small company growth portfolio€¦ · small company growth portfolio class ii $1,000.00 $1,008.70...

The Universal Institutional Funds, Inc.

The Portfolio is intended to be a funding vehicle for variable annuity contracts and variable life insurance policies offeredby the separate accounts of certain life insurance companies.

Small Company Growth Portfolio

Semi-Annual Report – June 30, 2016

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Table of Contents

Expense Example...................................................................................................................................................................... 2

Portfolio of Investments............................................................................................................................................................ 3

Statement of Assets and Liabilities ............................................................................................................................................ 5

Statement of Operations........................................................................................................................................................... 6

Statements of Changes in Net Assets......................................................................................................................................... 7

Financial Highlights ................................................................................................................................................................. 8

Notes to Financial Statements................................................................................................................................................... 9

Investment Advisory Agreement Approval ................................................................................................................................ 17

Director and Officer Information ............................................................................................................................... Back Cover

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As a shareholder of the Small Company Growth Portfolio (the “Portfolio”), you incur two types of costs: (1) insurance companycharges; and (2) ongoing costs, including advisory fees, administration fees, distribution (12b-1) fees and other Portfolioexpenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Portfolio and tocompare these costs with the ongoing costs of investing in other mutual funds.This example is based on an investment of $1,000 invested at the beginning of the six-month period ended June 30, 2016 andheld for the entire six-month period.Actual Expenses

The table below provides information about actual account values and actual expenses. You may use the information in thistable, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your accountvalue by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in thetable under the heading entitled “Actual Expenses Paid During Period” to estimate the expenses you paid on your accountduring this period.Hypothetical Example for Comparison Purposes

The table below provides information about hypothetical account values and hypothetical expenses based on the Portfolio’sactual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Portfolio’s actual return. Thehypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paidfor the period. You may use this information to compare the ongoing costs of investing in the Portfolio and other funds. To doso, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the otherfunds.Please note that the expenses shown in the table are meant to highlight your ongoing costs only and do not reflect any insurancecompany charges. Therefore, the table below is useful in comparing ongoing costs, but will not help you determine the relativetotal cost of owning different funds. In addition, if these insurance company charges were included, your costs would have beenhigher. Beginning Actual Ending Hypothetical Actual Hypothetical Net Expense Account Value Account Value Ending Expenses Paid Expenses Paid Ratio During 1/1/16 6/30/16 Account Value During Period* During Period* Period**

Small Company Growth Portfolio Class II $1,000.00 $1,008.70 $1,018.70 $6.19 $6.22 1.24%

* Expenses are calculated using the Portfolio Class’ annualized net expense ratio (as disclosed), multiplied by the average account value over the period,and multiplied by 182/366 (to reflect the most recent one-half year period).

**Annualized.

Expense Example (unaudited)Small Company Growth Portfolio

2



Portfolio of InvestmentsSmall Company Growth Portfolio

3The accompanying notes are an integral part of the financial statements.

Value Shares (000)

Common Stocks (95.3%)Aerospace & Defense (4.4%)

BWX Technologies, Inc. 13,557 $ 485

Biotechnology (2.5%)Agios Pharmaceuticals, Inc. (a)(b) 740 31Alnylam Pharmaceuticals, Inc. (b) 581 32Bellicum Pharmaceuticals, Inc. (b) 2,999 39Editas Medicine, Inc. (b) 1,866 46Intellia Therapeutics, Inc. (b) 2,262 48Intrexon Corp. (b) 2,166 53Juno Therapeutics, Inc. (a)(b) 792 30ZIOPHARM Oncology, Inc. (a)(b) 448 3

282

Capital Markets (2.7%)Artisan Partners Asset Management, Inc., Class A 3,877 107Financial Engines, Inc. 3,453 89WisdomTree Investments, Inc. (a) 10,184 100

296

Chemicals (0.4%)Platform Specialty Products Corp. (b) 5,511 49

Consumer Finance (0.5%)LendingClub Corp. (a)(b) 11,583 50

Electronic Equipment, Instruments & Components (1.2%)Cognex Corp. 1,731 75FARO Technologies, Inc. (b) 1,700 57

132

Health Care Equipment & Supplies (1.2%)Penumbra, Inc. (b) 2,204 131

Health Care Providers & Services (1.9%)HealthEquity, Inc. (b) 7,051 214

Health Care Technology (13.0%)athenahealth, Inc. (b) 4,079 563Castlight Health, Inc., Class B (b) 17,799 70Cotiviti Holdings, Inc. (b) 8,840 187Medidata Solutions, Inc. (b) 7,017 329Press Ganey Holdings, Inc. (b) 3,390 133Veeva Systems, Inc., Class A (b) 4,853 166

1,448

Hotels, Restaurants & Leisure (9.2%)Fiesta Restaurant Group, Inc. (b) 6,859 149Habit Restaurants, Inc. (The) (b) 6,117 100Shake Shack, Inc., Class A (a)(b) 10,699 390Wingstop, Inc. (b) 4,763 130Zoe’s Kitchen, Inc. (b) 6,911 251

1,020

Internet & Catalog Retail (4.5%)Blue Nile, Inc. 1,773 49Etsy, Inc. (b) 12,142 116MakeMyTrip Ltd. (India) (b) 3,026 45Ocado Group PLC (United Kingdom) (b) 27,687 85

Value Shares (000)

Wayfair, Inc., Class A (a)(b) 5,260 $ 205

500

Internet Software & Services (21.9%)Angie’s List, Inc. (b) 8,281 54Benefitfocus, Inc. (b) 3,807 145Criteo SA ADR (France) (b) 9,469 435GrubHub, Inc. (a)(b) 18,881 586Just Eat PLC (United Kingdom) (b) 27,552 157New Relic, Inc. (b) 4,141 122Quotient Technology, Inc. (b) 6,474 87Shutterstock, Inc. (a)(b) 4,601 211Twitter, Inc. (b) 10,334 175Zillow Group, Inc., Class A (b) 4,254 156Zillow Group, Inc., Class C (b) 8,557 310

2,438

Machinery (8.0%)Joy Global, Inc. 14,120 298Manitowoc Foodservice, Inc. (b) 16,491 291Terex Corp. 14,924 303

892

Multi-Line Retail (2.6%)Ollie’s Bargain Outlet Holdings, Inc. (b) 11,718 292

Multi-Utilities (0.0%)AET&D Holdings No. 1 Ltd. (Australia) (b)(c)(d) 113,183 —

Professional Services (6.6%)Advisory Board Co. (The) (b) 10,163 360CEB, Inc. 2,859 176WageWorks, Inc. (b) 3,340 200

736

Software (7.7%)Ellie Mae, Inc. (b) 1,154 106FleetMatics Group PLC (b) 4,707 204Guidewire Software, Inc. (b) 5,619 347Xero Ltd. (Australia) (b) 3,745 49Zendesk, Inc. (b) 5,801 153

859

Specialty Retail (7.0%)Burlington Stores, Inc. (b) 2,047 136Five Below, Inc. (b) 12,107 562Restoration Hardware Holdings, Inc. (b) 2,604 75

773

Total Common Stocks (Cost $9,111) 10,597

Preferred Stocks (0.0%)Internet Software & Services (0.0%)

Mode Media Corporation Series M-1 (b)(c)(d)(e)(acquisition cost — $142; acquired 3/19/08) 9,428 3

Mode Media Corporation Escrow Series M-1 (b)(c)(d)(e)(acquisition cost — $13; acquired 3/19/08) 1,346 —@

Total Preferred Stocks (Cost $155) 3


Semi-Annual Report – June 30, 2016 (unaudited)



Portfolio of Investments (cont’d)Small Company Growth Portfolio

4 The accompanying notes are an integral part of the financial statements.

Face Amount Value (000) (000)

Promissory Notes (0.1%)Internet Software & Services (0.1%)

Mode Media Corporation9.00%, 12/3/19 (b)(c)(d)(e)(acquisition cost — $60; acquired 3/19/08) $ 21 $ 13

Mode Media Corporation Escrow9.00%, 12/3/19 (b)(c)(d)(e)(acquisition cost — $2; acquired 3/19/08) 1 —@

Total Promissory Notes (Cost $62) 13

Shares Short-Term Investments (16.5%)Securities held as Collateral on Loaned Securities (12.8%)Investment Company (10.3%)

Morgan Stanley Institutional Liquidity Funds — Treasury Securities Portfolio —Institutional Class (See Note H) 1,149,395 1,149

Face Amount (000) Repurchase Agreements (2.5%)

Barclays Capital, Inc., (0.42%, dated 6/30/16, due 7/1/16; proceeds $266; fully collateralized by a U.S. Government obligation; 2.00% due 8/15/25; valued at $271) $ 266 $ 266

Merrill Lynch & Co., Inc., (0.44%, dated 6/30/16, due 7/1/16; proceeds $11; fully collateralized by a U.S. Government agency security; 4.50% due 4/20/44; valued at $11) 11 11

277

Total Securities held as Collateral on Loaned Securities (Cost $1,426) 1,426

Shares Investment Company (3.7%)

Morgan Stanley Institutional Liquidity Funds — Treasury Securities Portfolio —Institutional Class (See Note H) (Cost $409) 408,815 409

Total Short-Term Investments (Cost $1,835) 1,835

Total Investments (111.9%) (Cost $11,163) Including $1,606 of Securities Loaned (f)(g) 12,448

Liabilities in Excess of Other Assets (-11.9%) (1,320)

Net Assets (100.0%) $11,128

(a) All or a portion of this security was on loan at June 30, 2016.(b) Non-income producing security.(c) Security has been deemed illiquid at June 30, 2016.

(d) At June 30, 2016, the Portfolio held fair valued securities valued atapproximately $16,000, representing 0.1% of net assets. Thesesecurities have been fair valued as determined in good faith underprocedures established by and under the general supervision of theFund’s Directors.

(e) Security cannot be offered for public resale without first beingregistered under the Securities Act of 1933 and related rules(“restricted security”). Acquisition date represents the day on which anenforceable right to acquire such security is obtained and is presentedalong with related cost in the security description. The Portfolio hasregistration rights for certain restricted securities. Any costs related tosuch registration are borne by the issuer. The aggregate value ofrestricted securities (excluding 144A holdings) at June 30, 2016,amounts to approximately $16,000 and represents 0.1% of netassets.

(f) The approximate fair value and percentage of net assets, $291,000and 2.6%, respectively, represent the securities that have been fairvalued under the fair valuation policy for international investments asdescribed in Note A-1 within the Notes to the Financial Statements.

(g) At June 30, 2016, the aggregate cost for Federal income taxpurposes approximates the aggregate cost for book purposes. Theaggregate gross unrealized appreciation is approximately $2,132,000and the aggregate gross unrealized depreciation is approximately$847,000 resulting in net unrealized appreciation of approximately$1,285,000.

@ Value is less than $500.ADR American Depositary Receipt.

Portfolio Composition*

Percentage ofClassification Total InvestmentsOther** 25.9%Internet Software & Services 22.1Health Care Technology 13.1Hotels, Restaurants & Leisure 9.3Machinery 8.1Software 7.8Specialty Retail 7.0Professional Services 6.7Total Investments 100.0%

* Percentages indicated are based upon total investments (excluding Securities heldas Collateral on Loaned Securities) as of June 30, 2016.

** Industries and/or investment types representing less than 5% of total investments.







5

June 30, 2016Statement of Assets and Liabilities (000)

Assets:Investments in Securities of Unaffiliated Issuers, at Value(1) (Cost $9,605) $10,890Investment in Security of Affiliated Issuer, at Value (Cost $1,558) 1,558

Total Investments in Securities, at Value (Cost $11,163) 12,448Foreign Currency, at Value (Cost $-@) —@Receivable for Portfolio Shares Sold 137Due from Adviser 9Receivable for Investments Sold 3Interest Receivable —@Dividends Receivable —@Receivable from Affiliate —@Other Assets 8

Total Assets 12,605

Liabilities:Collateral on Securities Loaned, at Value 1,426Payable for Professional Fees 22Payable for Custodian Fees 12Payable for Servicing Fees 8Payable for Distribution Fees — Class II Shares 2Payable for Administration Fees 1Payable for Transfer Agency Fees —@Payable for Portfolio Shares Redeemed —@Other Liabilities 6

Total Liabilities 1,477

NET ASSETS $11,128

Net Assets Consist of:Paid-in-Capital $10,161Accumulated Net Investment Loss (10)Accumulated Net Realized Loss (308)Unrealized Appreciation (Depreciation) on:

Investments 1,285Foreign Currency Translations (—@)

Net Assets $11,128

CLASS II:Net Asset Value, Offering and Redemption Price Per Share Applicable to 1,096,773 Outstanding

$0.001 Par Value Shares (Authorized 500,000,000 Shares) $ 10.15(1) Including:

Securities on Loan, at Value: $ 1,606

@ Amount is less than $500.


The accompanying notes are an integral part of the financial statements.

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Six Months Ended June 30, 2016Statement of Operations (000)

Investment Income:Income from Securities Loaned — Net $ 44Dividends from Securities of Unaffiliated Issuers 12Dividends from Security of Affiliated Issuer (Note H) 1

Total Investment Income 57

Expenses:Advisory Fees (Note B) 49Professional Fees 46Distribution Fees — Class II Shares (Note E) 13Custodian Fees (Note G) 8Servicing Fees (Note D) 7Shareholder Reporting Fees 6Administration Fees (Note C) 4Pricing Fees 3Transfer Agency Fees (Note F) 1Directors’ Fees and Expenses 1Other Expenses 3

Total Expenses 141Waiver of Advisory Fees (Note B) (49)Expenses Reimbursed by Adviser (Note B) (26)Rebate from Morgan Stanley Affiliate (Note H) (—@)

Net Expenses 66

Net Investment Loss (9)

Realized Loss:Investments Sold (195)Foreign Currency Transactions (—@)

Net Realized Loss (195)

Change in Unrealized Appreciation (Depreciation):Investments 235Foreign Currency Translations —@

Net Change in Unrealized Appreciation (Depreciation) 235

Net Realized Loss and Change in Unrealized Appreciation (Depreciation) 40

Net Increase in Net Assets Resulting from Operations $ 31

@ Amount is less than $500.







7

Six Months Ended June 30, 2016 Year Ended (unaudited) December 31, 2015Statements of Changes in Net Assets (000) (000)

Increase (Decrease) in Net Assets:Operations:

Net Investment Loss $ (9) $ (77)Net Realized Gain (Loss) (195) 947Net Change in Unrealized Appreciation (Depreciation) 235 (2,176)

Net Increase (Decrease) in Net Assets Resulting from Operations 31 (1,306)

Distributions from and/or in Excess of:Class II:Net Realized Gain (992) (3,842)

Capital Share Transactions:(1)

Class II:Subscribed 292 529Distributions Reinvested 992 3,842Redeemed (1,061) (3,369)

Net Increase in Net Assets Resulting from Capital Share Transactions 223 1,002

Total Decrease in Net Assets (738) (4,146)Net Assets:

Beginning of Period 11,866 16,012

End of Period (Including Accumulated Net Investment Loss of $(10) and $(1)) $11,128 $11,866(1) Capital Share Transactions:

Class II:Shares Subscribed 28 41Shares Issued on Distributions Reinvested 98 298Shares Redeemed (103) (240)

Net Increase in Class II Shares Outstanding 23 99







8

Class II Six Months Ended June 30, 2016 Year Ended December 31,Selected Per Share Data and Ratios (unaudited) 2015 2014 2013 2012 2011

Net Asset Value, Beginning of Period $ 11.06 $ 16.43 $ 27.44 $ 16.67 $ 14.81 $ 16.87

Income (Loss) from Investment Operations:Net Investment Loss† (0.01) (0.08) (0.12) (0.15) (0.07) (0.08)Net Realized and Unrealized Gain (Loss) 0.11 (0.91) (3.58) 11.74 2.24 (1.30)

Total from Investment Operations 0.10 (0.99) (3.70) 11.59 2.17 (1.38)

Distributions from and/or in Excess of:Net Investment Income — — — — — (0.68)Net Realized Gain (1.01) (4.38) (7.31) (0.82) (0.31) —

Total Distributions (1.01) (4.38) (7.31) (0.82) (0.31) (0.68)

Net Asset Value, End of Period $ 10.15 $ 11.06 $ 16.43 $ 27.44 $ 16.67 $ 14.81

Total Return ++ 0.87%# (9.79)% (13.86)% 71.33% 14.71% (8.71)%

Ratios and Supplemental Data:Net Assets, End of Period (Thousands) $11,128 $11,866 $16,012 $23,375 $18,771 $21,696Ratio of Expenses to Average Net Assets(1) 1.24%+* 1.25%+ 1.24%+ 1.25%+ 1.25%+ 1.25%+Ratio of Net Investment Loss to Average Net Assets (1) (0.16)%+* (0.54)%+ (0.61)%+ (0.70)%+ (0.43)%+ (0.51)%+Ratio of Rebate from Morgan Stanley Affiliates to Average Net Assets 0.01%* 0.00%§ 0.01% 0.00%§ 0.00%§ 0.00%§Portfolio Turnover Rate 20%# 39% 50% 46% 22% 26%(1) Supplemental Information on the Ratios to Average Net Assets:

Ratios Before Expense Limitation:Expenses to Average Net Assets 2.66%* 2.46% 2.41% 2.25% 2.05% 1.92%Net Investment Loss to Average Net Assets (1.58)%* (1.75)% (1.78)% (1.70)% (1.23)% (1.18)%

† Per share amount is based on average shares outstanding.++ Calculated based on the net asset value as of the last business day of the period. Performance does not reflect fees and expenses imposed by your insurance

company’s separate account. If performance information included the effect of these additional charges, the total return would be lower.+ The Ratios of Expenses and Net Investment Loss reflect the rebate of certain Portfolio expenses in connection with the investments in Morgan Stanley affiliates

during the period. The effect of the rebate on the ratios is disclosed in the above table as “Ratio of Rebate from Morgan Stanley Affiliates to Average Net Assets.”§ Amount is less than 0.005%.# Not Annualized.* Annualized.


Financial HighlightsSmall Company Growth Portfolio

Merrill Corp - MS Universal Institutional Funds Small Company Growth Portfolio Semi-Annual Report [Fund...ED [AUX] | sholt | 19-Aug-16 16:32 | 16-14864-12.da | Sequence: 1CHKSUM Content: 29516 Layout: 1716 Graphics: No Graphics CLEAN




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The Universal Institutional Funds, Inc. (the “Fund”) is regis-tered under the Investment Company Act of 1940, asamended (the “Act”), as an open-end management investmentcompany. The Fund is comprised of eleven separate active, di-versified and non-diversified portfolios (individually referredto as a “Portfolio”, collectively as the “Portfolios”). The Fundapplies investment company accounting and reporting guidance.The accompanying financial statements relate to the SmallCompany Growth Portfolio. The Portfolio seeks long-termcapital appreciation by investing primarily in growth-orientedequity securities of small companies. The Portfolio holdspromissory notes it has made to certain investee companies forthis same purpose, the details of which are disclosed in thePortfolio of Investments. The Portfolio currently offers Class IIshares only, although Class I shares may be offered in the fu-ture.The Fund is intended to be the funding vehicle for variableannuity contracts and variable life insurance policies offeredby the separate accounts of certain life insurance companies.Effective at the close of business on May 30, 2014, the Portfo-lio suspended offering Class II shares of the Portfolio to newinvestors. The Portfolio will continue to offer Class II sharesof the Portfolio to existing shareholders. The Portfolio mayrecommence offering Class II shares of the Portfolio to newinvestors in the future. Any such offerings of the Portfolio’sClass II shares may be limited in amount and may commenceand terminate without any prior notice.A. Significant Accounting Policies: The following sig-nificant accounting policies are in conformity with U.S. gen-erally accepted accounting principles (“GAAP”). Such policiesare consistently followed by the Fund in the preparation of itsfinancial statements. GAAP may require management tomake estimates and assumptions that affect the reportedamounts and disclosures in the financial statements. Actualresults may differ from those estimates.1. Security Valuation: (1) An equity portfolio security

listed or traded on an exchange is valued at its latest re-ported sales price (or at the exchange official closing priceif such exchange reports an official closing price), and ifthere were no sales on a given day and if there is no offi-cial exchange closing price for that day, the security is val-ued at the mean between the last reported bid and askedprices if such bid and asked prices are available on the rel-evant exchanges; (2) all other equity portfolio securitiesfor which over-the-counter (“OTC”) market quotationsare readily available are valued at the latest reported salesprice (or at the market official closing price if such market reports an official closing price), and if there was

no trading in the security on a given day and if there isno official closing price from relevant markets for thatday, the security is valued at the mean between the last re-ported bid and asked prices if such bid and asked pricesare available on the relevant markets. Listed equity securi-ties not traded on the valuation date with no reported bidand asked prices available on the exchange are valued atthe mean between the current bid and asked prices ob-tained from one or more reputable brokers or dealers. Anunlisted equity security that does not trade on the valua-tion date and for which bid and asked prices from the rel-evant markets are unavailable is valued at the meanbetween the current bid and asked prices obtained fromone or more reputable brokers or dealers. In cases where asecurity is traded on more than one exchange, the secu-rity is valued on the exchange designated as the primarymarket; (3) when market quotations are not readily avail-able, including circumstances under which Morgan Stan-ley Investment Management Inc. (the “Adviser”)determines that the closing price, last sale price or themean between the last reported bid and asked prices arenot reflective of a security’s market value, portfolio securi-ties are valued at their fair value as determined in goodfaith under procedures established by and under the gen-eral supervision of the Fund’s Board of Directors (the“Directors”). Occasionally, developments affecting theclosing prices of securities and other assets may occur be-tween the times at which valuations of such securities aredetermined (that is, close of the foreign market on whichthe securities trade) and the close of business of the NewYork Stock Exchange (“NYSE”). If developments occurduring such periods that are expected to materially affectthe value of such securities, such valuations may be ad-justed to reflect the estimated fair value of such securitiesas of the close of the NYSE, as determined in good faithby the Directors or by the Adviser using a pricing serviceand/or procedures approved by the Directors; (4) quota-tions of foreign portfolio securities, other assets and lia-bilities and forward contracts stated in foreign currencyare translated into U.S. dollar equivalents at the prevail-ing market rates prior to the close of the NYSE; (5) in-vestments in mutual funds, including the Morgan StanleyInstitutional Liquidity Funds, are valued at the net assetvalue (“NAV”) as of the close of each business day; and(6) short-term debt securities with remaining maturitiesof 60 days or less at the time of purchase may be valuedat amortized cost, unless the Adviser determines such val-uation does not reflect the securities’ market value, inwhich case these securities will be valued at their fair mar-ket value determined by the Adviser.

Notes to Financial Statements

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The Directors have responsibility for determining ingood faith the fair value of the investments, and the Di-rectors may appoint others, such as the Fund’s Adviser ora valuation committee, to assist the Directors in deter-mining fair value and to make the actual calculationspursuant to the fair valuation methodologies previouslyapproved by the Directors. Under procedures approvedby the Directors, the Fund’s Adviser has formed a Valua-tion Committee whose members are approved by the Di-rectors. The Valuation Committee providesadministration and oversight of the Fund’s valuation poli-cies and procedures, which are reviewed at least annuallyby the Directors. These procedures allow the Fund to uti-lize independent pricing services, quotations from securi-ties and financial instrument dealers, and other marketsources to determine fair value.The Fund has procedures to determine the fair value ofsecurities and other financial instruments for which mar-ket prices are not readily available. Under these proce-dures, the Valuation Committee convenes on a regularand ad hoc basis to review such securities and considers anumber of factors, including valuation methodologiesand significant unobservable valuation inputs, when ar-riving at fair value. The Valuation Committee may em-ploy a market-based approach which may use related orcomparable assets or liabilities, recent transactions, mar-ket multiples, book values, and other relevant informa-tion for the investment to determine the fair value of theinvestment. An income-based valuation approach mayalso be used in which the anticipated future cash flows ofthe investment are discounted to calculate fair value. Dis-counts may also be applied due to the nature or durationof any restrictions on the disposition of the investments.Due to the inherent uncertainty of valuations of such in-vestments, the fair values may differ significantly fromthe values that would have been used had an active mar-ket existed. The Valuation Committee employs variousmethods for calibrating these valuation approaches in-cluding a regular review of valuation methodologies, keyinputs and assumptions, transactional back-testing or dis-position analysis, and reviews of any related market activity.

2. Fair Value Measurement: Financial AccountingStandards Board (“FASB”) Accounting Standards CodificationTM (“ASC”) 820, “Fair Value Measurement”(“ASC 820”), defines fair value as the value that the Fundwould receive to sell an investment or pay to transfer a li-ability in a timely transaction with an independent buyerin the principal market, or in the absence of a principalmarket the most advantageous market for the investmentor liability. ASC 820 establishes a three-tier hierarchy to

distinguish between (1) inputs that reflect the assump-tions market participants would use in valuing an asset orliability developed based on market data obtained fromsources independent of the reporting entity (observableinputs) and (2) inputs that reflect the reporting entity’sown assumptions about the assumptions market partici-pants would use in valuing an asset or liability developedbased on the best information available in the circum-stances (unobservable inputs) and to establish classification of fair value measurements for disclosurepurposes. Various inputs are used in determining thevalue of the Fund’s investments. The inputs are summa-rized in the three broad levels listed below.

• Level 1 – unadjusted quoted prices in active marketsfor identical investments

• Level 2 – other significant observable inputs (includ-ing quoted prices for similar investments, interestrates, prepayment speeds, credit risk, etc.)

• Level 3 – significant unobservable inputs includingthe Fund’s own assumptions in determining the fairvalue of investments. Factors considered in makingthis determination may include, but are not limitedto, information obtained by contacting the issuer,analysts, or the appropriate stock exchange (for exchange-traded securities), analysis of the issuer’s fi-nancial statements or other available documents and,if necessary, available information concerning othersecurities in similar circumstances

The inputs or methodology used for valuing securities arenot necessarily an indication of the risk associated withinvesting in those securities and the determination of thesignificance of a particular input to the fair value meas-urement in its entirety requires judgment and considersfactors specific to each security.The following is a summary of the inputs used to valuethe Portfolio’s investments as of June 30, 2016.

Level 2 Level 1 Other Level 3 Unadjusted significant Significant quoted observable unobservable prices inputs inputs TotalInvestment Type (000) (000) (000) (000)Assets:Common Stocks

Aerospace & Defense $ 485 $ — $ — $ 485Biotechnology 282 — — 282Capital Markets 296 — — 296Chemicals 49 — — 49Consumer Finance 50 — — 50Electronic Equipment,

Instruments & Components 132 — — 132

Notes to Financial Statements (cont’d)





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Level 2 Level 1 Other Level 3 Unadjusted significant Significant quoted observable unobservable prices inputs inputs TotalInvestment Type (000) (000) (000) (000)Common Stocks (cont’d)

Health Care Equipment & Supplies $ 131 $ — $ — $ 131

Health Care Providers & Services 214 — — 214

Health Care Technology 1,448 — — 1,448Hotels, Restaurants &

Leisure 1,020 — — 1,020Internet & Catalog Retail 415 85 — 500Internet Software &

Services 2,281 157 — 2,438Machinery 892 — — 892Multi-Line Retail 292 — — 292Multi-Utilities — — —† —†Professional Services 736 — — 736Software 810 49 — 859Specialty Retail 773 — — 773

Total Common Stocks 10,306 291 —† 10,597†Preferred Stocks — — 3 3

Promissory Notes — — 13 13

Short-Term InvestmentsInvestment Company 1,558 — — 1,558Repurchase Agreements — 277 — 277

Total Short-Term Investments 1,558 277 — 1,835

Total Assets $11,864 $568 $16† $12,448†

† Includes one security which is valued at zero.

Transfers between investment levels may occur as themarkets fluctuate and/or the availability of data used inan investment’s valuation changes. The Portfolio recog-nizes transfers between the levels as of the end of the

period. As of June 30, 2016, the Portfolio did not haveany investments transfer between investment levels. AtJune 30, 2016, the fair value of certain securities were ad-justed due to developments which occurred between thetime of the close of the foreign markets on which theytrade and the close of business on the NYSE which re-sulted in their Level 2 classification.Following is a reconciliation of investments in which sig-nificant unobservable inputs (Level 3) were used in deter-mining fair value.

Common Preferred Promissory Stock Stocks Notes (000) (000) (000)

Beginning Balance $—† $ 9 $14Purchases — — —Sales — — —Amortization of discount — — —Transfers in — — —Transfers out — — —Corporate actions — — —Change in unrealized

appreciation (depreciation) — (6) (1)Realized gains (losses) — — —

Ending Balance $—† $ 3 $13

Net change in unrealized appreciation (depreciation) from investments still held as of June 30, 2016 $— $ (6) $ (1)

† Includes one security which is valued at zero.

The following table presents additional information aboutvaluation techniques and inputs used for investments that aremeasured at fair value and categorized within Level 3 as ofJune 30, 2016. Various valuation techniques were used in thevaluation of certain investments and weighted based on thelevel of significance.


Fair Value at Impact to June 30, 2016 Valuation Unobservable Selected Valuation from an (000) Technique Input Range Value increase in inputInternet Software & Services

Weighted Average Preferred Stock $3 Discounted Cash Flow Cost of Capital 21.0% 23.0% 22.0% Decrease Perpetual Growth Rate 2.0% 3.0% 2.5% Increase

Market Comparable Enterprise Value/ Companies Revenue 1.3x 3.4x 2.1x Increase Discount for Lack of Marketability 20.0% 20.0% 20.0% Decrease

Valuation at Market Transaction Issuance as a Promissory Note $13 Method Percentage of Principal 100.0% 100.0% 100.0% Increase

Cost of Debt 17.7% 17.7% 17.7% Decrease Valuation as a Percentage of Principal 61.3% 61.3% 61.3% Increase





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3. Repurchase Agreements: The Portfolio may enterinto repurchase agreements under which the Portfoliolends cash and takes possession of securities with anagreement that the counterparty will repurchase such se-curities. In connection with transactions in repurchaseagreements, a bank as custodian for the Portfolio takespossession of the underlying securities which are held ascollateral, with a market value at least equal to theamount of the repurchase transaction, including principaland accrued interest. To the extent that any repurchasetransaction exceeds one business day, the value of the col-lateral is marked-to-market on a daily basis to determinethat the value of the collateral does not decrease belowthe repurchase price plus accrued interest as earned. Ifsuch a decrease occurs, additional collateral will be re-quested and, when received, will be added to the accountto maintain full collateralization. In the event of defaulton the obligation to repurchase, the Portfolio has theright to liquidate the collateral and apply the proceeds insatisfaction of the obligation. In the event of default orbankruptcy by the counterparty to the agreement, realiza-tion of the collateral proceeds may be subject to cost anddelays. The Portfolio, along with other affiliated invest-ment companies, may utilize a joint trading account forthe purpose of entering into repurchase agreements.

4. Foreign Currency Translation and Foreign Investments: The books and records of the Portfolioare maintained in U.S. dollars. Foreign currency amountsare translated into U.S. dollars as follows:— investments, other assets and liabilities at the prevail-

ing rate of exchange on the valuation date;— investment transactions and investment income at

the prevailing rates of exchange on the dates of suchtransactions.

Although the net assets of the Portfolio are presented atthe foreign exchange rates and market values at the closeof the period, the Portfolio does not isolate that portionof the results of operations arising as a result of changesin the foreign exchange rates from the fluctuations arisingfrom changes in the market prices of securities held at pe-riod end. Similarly, the Portfolio does not isolate the ef-fect of changes in foreign exchange rates from thefluctuations arising from changes in the market prices ofsecurities sold during the period. Accordingly, realizedand unrealized foreign currency gains (losses) on invest-ments in securities are included in the reported net real-ized and unrealized gains (losses) on investmenttransactions and balances. However, pursuant to U.S.Federal income tax regulations, gains and losses from

certain foreign currency transactions and the foreign cur-rency portion of gains and losses realized on sales andmaturities of foreign denominated debt securities aretreated as ordinary income for U.S. Federal income taxpurposes.Net realized gains (losses) on foreign currency transac-tions represent net foreign exchange gains (losses) fromforeign currency forward exchange contracts, dispositionof foreign currencies, currency gains (losses) realized be-tween the trade and settlement dates on securities trans-actions, and the difference between the amount ofinvestment income and foreign withholding taxesrecorded on the Portfolio’s books and the U.S. dollarequivalent amounts actually received or paid. Net unreal-ized currency gains (losses) from valuing foreign currencydenominated assets and liabilities at period end exchangerates are reflected as a component of unrealized apprecia-tion (depreciation) in the Statement of Assets and Liabili-ties. The change in unrealized currency gains (losses) onforeign currency translations for the period is reflected inthe Statement of Operations.Foreign security and currency transactions may involvecertain considerations and risks not typically associatedwith those of U.S. dollar denominated transactions as aresult of, among other factors, fluctuations of exchangerates in relation to the U.S. dollar, the possibility of lowerlevels of governmental supervision and regulation of for-eign securities markets and the possibility of political oreconomic instability.Governmental approval for foreign investments may berequired in advance of making an investment under cer-tain circumstances in some countries, and the extent offoreign investments in domestic companies may be sub-ject to limitation in other countries. Foreign ownershiplimitations also may be imposed by the charters of indi-vidual companies to prevent, among other concerns, vio-lations of foreign investment limitations. As a result, anadditional class of shares (identified as “Foreign” in thePortfolio of Investments) may be created and offered forinvestment. The “local” and “foreign shares” market val-ues may differ. In the absence of trading of the foreignshares in such markets, the Portfolio values the foreignshares at the closing exchange price of the local shares.

5. Securities Lending: The Portfolio lends securities toqualified financial institutions, such as broker-dealers, toearn additional income. Any increase or decrease in thefair value of the securities loaned that might occur andany interest earned or dividends declared on those securi-ties during the term of the loan would remain in the






13

Portfolio. The Portfolio would receive cash or securities ascollateral in an amount equal to or exceeding 100% ofthe current fair value of the loaned securities. The collat-eral is marked-to-market daily by State Street Bank andTrust Company (“State Street”), the securities lendingagent, to ensure that a minimum of 100% collateral cov-erage is maintained.Based on pre-established guidelines, the securities lendingagent invests any cash collateral that is received in an af-filiated money market portfolio and repurchase agree-ments. Securities lending income is generated from theearnings on the invested collateral and borrowing fees,less any rebates owed to the borrowers and compensationto the lending agent, and is recorded as “Income from Se-curities Loaned — Net” in the Portfolio’s Statement ofOperations. Risks in securities lending transactions arethat a borrower may not provide additional collateralwhen required or return the securities when due, and thatthe value of the short-term investments will be less thanthe amount of cash collateral plus any rebate that is re-quired to be returned to the borrower.The Portfolio has the right under the lending agreementto recover the securities from the borrower on demand.The following table presents financial instruments thatare subject to enforceable netting arrangements as ofJune 30, 2016.

Gross Amounts Not Offset in the Statement of Assets and Liabilities Gross Asset Amounts Presented in Statement of Net Amount Assets and Financial Collateral (not less Liabilities Instrument Received than $0) (000) (000) (000) (000) $1,606(a) $— $(1,606)(b)(c) $0

(a)Represents market value of loaned securities at period end.

(b)The Portfolio received cash collateral of approximately $1,426,000,which was subsequently invested in Repurchase Agreements andMorgan Stanley Institutional Liquidity Funds as reported in thePortfolio of Investments. In addition, the Portfolio received non-cashcollateral of approximately $203,000 in the form of U.S. Governmentobligations, which the Portfolio cannot sell or repledge, andaccordingly are not reflected in the Portfolio of Investments.

(c)The actual collateral received is greater than the amount shown heredue to overcollateralization.

The Portfolio has adopted the disclosure provisions ofFASB Accounting Standards Update No. 2014-11 (“ASUNo. 2014-11”), “Transfers & Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Fi-nancings, and Disclosures”. ASU No. 2014-11 is in-tended to provide increased transparency about the typesof collateral pledged in securities lending transactions and

other similar transactions that are accounted for as se-cured borrowing.The following table displays a breakdown of transactionsaccounted for as secured borrowings, the gross obliga-tions by class of collateral pledged, and the remainingcontractual maturity of those transactions as of June 30,2016.

Remaining Contractual Maturity of the Agreements Between

Overnight and 30 & Continuous <30 days 90 days >90 days Total

(000) (000) (000) (000) (000)Securities Lending

TransactionsCommon Stocks $ 1,426 $— $— $— $ 1,426

Total Borrowings $1,426 $— $— $— $1,426

Gross amount ofrecognized liabilitiesfor securities lendingtransactions $1,426

6. Restricted Securities: The Portfolio invests in unreg-istered or otherwise restricted securities. The term “re-stricted securities” refers to securities that are unregisteredor are held by control persons of the issuer and securitiesthat are subject to contractual restrictions on their resale.As a result, restricted securities may be more difficult tovalue and the Portfolio may have difficulty disposing ofsuch assets either in a timely manner or for a reasonableprice. In order to dispose of an unregistered security, thePortfolio, where it has contractual rights to do so, mayhave to cause such security to be registered. A consider-able period may elapse between the time the decision ismade to sell the security and the time the security is regis-tered so that the Portfolio could sell it. Contractual re-strictions on the resale of securities vary in length andscope and are generally the result of a negotiation be-tween the issuer and acquirer of the securities. The Port-folio would, in either case, bear market risks during thatperiod. Restricted securities are identified in the Portfolioof Investments.

7. Indemnifications: The Fund enters into contracts thatcontain a variety of indemnifications. The Fund’s maxi-mum exposure under these arrangements is unknown.However, the Fund has not had prior claims or lossespursuant to these contracts and expects the risk of loss tobe remote.

8. Security Transactions, Income and Expenses:Security transactions are accounted for on the trade date(date the order to buy or sell is executed). Realized gainsand losses on the sale of investment securities are






14

determined on the specific identified cost method. Divi-dend income and other distributions are recorded on theex-dividend date (except for certain foreign dividendswhich may be recorded as soon as the Portfolio is in-formed of such dividends) net of applicable withholdingtaxes. Interest income is recognized on the accrual basisexcept where collection is in doubt. Discounts are ac-creted and premiums are amortized over the life of the re-spective securities. Most expenses of the Fund can bedirectly attributed to a particular Portfolio. Expenseswhich cannot be directly attributed are apportionedamong the Portfolios based upon relative net assets orother appropriate methods. Income, expenses (other thanclass specific expenses) and realized and unrealized gainsor losses are allocated to each class of shares based upontheir relative net assets.

9. Dividends and Distributions to Shareholders:Dividend income and distributions to shareholders arerecorded on the ex-dividend date. Dividends from net in-vestment income, if any, are declared and paid annually.Net realized capital gains, if any, are distributed at leastannually.

B. Advisory Fees: The Adviser, a wholly-owned subsidiaryof Morgan Stanley, provides the Portfolio with advisory serv-ices under the terms of an Investment Advisory Agreement,paid quarterly, at the annual rate based on the daily net assetsas follows: First $1 Next $500 Over $1.5 billion million billion 0.92% 0.85% 0.80%

For the six months ended June 30, 2016, the advisory fee rate(net of waivers/rebate) was equivalent to an annual effectiverate of 0.00% of the Portfolio’s average daily net assets.The Adviser has agreed to reduce its advisory fee and/or reim-burse the Portfolio so that the total annual portfolio operatingexpenses, excluding certain investment related expenses, taxes,interest, and other extraordinary expenses (including litiga-tion), will not exceed 1.25% for Class II shares. The feewaivers and/or expense reimbursements will continue for atleast one year from the date of the Portfolio’s prospectus oruntil such time as the Directors act to discontinue all or aportion of such waivers and/or reimbursements when theydeem such action is appropriate. For the six months endedJune 30, 2016, approximately $49,000 of advisory fees werewaived and approximately $26,000 of other expenses were re-imbursed by the Adviser pursuant to this arrangement.C. Administration Fees: The Adviser also serves as Ad-ministrator to the Fund and provides administrative servicespursuant to an Administration Agreement for an annual fee,

accrued daily and paid monthly, of 0.08% of the Portfolio’saverage daily net assets.Under a Sub-Administration Agreement between the Admin-istrator and State Street, State Street provides certain adminis-trative services to the Fund. For such services, theAdministrator pays State Street a portion of the fee the Ad-ministrator receives from the Portfolio.D. Servicing Fees: The Fund accrues daily and pays quar-terly a servicing fee of up to 0.17% of the average daily valueof shares of the Portfolio held in an insurance company’s ac-count. Certain insurance companies have entered into a serv-icing agreement with the Fund to provide administrative andother contract-owner related services on behalf of the Portfolio.E. Distribution Fees: Morgan Stanley Distribution, Inc.(“MSDI” or the “Distributor”), a wholly-owned subsidiary ofthe Adviser and an indirect subsidiary of Morgan Stanley,serves as the Distributor of the Portfolio and provides thePortfolio’s Class II shareholders with distribution services pur-suant to a Distribution Plan (the “Plan”) in accordance withRule 12b-1 under the Act. Under the Plan, the Portfolio isauthorized to pay the Distributor a distribution fee, which isaccrued daily and paid monthly, at an annual rate of 0.25% ofthe Portfolio’s average daily net assets attributable to Class IIshares.F. Dividend Disbursing and Transfer Agent: TheFund’s dividend disbursing and transfer agent is Boston Fi-nancial Data Services, Inc. (“BFDS”). Pursuant to a TransferAgency Agreement, the Fund pays BFDS a fee based on thenumber of classes, accounts and transactions relating to thePortfolios of the Fund.G. Custodian Fees: State Street (the “Custodian”) serves asCustodian for the Fund in accordance with a CustodianAgreement. The Custodian holds cash, securities, and otherassets of the Fund as required by the Act. Custody fees arepayable monthly based on assets held in custody, investmentpurchases and sales activity and account maintenance fees,plus reimbursement for certain out-of-pocket expenses.H. Security Transactions and Transactions with Affiliates: For the six months ended June 30, 2016, pur-chases and sales of investment securities for the Portfolio,other than long-term U.S. Government securities and short-term investments, were approximately $2,118,000 and$2,937,000, respectively. There were no purchases and sales oflong-term U.S. Government securities for the six monthsended June 30, 2016.The Portfolio invests in the Institutional Class of the MorganStanley Institutional Liquidity Funds (the “Liquidity Funds”),






15

an open-end management investment company managed bythe Adviser, both directly and as a portion of the securitiesheld as collateral on loaned securities. Advisory fees paid bythe Portfolio are reduced by an amount equal to its pro-ratashare of the advisory and administration fees paid by the Port-folio due to its investment in the Liquidity Funds. For the sixmonths ended June 30, 2016, advisory fees paid were reducedby less than $500 relating to the Portfolio’s investment in theLiquidity Funds.A summary of the Portfolio’s transactions in shares of the Liq-uidity Funds during the six months ended June 30, 2016 is asfollows: Value Value December 31, Purchases Dividend June 30, 2015 at Cost Sales Income 2016 (000) (000) (000) (000) (000) $1,677 $3,905 $4,024 $1 $1,558

The Portfolio is permitted to purchase and sell securities(“cross-trade”) from and to other Morgan Stanley Funds aswell as other funds and client accounts for which the Adviseror an affiliate of the Adviser serves as investment adviser, pur-suant to procedures approved by the Directors in compliancewith Rule 17a-7 under the Act (the “Rule”). Each cross-tradeis executed at the current market price in compliance withprovisions of the Rule. For the six months ended June 30,2016, the Portfolio engaged in cross-trade purchases of ap-proximately $14,000.The Portfolio has an unfunded Deferred Compensation Plan(the “Compensation Plan”), which allows each independentDirector to defer payment of all, or a portion, of the fees heor she receives for serving on the Board of Directors. Each eli-gible Director generally may elect to have the deferredamounts credited with a return equal to the total return onone or more of the Morgan Stanley funds that are offered asinvestment options under the Compensation Plan. Apprecia-tion/depreciation and distributions received from these invest-ments are recorded with an offsetting increase/decrease in thedeferred compensation obligation and do not affect the NAVof the Portfolio.I. Federal Income Taxes: It is the Portfolio’s intention tocontinue to qualify as a regulated investment company anddistribute all of its taxable and tax-exempt income. Accord-ingly, no provision for Federal income taxes is required in thefinancial statements.The Portfolio may be subject to taxes imposed by countries inwhich it invests. Such taxes are generally based on incomeand/or capital gains earned or repatriated. Taxes are accruedbased on net investment income, net realized gains and netunrealized appreciation as such income and/or gains areearned. Taxes may also be based on transactions in foreign

currency and are accrued based on the value of investmentsdenominated in such currency.FASB ASC 740-10, “Income Taxes — Overall”, sets forth aminimum threshold for financial statement recognition of thebenefit of a tax position taken or expected to be taken in a taxreturn. Management has concluded that there are no signifi-cant uncertain tax positions that would require recognition inthe financial statements. If applicable, the Portfolio recognizesinterest accrued related to unrecognized tax benefits in “Inter-est Expense” and penalties in “Other Expenses” in the State-ment of Operations. The Portfolio files tax returns with theU.S. Internal Revenue Service, New York and various states.Each of the tax years in the four-year period ended Decem-ber 31, 2015, remains subject to examination by taxing authorities.The tax character of distributions paid may differ from thecharacter of distributions shown in the Statements of Changesin Net Assets due to short-term capital gains being treated asordinary income for tax purposes. The tax character of distri-butions paid during fiscal years 2015 and 2014 was as follows: 2015 Distributions 2014 Distributions Paid From: Paid From: Ordinary Long-Term Ordinary Long-Term Income Capital Gain Income Capital Gain (000) (000) (000) (000) $— $3,842 $179 $5,249

The amount and character of income and gains to be distrib-uted are determined in accordance with income tax regula-tions which may differ from GAAP. These book/taxdifferences are either considered temporary or permanent innature.Temporary differences are attributable to differing book andtax treatments for the timing of the recognition of gains(losses) on certain investment transactions and the timing ofthe deductibility of certain expenses.Permanent differences, primarily due to differing treatmentsof gains (losses) related to foreign currency transactions and anet operating loss, resulted in the following reclassificationsamong the components of net assets at December 31, 2015: Accumulated Accumulated Undistributed Net Investment Net Realized Paid-in- Loss Gain Capital (000) (000) (000) $77 $1 $(78)






16

At December 31, 2015, the components of distributable earn-ings for the Portfolio on a tax basis were as follows: Undistributed Undistributed Ordinary Long-Term Income Capital Gain (000) (000) $— $990

J. Credit Facility: As of April 4, 2016, the Fund and otherMorgan Stanley funds participate in a $150,000,000 commit-ted, unsecured revolving line of credit facility (the “facility”)with State Street. This facility is to be used for temporaryemergency purposes or funding of shareholder redemption re-quests. The interest rate on borrowings is based on the federalfunds rate or one month libor rate plus a spread. The facilityalso has a commitment fee of 0.25% per annum based on theunused portion of the facility. During the period endedJune 30, 2016, the Fund did not have any borrowings underthe facility.K. Other: At June 30, 2016, the Portfolio had record ownersof 10% or greater. Investment activities of these shareholderscould have a material impact on the Portfolio. The aggregatepercentage of such owners was 89.3%.






17

Nature, Extent and Quality of Services

The Board reviewed and considered the nature and extent of the investment advisory services provided by the Adviser (asdefined herein) under the advisory agreement, including portfolio management, investment research and equity and fixedincome securities trading. The Board also reviewed and considered the nature and extent of the non-advisory, administrativeservices provided by the Adviser under the administration agreement, including accounting, operations, clerical, bookkeeping,compliance, business management and planning, legal services and the provision of supplies, office space and utilities at theAdviser’s expense. The Board also considered the Adviser’s investment in personnel and infrastructure that benefits the Portfolio.(The advisory and administration agreements together are referred to as the “Management Agreement.”) The Board alsoconsidered that the Adviser serves a variety of other investment advisory clients and has experience overseeing service providers.The Board also compared the nature of the services provided by the Adviser with similar services provided by non-affiliatedadvisers as reported to the Board by Broadridge Financial Solutions, Inc. (“Broadridge”).

The Board reviewed and considered the qualifications of the portfolio managers, the senior administrative managers and otherkey personnel of the Adviser who provide the administrative and advisory services to the Portfolio. The Board determined thatthe Adviser’s portfolio managers and key personnel are well qualified by education and/or training and experience to perform theservices in an efficient and professional manner. The Board concluded that the nature and extent of the advisory andadministrative services provided were necessary and appropriate for the conduct of the business and investment activities of thePortfolio and supported its decision to approve the Management Agreement.

Performance, Fees and Expenses of the Portfolio

The Board reviewed the performance, fees and expenses of the Portfolio compared to its peers, as determined by Broadridge, andto appropriate benchmarks where applicable. The Board discussed with the Adviser the performance goals and the actual resultsachieved in managing the Portfolio. When considering a fund’s performance, the Board and the Adviser place emphasis ontrends and longer-term returns (focusing on one-year, three-year and five-year performance, as of December 31, 2015, or sinceinception, as applicable). When a fund underperforms its benchmark and/or its peer group average, the Board and the Adviserdiscuss the causes of such underperformance and, where necessary, they discuss specific changes to investment strategy orinvestment personnel. The Board noted that the Portfolio’s performance was below its peer group average for the one-, three-and five-year periods. The Board discussed with the Adviser the level of the advisory and administration fees (together, the“management fee”) for this Portfolio relative to comparable funds and/or other accounts advised by the Adviser and/or comparedto its peers as determined by Broadridge. In addition to the management fee, the Board also reviewed the Portfolio’s totalexpense ratio. When a fund’s management fee and/or its total expense ratio are higher than its peers, the Board and the Adviserdiscuss the reasons for this and, where appropriate, they discuss possible waivers and/or caps. The Board noted that thePortfolio’s contractual management fee was higher than its peer group average, the actual management fee was lower than its peergroup average and the total expense ratio was higher than but close to its peer group average. After discussion, the Boardconcluded that the Portfolio’s (i) performance was acceptable; and (ii) management fee and total expense ratio were competitivewith its peer group averages.

Economies of Scale

The Board considered the size and growth prospects of the Portfolio and how that relates to the Portfolio’s total expense ratioand particularly the Portfolio’s management fee rate, which includes breakpoints. In conjunction with its review of the Adviser’sprofitability, the Board discussed with the Adviser how a change in assets can affect the efficiency or effectiveness of managingthe Portfolio and whether the management fee level is appropriate relative to current and projected asset levels and/or whetherthe management fee structure reflects economies of scale as asset levels change. The Board has determined that its review of theactual and/or potential economies of scale of the Portfolio supports its decision to approve the Management Agreement.

Profitability of the Adviser and Affiliates

The Board considered information concerning the costs incurred and profits realized by the Adviser and its affiliates during thelast year from their relationship with the Portfolio and during the last two years from their relationship with the Morgan Stanley

Investment Advisory Agreement Approval (unaudited)

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18

Fund Complex and reviewed with the Adviser the cost allocation methodology used to determine the profitability of the Adviserand affiliates. The Board has determined that its review of the analysis of the Adviser’s expenses and profitability supports itsdecision to approve the Management Agreement.

Other Benefits of the Relationship

The Board considered other direct and indirect benefits to the Adviser and/or its affiliates derived from their relationship withthe Portfolio and other funds advised by the Adviser. These benefits may include, among other things, fees for trading,distribution and/or shareholder servicing and for transaction processing and reporting platforms used by securities lendingagents, and research received by the Adviser generated from commission dollars spent on funds’ portfolio trading. The Boardreviewed with the Adviser these arrangements and the reasonableness of the Adviser’s costs relative to the services performed. TheBoard has determined that its review of the other benefits received by the Adviser or its affiliates supports its decision to approvethe Management Agreement.

Resources of the Adviser and Historical Relationship Between the Portfolio and the Adviser

The Board considered whether the Adviser is financially sound and has the resources necessary to perform its obligations underthe Management Agreement. The Board also reviewed and considered the historical relationship between the Portfolio and theAdviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviserfor managing the Portfolio’s operations and the Board’s confidence in the competence and integrity of the senior managers andkey personnel of the Adviser. The Board concluded that the Adviser has the financial resources necessary to fulfill its obligationsunder the Management Agreement and 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 Fund’s ChiefCompliance Officer and concluded that the conduct of business by the Adviser indicates a good faith effort on its part to adhereto high ethical standards in the conduct of the Portfolio’s business.

General Conclusion

After considering and weighing all of the above factors, with various written materials and verbal information presented by theAdviser, the Board concluded that it would be in the best interest of the Portfolio and its shareholders to approve renewal of theManagement Agreement for another year. In reaching this conclusion the Board did not give particular weight to any singlepiece of information or factor referenced above. The Board considered these factors and information over the course of the yearand in numerous meetings, some of which were in executive session with only the independent Board members and theircounsel present. It is possible that individual Board members may have weighed these factors, and the information presented,differently in reaching their individual decisions to approve the Management Agreement.

Investment Advisory Agreement Approval (unaudited) (cont’d)



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Director and Officer Information

UIFSCGSAN1556429 EXP. 08.31.17

Reporting to Shareholders

Each Morgan Stanley fund provides a complete schedule of portfolio holdings in its semi-annual and annual reports within 60 days of the end of the fund’ssecond and fourth fiscal quarters. The semi-annual and annual reports are filed electronically with the Securities and Exchange Commission (SEC) onForm N-CSRS and Form N-CSR, respectively. Morgan Stanley also delivers the semi-annual and annual reports to fund shareholders and makes thesereports available on its public website, www.morganstanley.com/im. Each Morgan Stanley fund also files a complete schedule of portfolio holdings with theSEC 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 toshareholders, nor are the reports posted to the Morgan Stanley public website. You may, however, obtain the Form N-Q filings (as well as the Form N-CSRand N-CSRS filings) by accessing the SEC’s website, 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 toll free at 1 (800) SEC-0330. You can alsorequest copies of these materials, upon payment of a duplicating fee, by electronic request at the SEC’s email address ([email protected]) or by writingthe Public Reference Room of the SEC, Washington, DC 20549-0102.

Proxy Voting Policies and Procedures and Proxy Voting Record

You may obtain a copy of the Fund’s Proxy Voting Policy and Procedures and information regarding how the Fund voted proxies relating to portfoliosecurities during the most recent twelve-month period ended June 30, without charge, upon request, by calling toll free 1 (800) 548-7786 or by visiting ourwebsite at www.morganstanley.com/im. This information is also available on the SEC’s website at www.sec.gov.

This report is submitted for the general information of the shareholders of the Portfolio. For more detailed information about the Portfolio, its fees andexpenses and other pertinent information, please read its Prospectus. The Fund’s Statement of Additional Information contains additional information aboutthe Portfolio, including its Directors. It is available, without charge, by calling 1 (800) 548-7786.

This report is not authorized for distribution to prospective investors in the Portfolio unless preceded or accompanied by an effectiveProspectus. Read the Prospectus carefully before investing.

DirectorsFrank L. BowmanKathleen A. DennisNancy C. EverettJakki L. HausslerJames F. HigginsDr. Manuel H. JohnsonJoseph J. KearnsMichael F. KleinMichael E. Nugent, Chair of the BoardW. Allen ReedFergus Reid

Adviser and AdministratorMorgan Stanley Investment Management Inc.522 Fifth AvenueNew York, New York 10036

DistributorMorgan Stanley Distribution, Inc.522 Fifth AvenueNew York, New York 10036

Dividend Disbursing and Transfer AgentBoston Financial Data Services, Inc.2000 Crown Colony DriveQuincy, Massachusetts 02169

CustodianState Street Bank and Trust CompanyOne Lincoln StreetBoston, Massachusetts 02111

OfficersJohn H. GernonPresident and Principal Executive OfficerStefanie V. Chang YuChief Compliance OfficerJoseph C. BenedettiVice PresidentMary E. MullinSecretaryFrancis J. SmithTreasurer and Principal Financial Officer

Legal CounselDechert LLP1095 Avenue of the AmericasNew York, New York 10036

Counsel to the Independent DirectorsKramer Levin Naftalis & Frankel LLP1177 Avenue of the AmericasNew York, New York 10036

Independent Registered Public Accounting FirmErnst & Young LLP200 Clarendon StreetBoston, Massachusetts 02116


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small company growth portfolio€¦ · small company growth portfolio class ii $1,000.00 $1,008.70...

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