual (2.28% return)....................................... $1,000.00 $1,022.80 $4.08 Hypothetical (5% annual return before expenses)............. $1,000.00 $1,021.17 $4.08
------------------ * Expenses are equal to the Fund's annualized expense ratio of 0.80% multiplied by the average account value over the period, multiplied by 184/365 (to reflect the one-half year period). If the Fund had borne all of its expenses waived by the Investment Adviser and Administrator, the annualized expense ratios for the one-half period would have been 0.87%. 7 Morgan Stanley Limited Duration Fund PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED)
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE ----------------------------------------------------------------------------------------------------------- Corporate Bonds (44.8%) Aerospace & Defense (0.6%) $ 435 McDonnell Douglas Corp. ............................... 6.875% 11/01/06 $ 435,000 330 Northrop Grumman Corp. ................................ 4.079 11/16/06 329,833 65 Raytheon Co. .......................................... 6.15 11/01/08 66,125 55 Raytheon Co. .......................................... 6.75 08/15/07 55,522 ------------ 886,480 ------------ Air Freight/Couriers (0.3%) 385 FedEx Corp. ........................................... 2.65 04/01/07 380,623 ------------ Airlines (0.3%) 435 Southwest Airlines Co. (Series 01-1)................... 5.496 11/01/06 435,205 ------------ Auto Parts: O.E.M. (0.4%) 530 Johnson Controls, Inc. ................................ 5.00 11/15/06 529,842 ------------ Automotive Aftermarket (0.2%) 245 FedEx Corp. ........................................... 5.50 08/15/09 246,729 ------------ Beverages: Alcoholic (0.3%) 460 Miller Brewing Co. - 144A*............................. 4.25 08/15/08 451,461 ------------ Building Products (0.1%) 200 Masco Corp. ........................................... 4.625 08/15/07 198,179 ------------ Cable/Satellite TV (0.8%) 710 Comcast Cable Communications, Inc. .................... 6.875 06/15/09 738,568 427 Cox Communications Inc. ............................... 5.94+ 12/14/07 429,111 ------------ 1,167,679 ------------ Casino/Gaming (0.3%) 455 Harrahs Operating Co., Inc. ........................... 7.125 06/01/07 457,179 ------------ Chemicals: Major Diversified (0.2%) 275 ICI Wilmington Inc. ................................... 4.375 12/01/08 269,187 ------------ Computer Processing Hardware (0.2%) 295 Hewlett-Packard Co. ................................... 5.524+ 05/22/09 295,585 ------------ Containers/Packaging (0.1%) 145 Sealed Air Corp. - 144A*............................... 6.95 05/15/09 150,007 ------------ Department Stores (0.9%) 160 Federated Department Stores, Inc. ..................... 6.30 04/01/09 162,856 340 JC Penney Corp., Inc. ................................. 7.375 08/15/08 350,642 820 May Department Stores Co., Inc. ....................... 3.95 07/15/07 809,875 ------------ 1,323,373 ------------ Drugstore Chains (0.1%) 100 CVS Corp. ............................................. 3.875 11/01/07 98,332 ------------
8 See Notes to Financial Statements Morgan Stanley Limited Duration Fund PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE ----------------------------------------------------------------------------------------------------------- Electric Utilities (7.7%) $ 285 Ameren Corp. .......................................... 4.263% 05/15/07 $ 283,124 385 Appalachian Power Co. (Series G)....................... 3.60 05/15/08 375,355 475 Baltimore Gas & Electric Co. .......................... 6.625 03/15/08 483,015 1,175 Carolina Power & Light Company Inc. ................... 6.80 08/15/07 1,187,125 480 CC Funding Trust I..................................... 6.90 02/16/07 481,858 710 Columbus Southern Power Co. ........................... 4.40 12/01/10 686,486 110 Commonwealth Edison Co. ............................... 3.70 02/01/08 107,614 2,120 Consolidated Natural Gas Co. (Series B)................ 5.375 11/01/06 2,120,000 270 Consumers Energy Co. .................................. 4.80 02/17/09 266,837 350 Dominion Resources Inc. ............................... 5.687 05/15/08 351,609 335 Duke Energy Corp. ..................................... 3.75 03/05/08 328,685 185 Entergy Gulf States, Inc. ............................. 3.60 06/01/08 179,781 295 Entergy Gulf States, Inc. ............................. 5.80+ 12/01/09 294,469 605 FPL Group Capital Inc. ................................ 5.551 02/16/08 606,647 1,090 Pacific Gas & Electric Co. ............................ 3.60 03/01/09 1,052,699 230 Panhandle Eastern Pipe Line Co. (Series B)............. 2.75 03/15/07 227,651 595 Peco Energy Co. ....................................... 3.50 05/01/08 580,202 450 Southwestern Public Service Co. (Series A)............. 6.20 03/01/09 458,256 375 Texas-New Mexico Power Co. ............................ 6.25 01/15/09 381,759 345 Wisconsin Electric Power Co. .......................... 3.50 12/01/07 338,841 ------------ 10,792,013 ------------ Electrical Products (0.3%) 480 Cooper Industries, Inc. ............................... 5.25 07/01/07 478,072 ------------ Finance/Rental/Leasing (3.1%) 840 American Honda Finance Corp. - 144A*................... 3.85 11/06/08 819,256 710 Countrywide Home Loans, Inc. (Series MTN).............. 3.25 05/21/08 689,537 355 MBNA Corp. ............................................ 5.91+ 05/05/08 357,522 1,360 Nationwide Buildings Society - 144A* (United Kingdom)............................................. 2.625 01/30/07 1,350,917 500 Residential Capital Corp. ............................. 6.125 11/21/08 503,014 600 SLM Corp. ............................................. 4.00 01/15/10 579,958 ------------ 4,300,204 ------------ Financial Conglomerates (3.1%) 145 Chase Manhattan Corp. ................................. 7.00 11/15/09 152,016 695 CIT Group Inc. (Series MTN)............................ 4.75 08/15/08 689,850 485 Citigroup Inc. ........................................ 3.625 02/09/09 470,283 715 General Electric Capital Corp. ........................ 4.25 12/01/10 695,019 535 General Electric Capital Corp. ........................ 5.375 03/15/07 535,170 815 ING Security Life Institutional - 144A*................ 2.70 02/15/07 807,721 1,045 Pricoa Global Funding I - 144A*........................ 3.90 12/15/08 1,016,678 ------------ 4,366,737 ------------
9 See Notes to Financial Statements Morgan Stanley Limited Duration Fund PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE ----------------------------------------------------------------------------------------------------------- Food Retail (0.4%) $ 290 Fred Meyer, Inc. ...................................... 7.45% 03/01/08 $ 297,294 290 Safeway Inc. .......................................... 7.50 09/15/09 305,907 ------------ 603,201 ------------ Food: Major Diversified (1.3%) 565 General Mills Inc. .................................... 3.875 11/30/07 555,646 1,270 Kraft Foods Inc. ...................................... 5.25 06/01/07 1,268,123 ------------ 1,823,769 ------------ Forest Products (0.0%) 57 Weyerhaeuser Co. ...................................... 6.125 03/15/07 57,032 ------------ Gas Distributors (1.1%) 170 Keyspan Corp. ......................................... 4.90 05/16/08 169,195 320 NiSource Finance Corp. ................................ 5.968+ 11/23/09 320,237 1,025 Sempra Energy.......................................... 4.75 05/15/09 1,012,565 ------------ 1,501,997 ------------ Home Furnishings (0.3%) 450 Mohawk Industries, Inc. (Class C)...................... 6.50 04/15/07 451,791 ------------ Hotels/Resorts/Cruiselines (0.5%) 545 Hyatt Equities LLC - 144A*............................. 6.875 06/15/07 548,188 210 Starwood Hotels & Resorts Worldwide, Inc. ............. 7.375+ 05/01/07 212,362 ------------ 760,550 ------------ Household/Personal Care (0.4%) 510 Clorox Co. (The)....................................... 5.515+ 12/14/07 511,025 ------------ Industrial Conglomerates (0.3%) 400 Textron Financial Corp. ............................... 4.125 03/03/08 393,729 ------------ Insurance Brokers/Services (0.9%) 1,265 Marsh & McLennan Companies Inc. ....................... 5.375 03/15/07 1,264,209 ------------ Investment Banks/Brokers (1.4%) 1,055 Goldman Sachs Group Inc. (The)......................... 4.125 01/15/08 1,041,767 917 Lehman Brothers Holdings, Inc. ........................ 8.25 06/15/07 933,390 ------------ 1,975,157 ------------ Life/Health Insurance (2.9%) 1,540 Genworth Financial, Inc. .............................. 5.54+ 06/15/07 1,542,416 585 John Hancock Financial Services, Inc. ................. 5.625 12/01/08 590,527 1,255 Met Life Global Funding I - 144A*...................... 3.375 10/05/07 1,223,020 355 Monumental Global Funding II - 144A*................... 3.85 03/03/08 348,500 350 Monumental Global Funding II - 144A*................... 4.375 07/30/09 343,213 ------------ 4,047,676 ------------
10 See Notes to Financial Statements Morgan Stanley Limited Duration Fund PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE ----------------------------------------------------------------------------------------------------------- Major Banks (4.0%) $1,290 ABN Amro Bank (Netherlands)............................ 5.464+% 05/11/07 $ 1,290,668 800 Bank of America Corp. ................................. 3.375 02/17/09 771,584 285 Bank of New York Co., Inc. (The)....................... 5.20 07/01/07 284,933 755 HBOS Treasury Services PLC - 144A* (United Kingdom).... 5.625 07/20/09 763,701 315 Popular North America Inc. (Series MTN)................ 5.65 04/15/09 316,361 585 Suntrust Bank Atlanta.................................. 4.55 05/25/09 577,015 565 Unicredit Luxembourg Finance S.A. - 144A*.............. 5.426+ 10/24/08 565,219 180 Wachovia Corp. ........................................ 3.625 02/17/09 174,175 365 Wells Fargo & Co. ..................................... 3.12 08/15/08 352,272 470 World Savings Bank FSB (Series BKNT)................... 4.125 12/15/09 457,124 ------------ 5,553,052 ------------ Major Telecommunications (1.1%) 325 Deutsche Telekom International Finance BV (Netherlands)........................................ 8.00+ 06/15/10 355,037 385 Telecom Italia Capital SA (Luxembourg)................. 4.00 11/15/08 374,730 740 Verizon Global Funding Corp. .......................... 6.125 06/15/07 743,505 ------------ 1,473,272 ------------ Managed Health Care (0.3%) 480 UnitedHealth Group Inc. ............................... 4.125 08/15/09 466,754 ------------ Media Conglomerates (0.6%) 340 Time Warner, Inc. ..................................... 6.15 05/01/07 341,271 155 Viacom Inc. ........................................... 5.74+ 06/16/09 155,131 300 Viacom Inc. ........................................... 5.75 04/30/11 300,667 ------------ 797,069 ------------ Medical Specialties (0.4%) 605 Baxter International Inc. ............................. 5.196 02/16/08 602,336 ------------ Motor Vehicles (0.5%) 295 DaimlerChrysler North American Holdings Co. ........... 4.05 06/04/08 288,556 345 DaimlerChrysler North American Holdings Co............. 5.82+ 03/13/09 345,451 ------------ 634,007 ------------ Multi-Line Insurance (1.0%) 125 AXA Financial, Inc. ................................... 6.50 04/01/08 127,076 490 Hartford Financial Services Group, Inc. (The).......... 5.55 08/16/08 492,855 500 International Lease Finance Corp. ..................... 3.75 08/01/07 493,795 310 International Lease Finance Corp. ..................... 4.625 06/02/08 306,853 ------------ 1,420,579 ------------ Oil & Gas Pipelines (0.4%) 555 Enbridge Energy Partners, LP........................... 4.00 01/15/09 537,788 ------------
11 See Notes to Financial Statements Morgan Stanley Limited Duration Fund PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE ----------------------------------------------------------------------------------------------------------- Other Metals/Minerals (0.3%) $ 340 Brascan Corp. (Canada)................................. 8.125% 12/15/08 $ 357,732 ------------ Property - Casualty Insurers (1.4%) 815 Mantis Reef Ltd. - 144A* (Australia)................... 4.692 11/14/08 801,531 255 Platinum Underwriters Holdings, Ltd. (Series B) (Bermuda)............................................ 6.371 11/16/07 253,316 405 St. Paul Travelers Companies, Inc. (The)............... 5.01 08/16/07 402,832 500 XLLIAC Global Funding - 144A*.......................... 4.80 08/10/10 491,310 ------------ 1,948,989 ------------ Pulp & Paper (0.3%) 365 International Paper Co. ............................... 3.80 04/01/08 356,807 ------------ Railroads (1.5%) 385 Burlington North Santa Fe Railway Co. ................. 6.125 03/15/09 392,779 270 Norfolk Southern Corp. ................................ 7.35 05/15/07 272,742 285 Union Pacific Corp. ................................... 3.625 06/01/10 270,077 1,120 Union Pacific Corp. (Series MTNE)...................... 6.79 11/09/07 1,131,915 ------------ 2,067,513 ------------ Real Estate Development (0.6%) 407 World Financial Properties - 144A*..................... 6.91 09/01/13 427,961 359 World Financial Properties - 144A*..................... 6.95 09/01/13 378,204 ------------ 806,165 ------------ Real Estate Investment Trusts (0.6%) 440 EOP Operating LP....................................... 6.763 06/15/07 443,302 330 Simon Property Group LP................................ 6.375 11/15/07 332,889 ------------ 776,191 ------------ Regional Banks (0.4%) 510 Banco Santander Central Hispano Issuances Ltd. (Cayman Islands)............................................. 7.625 11/03/09 544,400 ------------ Savings Banks (1.5%) 420 Household Finance Corp. ............................... 4.125 12/15/08 411,944 1,010 Household Finance Corp. ............................... 6.40 06/17/08 1,029,296 150 Sovereign Bank (Series CD)............................. 4.00 02/01/08 147,543 155 Washington Mutual Inc. ................................ 4.00 01/15/09 151,372 310 Washington Mutual Inc. ................................ 8.25 04/01/10 336,364 ------------ 2,076,519 ------------
12 See Notes to Financial Statements Morgan Stanley Limited Duration Fund PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE ----------------------------------------------------------------------------------------------------------- Trucks/Construction/Farm Machinery (1.0%) $ 500 Caterpillar Financial Services Corp. (Series MTNF)..... 3.625% 11/15/07 $ 491,492 525 John Deere Capital Corp. .............................. 3.375 10/01/07 515,222 360 John Deere Capital Corp. .............................. 4.50 08/22/07 357,531 ------------ 1,364,245 ------------ Wireless Telecommunications (0.4%) 580 Vodafone Group PLC (United Kingdom).................... 5.457+ 12/28/07 580,366 ------------ Total Corporate Bonds (Cost $63,299,209).................................... 62,580,807 ------------ Private Issues - Collateralized Mortgage Obligations (24.2%) 999 Banc of America Funding Corp. 2006-H 3A1............... 6.239 09/20/46 1,005,965 615 Bear Stearns Alt-A Trust 2003-3 3A..................... 5.67+ 10/25/33 616,555 950 Bear Stearns Mortgage Funding Trust 2006-AR3 1A1....... 5.50+ 10/25/36 950,148 820 Bear Stearns Mortgage Funding Trust 2006-AR1 1A2....... 5.595+ 07/25/36 820,256 1,077 Countrywide Alternative Loan Trust 2005-58 A2.......... 5.71+ 12/20/35 1,082,048 864 Countrywide Alternative Loan Trust 2006-OA1 1A2........ 5.62+ 03/20/46 864,296 3,829 Countrywide Alternative Loan Trust 2005-81 X1 (IO)..... 1.566+ 02/25/37 210,002 821 Countrywide Alternative Loan Trust 2006-OA14 2A1....... 5.514+ 11/25/46 821,537 1,189 Countrywide Alternative Loan Trust 2006-OA16 A3........ 5.57+ 10/25/46 1,188,898 131 Countrywide Alternative Loan Trust NIM 2006-OA6N N1 - 144A*................................................ 5.25 07/25/46 130,237 4,986 Countrywide Alternative Loan Trust 2006-OA1 2X (IO).... 1.04+ 03/20/46 248,557 126 Countrywide Asset-Backed Certificates 2005-2N N - 144A*............................................ 4.50 08/25/36 124,547 5,300 Countrywide Home Loans 2004-25 1X (IO)................. 1.742+ 02/25/35 122,555 1,031 DSLA Mortgage Loan Trust 2006-AR2 2A1A................. 5.52+ 11/19/37 1,033,177 84 DSLA NIM Corp. 2006-1 N1 - 144A*....................... 5.926 04/20/46 84,095 839 Greenpoint Mortgage Funding Trust 2006-AR2 4A1......... 6.664+ 03/25/36 859,040 2,363 Greenpoint Mortgage Funding Trust 2005-AR3 X1 (IO)..... 1.028+ 08/25/45 74,574 4,037 Greenpoint Mortgage Funding Trust 2005-AR4 X4 (IO)..... 1.005+ 10/25/45 126,773 129 GS Mortgage Securities Corp. 2006-NIM3 N1 - 144A*...... 6.414 06/25/46 129,098 4,923 Harborview Mortgage Loan Trust 2005-2 X (IO)........... 0.719+ 05/19/35 119,235 1,100 Harborview Mortgage Loan Trust 2006-10 2A1B............ 5.56+ 11/19/36 1,100,086 841 Harborview Mortgage Loan Trust 2006-7 2A1B............. 5.57+ 10/19/37 843,234 1,017 Harborview Mortgage Loan Trust 2006-8 2A1B............. 5.57+ 08/21/46 1,016,846 945 Harborview Mortgage Loan Trust 2006-1 2A1A............. 5.56+ 03/19/37 946,658 0 Harborview Mortgage Loan Trust 2006-5 PO2 (PO)......... 0.00 07/19/47 10 3,593 Harborview Mortgage Loan Trust 2006-5 X2 (IO).......... 1.369+ 07/19/47 135,860 3,342 Harborview Mortgage Loan Trust 2005-16 X1 (IO)......... 1.409+ 01/19/36 97,131 9,661 Harborview Mortgage Loan Trust 2005-16 X3 (IO)......... 1.334+ 01/19/36 259,628 4,060 Harborview Mortgage Loan Trust 2005-3 X2 (IO).......... 0.631+ 06/19/35 91,972 250 Harborview Mortgage Loan Trust 2005-9 B1............... 5.92+ 06/20/35 253,454 2 Harborview Mortgage Loan Trust 2006-1 PO1 (PO)......... 0.00 03/19/37 1,616
13 See Notes to Financial Statements Morgan Stanley Limited Duration Fund PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE ----------------------------------------------------------------------------------------------------------- $1,300 Harborview Mortgage Loan Trust 2006-12 2A2B............ 5.57+% 12/19/37 $ 1,300,101 1,846 Harborview Mortgage Loan Trust 2005-16 4A1A............ 6.664+ 01/19/36 1,886,586 5,113 Harborview Mortgage Loan Trust 2006-1 X1 (IO).......... 1.636+ 03/19/37 241,259 115 Harborview NIM Corp. 2006-7A N1 - 144A*................ 6.409 09/19/36 114,653 68 Harborview NIM Corp. 2006-BU1 N1 - 144A*............... 5.926 02/20/46 68,485 381 IndyMac INDX Mortgage Loan Trust 2004-AR3 B1........... 5.82+ 07/25/34 380,885 139 IndyMac INDX NIM Corp. 2006-AR6 N1 - 144A*............. 6.654 06/25/46 138,871 138 Lehman XS Net Interest Margin Notes 2006-GP1 A1 - 144A*........................................... 6.25 05/28/46 137,777 987 Luminent Mortgage Trust 2006-6 A1...................... 5.52+ 10/25/46 987,409 873 Luminent Mortgage Trust 2006-1 A1...................... 5.56+ 04/25/36 875,447 858 Luminent Mortgage Trust 2006-2 A1B..................... 5.60+ 02/25/46 859,245 117 RALI NIM Corp. 2006-Q04 N1 - 144A*..................... 6.048 04/25/46 117,287 408 Residential Accredit Loans, Inc. 2006-Q01 1A1.......... 5.58+ 02/25/46 408,970 468 Residential Accredit Loans, Inc. 2006-Q01 2A1.......... 5.59+ 02/25/46 468,185 739 Residential Accredit Loans, Inc. 2006-Q01 2A2.......... 5.65+ 02/25/46 742,410 1,117 Residential Accredit Loans, Inc. 2006-Q06 A2........... 5.55+ 06/25/46 1,115,755 739 Structured Asset Mortgage Investments, Inc. 2006-AR1 2A2.................................................. 5.63+ 02/25/36 741,554 1,017 Structured Asset Mortgage Investments, Inc. 2006-AR2 A2................................................... 5.63+ 02/25/36 1,020,796 1,000 Structured Asset Mortgage Investments, Inc. 2006-AR8 A1A.................................................. 5.52+ 10/25/36 1,000,156 1,428 Washington Mutual 2005-AR13 A1B3....................... 5.68+ 10/25/45 1,436,522 1,454 Washington Mutual 2005-AR15 A1B3....................... 5.66+ 11/25/45 1,464,662 569 Washington Mutual 2005-AR8 2AB3........................ 5.68+ 07/25/45 572,231 1,418 Washington Mutual 2006-AR9 1A.......................... 5.664+ 08/25/46 1,421,952 4,899 Washington Mutual 2004-AR10 X (IO)..................... 0.853+ 07/25/44 88,791 6,797 Washington Mutual 2004-AR12 X (IO)..................... 0.879+ 10/25/44 121,062 2,789 Washington Mutual 2004-AR8 X (IO)...................... 0.871+ 06/25/44 50,542 751 WMALT Mortgage Pass-Through Certificates 2006-AR6 2A... 5.92+ 08/25/46 753,367 ------------ Total Private Issues - Collateralized Mortgage Obligations (Cost $34,371,234)................................................................ 33,873,048 ------------ U.S. Government Agencies - Mortgage-Backed Securities (18.4%) 1,199 Federal Home Loan Mortgage Corp. ...................... 7.50 10/01/26- 1,248,960 08/01/32 780 Federal Home Loan Mortgage Corp. ARM................... 3.538 07/01/34 765,153 1,203 Federal Home Loan Mortgage Corp. ARM................... 4.161 08/01/34 1,197,488 10 Federal Home Loan Mortgage Corp. PC Gold............... 6.50 07/01/29- 10,435 09/01/29 1,669 Federal Home Loan Mortgage Corp. PC Gold............... 7.50 01/01/30- 1,735,329 07/01/32 962 Federal National Mortgage Assoc. ...................... 6.50 01/01/29- 986,889 07/01/32 4,234 Federal National Mortgage Assoc. ...................... 7.00 02/01/26- 4,373,680 09/01/35 1,300 Federal National Mortgage Assoc. ...................... 7.00 *** 1,336,969
14 See Notes to Financial Statements Morgan Stanley Limited Duration Fund PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE ----------------------------------------------------------------------------------------------------------- $ 651 Federal National Mortgage Assoc. ...................... 7.50% 09/01/29- $ 678,543 09/01/32 853 Federal National Mortgage Assoc. ARM................... 3.607 07/01/34 854,601 475 Federal National Mortgage Assoc. ARM................... 3.761 06/01/34 476,943 1,009 Federal National Mortgage Assoc. ARM................... 4.142 09/01/34 1,003,277 1,332 Federal National Mortgage Assoc. ARM................... 4.195 05/01/35 1,330,972 1,157 Federal National Mortgage Assoc. ARM................... 4.296 04/01/35 1,149,042 1,090 Federal National Mortgage Assoc. ARM................... 4.34 05/01/35 1,087,382 810 Federal National Mortgage Assoc. ARM................... 4.487 04/01/35 800,780 1,300 Federal National Mortgage Assoc. ARM................... 4.754 07/01/35 1,286,023 1,668 Federal National Mortgage Assoc. ARM................... 4.782 09/01/35 1,646,076 885 Federal National Mortgage Assoc. ARM................... 5.908 07/01/33 896,055 1,362 Government National Mortgage Assoc. II................. 4.50+ 08/20/29- 1,367,482 09/20/29 296 Government National Mortgage Assoc. II................. 5.125+ 10/20/24- 299,085 12/20/24 1,279 Government National Mortgage Assoc. II................. 5.375+ 06/20/22- 1,286,803 05/20/23 ------------ Total U.S. Government Agencies - Mortgage-Backed Securities (Cost $26,073,403)................................................................ 25,817,967 ------------ Asset-Backed Securities (8.5%) 275 Aegis Asset Backed Securities Trust 2004-2 B1.......... 7.32+ 06/25/34 278,123 350 Ameriquest Mortgage Securities Inc. 2004-R7 M5......... 6.47+ 08/25/34 352,950 1,300 Capital Auto Receivables Asset Trust 2006-SN1A A3 -144A*............................................... 5.31 10/20/09 1,302,853 1,300 Capital Auto Receivables Asset Trust 2006-1 A3......... 5.03 10/15/09 1,297,586 1,000 Caterpillar Financial Asset Trust 2006-A A3............ 5.57 05/25/10 1,008,866 1,800 Chase Manhattan Auto Owner Trust 2004-A A4............. 2.83 09/15/10 1,762,654 500 CNH Equipment Trust 2006-B A3.......................... 5.20 06/15/10 501,219 1,450 CNH Equipment Trust 2005-A A3.......................... 4.02 04/15/09 1,438,660 467 Harley-Davidson Motorcycle Trust 2002-2 A2............. 3.09 06/15/10 462,991 2,152 Harley-Davidson Motorcycle Trust 2003-3 A2............. 2.76 05/15/11 2,121,831 725 Hertz Vehicle Financing LLC 2005-2A A2 - 144A*......... 4.93 02/25/10 722,204 150 Home Equity Asset Trust 2004-3 B1...................... 7.42+ 08/25/34 152,410 425 Park Place Securities Inc. 2004-MCW1 M7................ 7.17+ 10/25/34 434,502 ------------ Total Asset-Backed Securities (Cost $11,907,805)............................ 11,836,849 ------------ U.S. Government Agencies - Collateralized Mortgage Obligations (2.9%) 1,419 Federal Home Loan Mortgage Corp. 2182 ZC............... 7.50 09/15/29 1,490,395 1,575 Federal National Mortgage Assoc. 2005-27 NA (PAC)...... 5.50 01/25/24 1,573,473 995 Federal National Mortgage Assoc. 2005-27 NA (PAC)...... 6.50 06/25/35 1,031,344 ------------ Total U.S. Government Agencies - Collateralized Mortgage Obligations (Cost $4,260,035)................................................................. 4,095,212 ------------
15 See Notes to Financial Statements Morgan Stanley Limited Duration Fund PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE ----------------------------------------------------------------------------------------------------------- Short-Term Investments (4.5%) U.S. Government Obligation (a) (0.1%) $ 200 U.S. Treasury Bill** (Cost $197,992)................... 5.09% 01/11/07 $ 197,992 ------------ Repurchase Agreement (4.4%) 6,187 Joint repurchase agreement account (dated 10/31/06; proceeds $6,187,910) (b) (Cost $6,187,000)........... 5.295 11/01/06 6,187,000 ------------ Total Short-Term Investments (Cost $6,384,992).............................. 6,384,992 ------------
Total Investments (Cost $146,296,678) (c) (d)..................... 103.3% 144,588,875 Liabilities in Excess of Other Assets............................. (3.3) (4,642,435) ----- ------------ Net Assets........................................................ 100.0% $139,946,440 ===== ============
--------------------- ARM Adjustable Rate Mortgage. Interest rate in effect as of October 31, 2006. IO Interest Only Security. PAC Planned Amortization Class. PC Participation Certificate. PO Principal Only Security. * 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 $23,630. *** Securities were 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. + Floating rate security; rate shown is the rate in effect at October 31, 2006. (a) Purchased on a discount basis. The interest rate shown has been adjusted to reflect a money market equivalent yield. (b) Collateralized by federal agency and U.S. Treasury obligations. (c) Securities have been designated as collateral in an amount equal to $51,800,205 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 $162,913 and the aggregate gross unrealized depreciation is $1,870,716, resulting in net unrealized depreciation of $1,707,803.
FUTURES CONTRACTS OPEN AT OCTOBER 31, 2006:
UNREALIZED NUMBER OF DESCRIPTION, DELIVERY UNDERLYING FACE APPRECIATION CONTRACTS LONG/SHORT MONTH AND YEAR AMOUNT AT VALUE (DEPRECIATION) ------------------------------------------------------------------------------------------ 169 Long U.S. Treasury Note 2 $ 34,544,658 $ 56,537 Year, December 2006 111 Short U.S. Treasury Note 5 (11,717,438) (69,189) Year, December 2006 Net Unrealized Depreciation..................... $(12,652) ========
16 See Notes to Financial Statements Morgan Stanley Limited Duration Fund FINANCIAL STATEMENTS Statement of Assets and Liabilities October 31, 2006 (unaudited) Assets: Investments in securities, at value (cost $146,296,678)..... $144,588,875 Cash........................................................ 11,158 Receivable for: Investments sold........................................ 1,338,658 Interest................................................ 1,207,486 Shares of beneficial interest sold...................... 49,194 Variation margin........................................ 6,659 Principal paydowns...................................... 1,788 Prepaid expenses and other assets........................... 10,990 ------------ Total Assets............................................ 147,214,808 ------------ Liabilities: Payable for: Investments purchased................................... 6,854,309 Shares of beneficial interest redeemed.................. 189,982 Dividends to shareholders............................... 73,903 Investment advisory fee................................. 54,653 Transfer agent fee...................................... 21,658 Administration fee...................................... 9,896 Accrued expenses and other payables......................... 63,967 ------------ Total Liabilities....................................... 7,268,368 ------------ Net Assets.............................................. $139,946,440 ============ Composition of Net Assets: Paid-in-capital............................................. $170,645,053 Net unrealized depreciation................................. (1,720,455) Dividends in excess of net investment income................ (2,418,603) Accumulated net realized loss............................... (26,559,555) ------------ Net Assets.............................................. $139,946,440 ============ Net Asset Value Per Share, 15,532,254 shares outstanding (unlimited shares authorized of $.01 par value).......................................... $9.01 ============
17 See Notes to Financial Statements Morgan Stanley Limited Duration Fund FINANCIAL STATEMENTS continued Statement of Operations For the six months ended October 31, 2006 (unaudited) Net Investment Income: Interest Income............................................. $ 3,644,481 ----------- Expenses Investment advisory fee..................................... 391,331 Transfer agent fees and expenses............................ 85,887 Administration fee.......................................... 60,205 Shareholder reports and notices............................. 37,000 Professional fees........................................... 35,537 Registration fees........................................... 15,838 Custodian fees.............................................. 13,136 Trustees' fees and expenses................................. 1,100 Other....................................................... 14,650 ----------- Total Expenses.......................................... 654,684 Less: amounts waived........................................ (52,248) Less: expense offset........................................ (388) ----------- Net Expenses............................................ 602,048 ----------- Net Investment Income................................... 3,042,433 ----------- Net Realized and Unrealized Gain (Loss): Net Realized Gain (Loss) on: Investments................................................. (266,995) Futures contracts........................................... (226,024) Options contracts........................................... 5,297 ----------- Net Realized Loss....................................... (487,722) ----------- Net Change in Unrealized Appreciation/Depreciation on: Investments................................................. 758,897 Futures contracts........................................... 50,028 ----------- Net Appreciation........................................ 808,925 ----------- Net Gain................................................ 321,203 ----------- Net Increase................................................ $ 3,363,636 ===========
18 See Notes to Financial Statements Morgan Stanley Limited Duration Fund FINANCIAL STATEMENTS continued Statements of Changes in Net Assets
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED OCTOBER 31, 2006 APRIL 30, 2006 ---------------- -------------- (unaudited) Increase (Decrease) in Net Assets: Operations: Net investment income....................................... $ 3,042,433 $ 7,699,849 Net realized loss........................................... (487,722) (2,966,520) Net change in unrealized appreciation/depreciation.......... 808,925 674,043 ------------ ------------- Net Increase............................................ 3,363,636 5,407,372 ------------ ------------- Dividends to shareholders from net investment income........ (3,582,340) (10,065,548) Net decrease from transactions in shares of beneficial interest.................................................. (20,035,176) (191,265,877) ------------ ------------- Net Decrease............................................ (20,253,880) (195,924,053) Net Assets: Beginning of period......................................... 160,200,320 356,124,373 ------------ ------------- End of Period (Including dividends in excess of net investment income of $2,418,603 and $1,878,696, respectively).................... $139,946,440 $ 160,200,320 ============ =============
19 See Notes to Financial Statements Morgan Stanley Limited Duration Fund NOTES TO FINANCIAL STATEMENTS - OCTOBER 31, 2006 (UNAUDITED) 1. Organization and Accounting Policies Morgan Stanley Limited Duration Fund (the "Fund") is registered under the Investment Company Act of 1940, as amended, as a diversified, open-end management investment company. The Fund's investment objective is to provide a high level of current income consistent with the preservation of capital. The Fund was organized as a Massachusetts business trust on October 22, 1993 and commenced operations on January 10, 1994. The Fund will assess a 2% redemption fee, which is paid directly to the Fund, for shares redeemed within seven days of purchase, subject to certain exceptions. The redemption fee is designed to protect the Fund and its remaining shareholders from the effects of short-term trading. The following is a summary of significant accounting policies: A. Valuation of Investments -- (1) 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 including circumstances under which 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; (5) listed options are valued at the latest sale price on the exchange on which they are listed unless no sales of such options have taken place that day, in which case they are valued at the mean between their latest bid and asked price; and (6) short-term debt securities having a maturity date of more than sixty days at time of purchase are valued on a mark-to-market basis until sixty days prior to maturity and thereafter at amortized cost based on their value on the 61st day. Short-term debt securities having a maturity date of sixty days or less at the time of purchase are valued at amortized cost. B. Accounting for Investments -- Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Realized gains and losses on security transactions are determined by the identified cost method. Discounts are accreted and premiums are amortized over the life of the respective securities. Interest income is accrued daily. C. Repurchase Agreements -- Pursuant to an Exemptive Order issued by the Securities and Exchange Commission, the Fund, along with other affiliated entities managed by the Investment Adviser, may transfer uninvested cash balances into one or more joint repurchase agreement accounts. These balances are invested in one or more repurchase agreements and are collateralized 20 Morgan Stanley Limited Duration Fund NOTES TO FINANCIAL STATEMENTS - OCTOBER 31, 2006 (UNAUDITED) continued by cash, U.S. Treasury or federal agency obligations. The Fund may also invest directly with institutions in repurchase agreements. The Fund's custodian receives the collateral, which is marked-to-market daily to determine that the value of the collateral does not decrease below the repurchase price plus accrued interest. D. Futures Contracts -- A futures contract is an agreement between two parties to buy and sell financial instruments or contracts based on financial indices at a set price on a future date. Upon entering into such a contract, the Fund is required to pledge to the broker cash, U.S. Government securities or other liquid portfolio securities equal to the minimum initial margin requirements of the applicable futures exchange. Pursuant to the contract, the Fund agrees to receive from or pay to the broker an amount of cash equal to the daily fluctuation in the value of the contract. Such receipts or payments known as variation margin are recorded by the Fund as unrealized gains and losses. Upon closing of the contract, the Fund realizes a gain or loss equal to the difference between the value of the contract at the time it was opened and the value at the time it was closed. E. Options -- When the Fund writes a call option, an amount equal to the premium received is included in the Fund's Statement of Assets and Liabilities as a liability which is subsequently marked-to-market to reflect the current market value of the option written. If a written option either expires or the Fund enters into a closing purchase transaction, the Fund realizes a gain or loss without regard to any unrealized gain or loss on the underlying security or currency and the liability related to such option is extinguished. If a written call option is exercised, the Fund realizes a gain or loss from the sale of the underlying security or currency and the proceeds from such sale are increased by the premium originally received. When the Fund purchases a call or put option, the premium paid is recorded as an investment and is subsequently marked-to-market to reflect the current market value. If a purchased option expires, the Fund will realize a loss to the extent of the premium paid. If the Fund enters into a closing sale transaction, a gain or loss is realized for the difference between the proceeds from the sale and the cost of the option. If a put option is exercised, the cost of the security or currency sold upon exercise will be increased by the premium originally paid. If a call option is exercised, the cost of the security purchased upon exercise will be increased by the premium originally paid. F. 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. 21 Morgan Stanley Limited Duration Fund NOTES TO FINANCIAL STATEMENTS - OCTOBER 31, 2006 (UNAUDITED) continued 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 Morgan Stanley Investment Adviser, the Fund pays an advisory fee, accrued daily and payable monthly, by applying the following annual rates to the net assets of the Fund determined as of the close of each business day: 0.52% of the portion of the daily net assets not exceeding $1 billion; 0.47% to the portion of the daily net assets exceeding $1 billion but not exceeding $2 billion and 0.42% of 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 Fund pays an administration fee, accrued daily and payable monthly, by applying the annual rate of 0.08% to the Fund's daily net assets. Effective November 18, 2005, the Investment Adviser has agreed to cap the Fund's operating expenses for one year by assuming the Fund's "other expenses" and/or waiving the Fund's advisory fees, and the Administrator has agreed to waive the Fund's administrative fees, to the extent such operating expenses on an annualized basis exceed 0.80% of the average daily net assets of the Fund. 3. Security Transactions and Transactions with Affiliates The cost of purchases and proceeds from sales/maturities/prepayments of portfolio securities, excluding short-term investments, for the six months ended October 31, 2006 were $40,956,339, and $55,278,858, respectively. Included in the aforementioned are purchases and sales/prepayments of U.S. Government securities of $7,481,640 and $12,744,948, respectively. Morgan Stanley Trust, an affiliate of the Investment Adviser and Administration, is the Fund's transfer agent. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he or she 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. 22 Morgan Stanley Limited Duration Fund NOTES TO FINANCIAL STATEMENTS - OCTOBER 31, 2006 (UNAUDITED) continued 4. Shares of Beneficial Interest Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED OCTOBER 31, 2006 APRIL 30, 2006 ------------------------- --------------------------- (unaudited) SHARES AMOUNT SHARES AMOUNT ---------- ------------ ----------- ------------- Sold............................................ 594,933 $ 5,348,340 3,479,165 $ 31,694,608 Reinvestment of dividends....................... 279,640 2,516,080 795,079 7,229,149 ---------- ------------ ----------- ------------- 874,573 7,864,420 4,274,244 38,923,757 Redeemed........................................ (3,101,581) (27,899,596) (25,350,341) (230,189,634) ---------- ------------ ----------- ------------- Net decrease.................................... (2,227,008) $(20,035,176) (21,076,097) $(191,265,877) ========== ============ =========== =============
5. Expense Offset The expense offset represents a reduction of the fees and expenses for interest earned on cash balances maintained by the Fund with the transfer agent. 6. Purposes of and Risks Relating to Certain Financial Instruments To hedge against adverse interest rate and market risks on portfolio positions or anticipated positions in U.S. Government securities, the Fund may enter into interest rate futures contracts ("futures contracts"). For hedging and investment purposes, the Fund may also engage in transactions in listed and over-the-counter options. These futures contracts involve elements of market risk in excess of the amount reflected in the Statement of Assets and Liabilities. The Fund 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 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. 23 Morgan Stanley Limited Duration Fund NOTES TO FINANCIAL STATEMENTS - OCTOBER 31, 2006 (UNAUDITED) continued As of April 30, 2006, the Fund had a net capital loss carryforward of $21,831,288 of which $20,504 will expire on April 30, 2007, $51,242 will expire on April 30, 2008, $2,035,052 will expire on April 30, 2009, $1,582,163 will expire on April 30, 2011, $2,183,130 will expire on April 30, 2012, $11,744,997 will expire on April 30, 2013 and $4,214,200 will expire on April 30, 2014 to offset future capital gains to the extent provided by regulations. As of April 30, 2006, the Fund had temporary book/tax differences primarily attributable to post-October losses (capital losses incurred after October 31 within the taxable year which are deemed to arise on the first business day of the Fund's next taxable year), and book amortization on debt securities. 8. New Accounting Pronouncements In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation 48, Accounting for Uncertainty in Income Taxes -- an interpretation of FASB Statement 109 (FIN 48). FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position must meet before being recognized in the financial statements. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Fund will adopt FIN 48 for the fiscal year ending 2008 and the impact to the Fund's financial statements, if any, is currently being assessed. In addition, in September 2006, Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS 157), was issued and is effective for fiscal years beginning after November 15, 2007. SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Management is currently evaluating the impact the adoption of SFAS 157 will have on the Fund's financial statement disclosures. 24 Morgan Stanley Limited Duration Fund FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE SIX FOR THE YEAR ENDED APRIL 30, MONTHS ENDED ----------------------------------------------------------------- OCTOBER 31, 2006 2006 2005 2004 2003 2002 ---------------- --------- --------- --------- --------- --------- (unaudited) Selected Per Share Data: Net asset value, beginning of period... $9.02 $9.17 $9.41 $9.68 $9.59 $9.44 ----- ----- ----- ----- ----- ----- Income (loss) from investment operations: Net investment income.............. 0.17 0.16 0.19 0.17 0.24 0.41 Net realized and unrealized gain (loss)............................. 0.04 0.05 (0.08) (0.07) 0.13 0.19 ----- ----- ----- ----- ----- ----- Total income from investment operations............................ 0.21 0.21 0.11 0.10 0.37 0.60 ----- ----- ----- ----- ----- ----- Less dividends from net investment income................................ (0.22) (0.36) (0.35) (0.37) (0.28) (0.45) ----- ----- ----- ----- ----- ----- Net asset value, end of period......... $9.01 $9.02 $9.17 $9.41 $9.68 $9.59 ===== ===== ===== ===== ===== ===== Total Return+.......................... 2.28%(1) 2.29% 1.20% 0.99% 3.93% 6.50% Ratios To Average Net Assets: Expenses (before expense offset)....... 0.80%(2)(4) 0.80%(4) 0.76%(3) 0.85%(3) 0.84%(4) 0.80%(4) Net investment income.................. 4.04%(2)(4) 2.95%(4) 2.63% 1.75% 1.90%(4) 3.94%(4) Supplemental Data: Net assets, end of period, in thousands............................ $139,946 $160,200 $356,124 $488,409 $429,409 $166,631 Portfolio turnover rate................ 28%(1) 54% 82% 240% 217% 327%
--------------------- + Calculated based on the net asset value as of the last business day of the period. (1) Not annualized. (2) Annualized. (3) Does not reflect the effect of expense offset of 0.01%. (4) If the Fund had borne all expenses that were assumed or waived by the Investment Adviser and Administrator, the annualized expense and net investment income ratios would have been as follows:
EXPENSE NET INVESTMENT PERIOD ENDED RATIO INCOME RATIO ------------ ------- -------------- October 31, 2006 0.87% 3.97% April 30, 2006 0.83 2.93 April 30, 2003 0.87 1.86 April 30, 2002 0.92 3.82
25 See Notes to Financial Statements Morgan Stanley Limited Duration Fund RESULTS OF SPECIAL SHAREHOLDER MEETING (UNAUDITED) On August 1, 2006, a Special Meeting of Shareholders of the Fund was scheduled in order to vote on the proposals set forth below. The proposals failed to obtain the quorum necessary in order to hold the meeting, and, therefore, the meeting was adjourned until August 23, 2006 and further adjourned to September 27, 2006 to permit further solicitation of proxies. The meeting was held on September 27, 2006 and the voting results with respect to these proposals were as follows: (1) Election of Trustees:
FOR WITHHOLD ABSTAIN BNV* ------------------------------------------------- Frank L. Bowman............................................. 8,471,610 378,873 0 0 Kathleen A. Dennis.......................................... 8,460,919 389,564 0 0 James F. Higgins............................................ 8,461,508 388,975 0 0 Joseph J. Kearns............................................ 8,461,596 388,887 0 0 Michael F. Klein............................................ 8,460,290 390,193 0 0 W. Allen Reed............................................... 8,459,733 390,750 0 0 Fergus Reid................................................. 8,456,697 393,786 0 0
(2) Elimination of certain fundamental investment restrictions:
FOR AGAINST ABSTAIN BNV* ---------------------------------------------------- Elimination of the fundamental policy restricting the Fund's ability to pledge assets......................... 7,632,626 364,794 254,546 598,517 Elimination of the fundamental policy restricting purchases of securities on margin....................... 7,615,227 359,568 277,171 598,517 Elimination of the fundamental policy prohibiting investments in oil, gas, and other types of minerals or mineral leases.......................................... 7,458,791 512,364 280,811 598,517 Elimination of the fundamental policy prohibiting investments for purposes of exercising control.......... 7,620,295 344,024 287,647 598,517 Elimination of the fundamental policy regarding investments in unseasoned companies..................... 7,601,002 336,577 314,387 598,517
26 Morgan Stanley Limited Duration Fund RESULTS OF SPECIAL SHAREHOLDER MEETING (UNAUDITED) continued (3) Modify certain fundamental investment restrictions:
FOR AGAINST ABSTAIN BNV* ---------------------------------------------------- Modify fundamental policy regarding diversification....... 7,649,022 312,161 290,783 598,517 Modify fundamental policy regarding borrowing money....... 7,602,110 358,319 291,537 598,517 Modify fundamental policy regarding loans................. 7,425,832 527,030 299,104 598,517 Modify fundamental policy regarding investment in commodities, commodity contracts and futures contracts............................................... 7,476,634 471,386 303,946 598,517 Modify fundamental policy regarding issuance of senior securities.............................................. 7,473,395 469,138 309,433 598,517
(4) Reclassify certain fundamental policies as non-fundamental policies:
FOR AGAINST ABSTAIN BNV* ---------------------------------------------------- Reclassification as non-fundamental the fundamental policy regarding the short sale of securities.................. 7,438,184 501,180 312,602 598,517 Reclassification as non-fundamental the fundamental policy prohibiting investments in other investment companies... 7,456,776 474,994 320,196 598,517
------------------ * Broker "non-votes" are shares held in street name for which the broker indicates that instructions have not been received from the beneficial owners or other persons entitled to vote and for which the broker does not have discretionary voting authority. 27 TRUSTEES Frank L. Bowman Michael Bozic Kathleen A. Dennis Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael F. Klein Michael E. Nugent W. Allen Reed Fergus Reid OFFICERS Michael E. Nugent Chairman of the Board Ronald E. Robison President and Principal Executive Officer J. David Germany Vice President Dennis F. Shea Vice President Barry Fink Vice President Amy R. Doberman Vice President Carsten Otto Chief Compliance Officer Stefanie V. Chang Yu Vice President Francis J. Smith Treasurer and Chief Financial Officer Mary E. Mullin Secretary TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT ADVISER Morgan Stanley Investment Advisors Inc. 1221 Avenue of the Americas New York, New York 10020 The financial statements included herein have been taken from the records of the Fund without examination by the independent auditors and accordingly they do not express an opinion thereon. This report is submitted for the general information of the shareholders of the Fund. For more detailed information about the Fund, its fees and expenses and other pertinent information, please read its Prospectus. The Fund's Statement of Additional Information contains additional information about the Fund, including its trustees. It is available, without charge, by calling (800) 869-NEWS. This report is not authorized for distribution to prospective investors in the Fund unless preceded or accompanied by an effective Prospectus. Read the Prospectus carefully before investing. Investments and services offered through Morgan Stanley DW Inc., member SIPC. Morgan Stanley Distributors Inc., member NASD. (c) 2006 Morgan Stanley [MORGAN STANLEY LOGO] MORGAN STANLEY FUNDS Morgan Stanley Limited Duration Fund Semiannual Report October 31, 2006 [MORGAN STANLEY LOGO] RA06-01138P-Y10/06 MALSAN SAR Item 2. Code of Ethics. Not applicable for semiannual reports. Item 3. Audit Committee Financial Expert. Not applicable for semiannual reports. Item 4. Principal Accountant Fees and Services Not applicable for semiannual reports. Item 5. Audit Committee of Listed Registrants. Not applicable for semiannual reports. Item 6. Refer to Item 1. Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies. Not applicable for semiannual reports. Item 8. Portfolio Managers of Closed-End Management Investment Companies Applicable only to reports filed by closed-end funds. Item 9. Closed-End Fund Repurchases Applicable to reports filed by closed-end funds. Item 10. Submission of Matters to a Vote of Security Holders Not applicable. Item 11. Controls and Procedures (a) The Fund's principal executive officer and principal financial officer have concluded that the Fund's disclosure controls and procedures are sufficient to ensure that information required to be disclosed by the Fund in this Form N-CSR was recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, based upon such officers' evaluation of these controls and procedures as of a date within 90 days of the filing date of the report. (b) There were no changes in the registrant's internal control over financial reporting that occurred during the second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. Item 12. Exhibits (a) Code of Ethics - Not applicable for semiannual reports. (b) A separate certification for each principal executive officer and principal financial officer of the registrant are attached hereto as part of EX-99.CERT. 2 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Morgan Stanley Limited Duration Fund /s/ Ronald E. Robison ------------------------------------- Ronald E. Robison Principal Executive Officer December 19, 2006 Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ Ronald E. Robison ------------------------------------- Ronald E. Robison Principal Executive Officer December 19, 2006 /s/ Francis Smith ------------------------------------- Francis Smith Principal Financial Officer December 19, 2006 3