10-Q 1 css22.txt CORNERSTONE FUND 2 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2008 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File No. 0-13298 MORGAN STANLEY CORNERSTONE FUND II L.P. (Exact name of registrant as specified in its charter) New York 13-3212871 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) Demeter Management Corporation 522 Fifth Avenue, 13th Floor New York, NY 10036 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (212) 296-1999 (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of ?large accelerated filer?, ?accelerated filer? and ?smaller reporting company? in Rule 12b-2 of the Exchange Act. Large accelerated filer_______ Accelerated filer_______ Non-accelerated filer X Smaller reporting company_______ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ___ No X MORGAN STANLEY CORNERSTONE FUND II L.P. INDEX TO QUARTERLY REPORT ON FORM 10-Q September 30, 2008
PART I. FINANCIAL INFORMATION Item 1. Financial Statements Statements of Financial Condition as of September 30, 2008 (Unaudited) and December 31, 2007 ......................... 2 Statements of Operations for the Three and Nine Months Ended September 30, 2008 and 2007(Unaudited)................3 Statements of Changes in Partners? Capital for the Nine Months Ended September 30, 2008 and 2007 (Unaudited)...4 Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2007 (Unaudited).....................5 Condensed Schedules of Investments as of September 30, 2008 (Unaudited) and December 31, 2007...........................6 Notes to Financial Statements (Unaudited) ...............7-14 Item 2. Management?s Discussion and Analysis of Financial Condition and Results of Operations .......15-27 Item 3. Quantitative and Qualitative Disclosures About Market Risk ........................................ 28-40 Item 4. Controls and Procedures ................................40 Item 4T. Controls and Procedures ................................40 PART II. OTHER INFORMATION Item 1A.Risk Factors............................................41 Item 5. Other Information....................................41-42 Item 6. Exhibits.............................................42-43
PART I. FINANCIAL INFORMATION Item 1. Financial Statements MORGAN STANLEY CORNERSTONE FUND II L.P. STATEMENTS OF FINANCIAL CONDITION
September 30, December 31, 2008 2007 $ $ (Unaudited) ASSETS Trading Equity: Unrestricted cash 6,464,865 6,584,973 Restricted cash 59,443 444,742 Total cash 6,524,308 7,029,715 Net unrealized gain on open contracts (MS&Co.) 149,856 98,394 Total Trading Equity 6,674,164 7,128,109 Interest receivable (MS&Co.) 6,830 15,021 Due from MS&Co. 752 3,416 Total Assets 6,681,746 7,146,546 LIABILITIES AND PARTNERS' CAPITAL Liabilities Redemptions payable 644,439 92,051 Accrued administrative expenses 28,631 30,222 Accrued management fees 19,405 20,756 Total Liabilities 692,475 143,029 Partners? Capital Limited Partners (1,481.945 and 2,025.388 Units, respectively) 5,757,834 6,774,185 General Partner (59.567 and 68.567 Units, respectively) 231,437 229,332 Total Partners? Capital 5,989,271 7,003,517 Total Liabilities and Partners? Capital 6,681,746 7,146,546 NET ASSET VALUE PER UNIT 3,885.32 3,344.64 The accompanying notes are an integral part of these financial statements.
MORGAN STANLEY CORNERSTONE FUND II L.P. STATEMENTS OF OPERATIONS (Unaudited)
For the Three Months For the Nine Months Ended September 30, Ended September 30, 2008 2007 2008 2007 $ $ $ $ INVESTMENT INCOME Interest income (MS&Co.) 23,552 70,341 77,352 235,586 EXPENSES Brokerage commissions (MS&Co.) 84,672 113,582 267,429 365,356 Management fees 60,540 67,412 184,339 214,352 Administrative expenses 10,000 12,000 29,000 36,000 Transaction fees and costs 4,268 4,665 13,994 23,810 Total Expenses 159,480 197,659 494,762 639,518 NET INVESTMENT LOSS (135,928) (127,318) (417,410) (403,932) TRADING RESULTS Trading profit (loss): Realized 704,022 (414,391) 1,402,341 142,020 Net change in unrealized (133,464) 128,656 51,462 (22,432) Total Trading Results 570,558 (285,735) 1,453,803 119,588 NET INCOME (LOSS) 434,630 (413,053) 1,036,393 (284,344) NET INCOME (LOSS) ALLOCATION Limited Partners 419,775 (399,735) 1,001,006 (275,808) General Partner 14,855 (13,318) 35,387 (8,536) NET INCOME (LOSS) PER UNIT Limited Partners 241.22 (173.95) 540.68 (107.38) General Partner 241.22 (173.95) 540.68 (107.38) Units Units Units Units WEIGHTED AVERAGE NUMBER OF UNITS OUTSTANDING 1,751.889 2,279.158 1,908.821 2,421.537 The accompanying notes are an integral part of these financial statements.
MORGAN STANLEY CORNERSTONE FUND II L.P. STATEMENTS OF CHANGES IN PARTNERS? CAPITAL For the Nine Months Ended September 30, 2008 and 2007 (Unaudited)
Units of Partnership Limited General Interest Partners Partner Total $ $ $ Partners? Capital, December 31, 2006 2,611.342 8,722,240 295,488 9,017,728 Net Loss ? (275,808) (8,536) (284,344) Redemptions (401.831) (1,309,788) (30,765) (1,340,553) Partners? Capital, September 30, 2007 2,209.511 7,136,644 256,187 7,392,831 Partners? Capital, December 31, 2007 2,093.955 6,774,185 229,332 7,003,517 Net Income ? 1,001,006 35,387 1,036,393 Redemptions (552.443) (2,017,357) (33,282) (2,050,639) Partners? Capital, September 30, 2008 1,541.512 5,757,834 231,437 5,989,271 The accompanying notes are an integral part of these financial statements.
MORGAN STANLEY CORNERSTONE FUND II L.P. STATEMENTS OF CASH FLOWS (Unaudited)
For the Nine Months Ended September 30, 2008 2007 $ $ CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) 1,036,393 (284,344) Noncash item included in net income (loss): Net change in unrealized (51,462) 22,432 (Increase) decrease in operating assets: Restricted cash 385,299 230,016 Interest receivable (MS&Co.) 8,191 9,422 Due from MS&Co. 2,664 (4,708) Decrease in operating liabilities: Accrued administrative expenses (1,591) (7,377) Accrued management fees (1,351) (4,734) Net cash provided by (used for) operating activities 1,378,143 (39,293) CASH FLOWS FROM FINANCING ACTIVITIES Cash paid for redemptions of Units (1,498,251) (1,334,218) Net cash used for financing activities (1,498,251) (1,334,218) Net decrease in unrestricted cash (120,108) (1,373,511) Unrestricted cash at beginning of period 6,584,973 8,331,036 Unrestricted cash at end of period 6,464,865 6,957,525 The accompanying notes are an integral part of these financial statements.
MORGAN STANLEY CORNERSTONE FUND II L.P. CONDENSED SCHEDULES OF INVESTMENTS September 30, 2008 (Unaudited) and December 31, 2007
Futures and Forward Contracts Long Unrealized Gain/(Loss) Percentage of Net Assets Short Unrealized Gain/(Loss) Percentage of Net Assets Net Unrealized Gain/(Loss) $ % $ % $ September 30, 2008, Partnership Net Assets: $5,989,271 Commodity ? ? 5,580 0.09 5,580 Equity ? ? 21,120 0.35 21,120 Foreign currency (29,907) (0.50) 111,059 1.86 81,152 Interest rate (13,242) (0.22) ? ? (13,242) Grand Total: (43,149) (0.72) 137,759 2.30 94,610 Unrealized Currency Gain 55,246 Total Net Unrealized Gain 149,856 December 31, 2007, Partnership Net Assets: $7,003,517 Commodity 5,659 0.08 (1,460) (0.02) 4,199 Equity 17,639 0.25 (3,360) (0.05) 14,279 Foreign currency (23,706) (0.34) (45,218) (0.65) (68,924) Interest rate 24,883 0.36 30,805 0.44 55,688 Grand Total: 24,475 0.35 (19,233) (0.28) 5,242 Unrealized Currency Gain 93,152 Total Net Unrealized Gain 98,394 The accompanying notes are an integral part of these financial statements.
MORGAN STANLEY CORNERSTONE FUND II L.P. NOTES TO FINANCIAL STATEMENTS September 30, 2008 (Unaudited) The unaudited financial statements contained herein include, in the opinion of management, all adjustments necessary for a fair presentation of the financial condition and results of operations of Morgan Stanley Cornerstone Fund II L.P. (the "Partnership"). The financial statements and condensed notes herein should be read in conjunction with the Partnership's December 31, 2007, Annual Report on Form 10-K. 1. Organization Morgan Stanley Cornerstone Fund II L.P. is a New York limited partnership organized in 1983 to engage in the speculative trading of futures contracts, options on futures contracts, and forward contracts on foreign currencies and other commodity interests (collectively, "Futures Interests"). The Partnership is one of the Morgan Stanley Cornerstone Funds, comprised of the Partnership, Morgan Stanley Cornerstone Fund III L.P., and Morgan Stanley Cornerstone Fund IV L.P. The Partnership?s general partner is Demeter Management Corporation ("Demeter"). The commodity brokers are Morgan Stanley & Co. Incorporated ("MS&Co.") and Morgan Stanley & Co. International plc ("MSIP"). MS&Co. also acts as the counterparty on all trading of foreign currency forward contracts. MSIP serves as the commodity broker for trades on the London Metal Exchange. Demeter, MS&Co., and MSIP are wholly-owned subsidiaries of Morgan Stanley. The trading managers to the Partnership are Northfield Trading L.P. and John W. Henry & Company, Inc. (individually, a "Trading Manager", or collectively, the "Trading Managers"). 2. Related Party Transactions The Partnership's cash is on deposit with MS&Co. and MSIP in futures, forward, and options trading accounts to meet margin requirements as needed. Monthly, MS&Co. pays the Partnership interest income on 80% of its average daily Net Assets at a rate equal to the average yield on 13-week U.S. Treasury bills. The Partnership pays brokerage commissions to MS&Co. 3. Income Taxes No provision for income taxes has been made in the accompanying financial statements, as partners are individually responsible for reporting income or loss based upon their respective share of the Partnership?s revenues or expenses for income tax purposes. The Partnership files U.S. federal and state tax returns. The 2004 through 2007 tax years generally remain subject to examination by U.S. federal and most state tax authorities. 4. Financial Instruments The Partnership trades Futures Interests. Futures and forwards represent contracts for delayed delivery of an instrument at a specified date and price. Risk arises from changes in the value of these contracts and the potential inability of counterparties to perform under the terms of the contracts. There are numerous factors which may significantly influence the market value of these contracts, including interest rate volatility. The market value of exchange-traded contracts is based on the settlement price quoted by the exchange on the day with respect to which market value is being determined. If an exchange-traded contract could not have been liquidated on such day due to the operation of daily limits or other rules of the exchange, the settlement price shall be the settlement price on the first subsequent day on which the contract could be liquidated. The market value of off-exchange-traded contracts is based on the fair market value quoted by the counterparty. The Partnership?s contracts are accounted for on a trade-date basis and marked to market on a daily basis. The Partnership accounts for its derivative investments in accordance with the provisions of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 defines a derivative as a financial instrument or other contract that has all three of the following characteristics: 1) One or more underlying notional amounts or payment provisions; 2) Requires no initial net investment or a smaller initial net investment than would be required relative to changes in market factors; 3) Terms require or permit net settlement. Generally, derivatives include futures, forward, swap or options contracts, and other financial instruments with similar characteristics such as caps, floors, and collars. The net unrealized gains (losses) on open contracts, reported as a component of "Trading Equity" on the Statements of Financial Condition, and their longest contract maturities were as follows:
Net Unrealized Gains/(Losses) On Open Contracts Longest Maturities Exchange- Off-Exchange- Exchange- Off-Exchange- Date Traded Traded Total Traded Traded $ $ $ Sep. 30, 2008 85,066 64,790 149,856 Dec. 2009 Oct. 2008 Dec. 31, 2007 160,568 (62,174) 98,394 Dec. 2008 Mar. 2008
The Partnership has credit risk associated with counterparty non- performance. As of the date of the financial statements, the credit risk associated with the instruments in which the Partnership trades is limited to the amounts reflected in the Partnership's Statements of Financial Condition. The Partnership also has credit risk because MS&Co. and MSIP act as the futures commission merchants or the counterparties, with respect to most of the Partnership?s assets. Exchange-traded futures, exchange-traded forward, and exchange-traded futures- styled options contracts are marked to market on a daily basis, with variations in value settled on a daily basis. MS&Co. and MSIP, each acting as a commodity broker for the Partnership?s exchange-traded futures, exchange-traded forward, and exchange- traded futures-styled options contracts, are required, pursuant to regulations of the Commodity Futures Trading Commission ("CFTC"), to segregate from their own assets, and for the sole benefit of their commodity customers, all funds held by them with respect to exchange-traded futures, exchange-traded forward, and exchange- traded futures-styled options contracts, including an amount equal to the net unrealized gains (losses) on all open exchange-traded futures, exchange-traded forward, and exchange-traded futures- styled options contracts, which funds, in the aggregate, totaled $6,609,374 and $7,190,283 at September 30, 2008, and December 31, 2007, respectively. With respect to the Partnership?s off- MORGAN STANLEY CORNERSTONE FUND II L.P. NOTES TO FINANCIAL STATEMENTS (CONTINUED) exchange-traded forward currency contracts, there are no daily settlements of variation in value, nor is there any requirement that an amount equal to the net unrealized gains (losses) on such contracts be segregated. However, the Partnership is required to meet margin requirements equal to the net unrealized loss on open forward currency contracts in the Partnership accounts with the counterparty, which is accomplished by daily maintenance of the cash balance in a custody account held at MS&Co. With respect to those off-exchange-traded forward currency contracts, the Partnership is at risk to the ability of MS&Co., the sole counterparty on all such contracts, to perform. The Partnership has a netting agreement with MS&Co. This agreement, which seeks to reduce both the Partnership?s and MS&Co.?s exposure on off- exchange-traded forward currency contracts, should materially decrease the Partnership?s credit risk in the event of MS&Co.?s bankruptcy or insolvency. 5. New Accounting Developments In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 157 ("SFAS 157"), "Fair Value Measurements". SFAS 157 requires use of a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels: Level 1 - quoted market prices in active markets for MORGAN STANLEY CORNERSTONE FUND II L.P. NOTES TO FINANCIAL STATEMENTS (CONTINUED) identical assets and liabilities; Level 2 - inputs other than quoted market prices that are observable for the asset or liability, either directly or indirectly (including quoted prices for similar investments, interest rates, credit risk); and Level 3 - unobservable inputs for the asset or liability (including the Partnership?s own assumptions used in determining the fair value of investments). Demeter evaluated the impact of adopting SFAS 157 on the Partnership?s financial statements. The Partnership adopted SFAS 157 as of January 1, 2008. Based on its analysis, the effect of applying SFAS 157 to the investments included in the financial statements does not have a material impact on the Partnership?s financial statements. The following table summarizes the valuation of the Partnership?s investments by the above SFAS 157 fair value hierarchy as of September 30, 2008:
Assets Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Unrealized gain on open contracts $85,066 $64,790 n/a $149,856
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities ("SFAS 161"). SFAS MORGAN STANLEY CORNERSTONE FUND II L.P. NOTES TO FINANCIAL STATEMENTS (CONCLUDED) 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand how those instruments and activities are accounted for; how and why they are used; and their effects on a Partnership?s financial position, financial performance, and cash flows. SFAS 161 is effective for financial statements issued for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The Partnership is currently evaluating the impact that the adoption of SFAS No. 161 will have on its financial statement disclosures. 6. Restricted and Unrestricted Cash As reflected on the Partnership?s Statements of Financial Condition, restricted cash equals the cash portion of assets on deposit to meet margin requirements plus the cash required to offset unrealized losses on foreign currency forwards and options and offset losses on offset London Metal Exchange positions. All of these amounts are maintained separately. Cash that is not classified as restricted cash is therefore classified as unrestricted cash. Item 2. MANAGEMENT?S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity. The Partnership deposits its assets with MS&Co. and MSIP as commodity brokers in separate futures, forward, and options trading accounts established for each Trading Manager. Such assets are used as margin to engage in trading and may be used as margin solely for the Partnership?s trading. The assets are held in either non-interest bearing bank accounts or in securities and instruments permitted by the CFTC for investment of customer segregated or secured funds. Since the Partnership?s sole purpose is to trade in futures, forwards, and options, it is expected that the Partnership will continue to own such liquid assets for margin purposes. The Partnership?s investment in futures, forwards, and options may, from time to time, be illiquid. Most U.S. futures exchanges limit fluctuations in prices during a single day by regulations referred to as "daily price fluctuations limits" or "daily limits". Trades may not be executed at prices beyond the daily limit. If the price for a particular futures or options contract has increased or decreased by an amount equal to the daily limit, positions in that futures or options contract can neither be taken nor liquidated unless traders are willing to effect trades at or within the limit. Futures prices have occasionally moved the daily limit for several consecutive days with little or no trading. These market conditions could prevent the Partnership from promptly liquidating its futures or options contracts and result in restrictions on redemptions. There is no limitation on daily price moves in trading forward contracts on foreign currencies. The markets for some world currencies have low trading volume and are illiquid, which may prevent the Partnership from trading in potentially profitable markets or prevent the Partnership from promptly liquidating unfavorable positions in such markets, subjecting it to substantial losses. Either of these market conditions could result in restrictions on redemptions. For the periods covered by this report, illiquidity has not materially affected the Partnership?s assets. There are no known material trends, demands, commitments, events, or uncertainties at the present time that are reasonably likely to result in the Partnership?s liquidity increasing or decreasing in any material way. Capital Resources. The Partnership does not have, nor does it expect to have, any capital assets. Redemptions of units of limited partnership interest ("Unit(s)") in the future will affect the amount of funds available for investments in futures, forwards, and options in subsequent periods. It is not possible to estimate the amount, and therefore the impact, of future outflows of Units. There are no known material trends, favorable or unfavorable, that would affect, nor any expected material changes to, the Partnership?s capital resource arrangements at the present time. Off-Balance Sheet Arrangements and Contractual Obligations. The Partnership does not have any off-balance sheet arrangements, nor does it have contractual obligations or commercial commitments to make future payments that would affect its liquidity or capital resources. Results of Operations General. The Partnership?s results depend on the Trading Managers and the ability of each Trading Manager?s trading program to take advantage of price movements in the futures, forward, and options markets. The following presents a summary of the Partnership?s operations for the three and nine month periods ended September 30, 2008 and 2007, and a general discussion of its trading activities during each period. It is important to note, however, that the Trading Managers trade in various markets at different times and that prior activity in a particular market does not mean that such market will be actively traded by the Trading Managers or will be profitable in the future. Consequently, the results of operations of the Partnership are difficult to discuss other than in the context of the Trading Managers? trading activities on behalf of the Partnership during the period in question. Past performance is no guarantee of future results. The Partnership?s results of operations set forth in the financial statements on pages 2 through 14 of this report are prepared in accordance with accounting principles generally accepted in the United States of America, which require the use of certain accounting policies that affect the amounts reported in these financial statements, including the following: The contracts the Partnership trades are accounted for on a trade-date basis and marked to market on a daily basis. The difference between their cost and market value is recorded on the Statements of Operations as "Net change in unrealized trading gain (loss)" for open (unrealized) contracts, and recorded as "Realized trading gain (loss)" when open positions are closed out. The sum of these amounts constitutes the Partnership?s trading results. The market value of a futures contract is the settlement price on the exchange on which that futures contract is traded on a particular day. The value of a foreign currency forward contract is based on the spot rate as of the close of business. Interest income, as well as management fees, brokerage commissions, transaction fees and costs, and administrative expenses of the Partnership are recorded on an accrual basis. Demeter believes that, based on the nature of the operations of the Partnership, no assumptions relating to the application of critical accounting policies other than those presently used could reasonably affect reported amounts. For the Three and Nine Months Ended September 30, 2008 The Partnership recorded total trading results including interest income totaling $594,110 and expenses totaling $159,480, resulting in net income of $434,630 for the three months ended September 30, 2008. The Partnership?s net asset value per Unit increased from $3,644.10 at June 30, 2008, to $3,885.32 at September 30, 2008. The most significant trading gains of approximately 6.8% were achieved in the currency sector, primarily during August and September. Such gains were recorded from short positions in the Australian dollar, Swiss franc, Taiwan dollar, New Zealand dollar, euro, Brazilian real, and Korean won versus the U.S. dollar as the value of the U.S. dollar moved higher after U.S. consumer confidence increased in August. Furthermore, the value of the U.S. dollar moved higher in September amid a worldwide ?flight-to-quality? due to fears of an intense credit crunch and subsequent fears of a global recession. Additional gains of approximately 2.2% were experienced within the global stock index sector during July from short positions in European and Taiwan equity index futures as prices moved lower on concerns that widening credit-market losses, weakening consumer demand, and surging commodity prices would erode corporate earnings. Additional gains were achieved during September from short positions in U.S., Asian, and European stock index futures as prices moved sharply lower amid unprecedented U.S. financial market volatility and turmoil following news of the collapse of a major U.S. investment bank and the government rescue of a U.S. insurance giant. Furthermore, U.S. equity markets plunged on Monday, September 29, 2008, after the U.S. House of Representatives rejected the Economic Stabilization Act of 2008, which would have allowed the U.S. Treasury to purchase troubled mortgage-backed securities from U.S. financial institutions. A portion of the Partnership?s gains during the quarter was offset by losses of approximately 0.9% recorded in the global interest rate sector primarily during July and September from short positions in European fixed-income futures as prices moved higher following a sharp decline in the global equity markets, weaker-than-expected U.K. and German economic data, and comments from European Central Bank President Jean- Claude Trichet saying that economic growth would be ?particularly weak?, thereby fueling demand for the ?safe haven? of government bonds. During September, additional losses were recorded from long positions in Japanese fixed-income futures as prices reversed lower during the middle of the month after news of a major U.S. government intervention in the financial sector eased concerns that the credit crisis would continue to deteriorate the growth of the global economy. Smaller losses of approximately 0.2% were recorded in the energy markets primarily during July and September from long futures positions in crude oil and its related products as prices reversed lower on signs that global economic growth might be slowing, which might curb future energy demand. The Partnership recorded total trading results including interest income totaling $1,531,155 and expenses totaling $494,762, resulting in net income of $1,036,393 for the nine months ended September 30, 2008. The Partnership?s net asset value per Unit increased from $3,344.64 at December 31, 2007, to $3,885.32 at September 30, 2008. The most significant trading gains of approximately 12.2% were experienced in the currency sector during February, March, May, and June from long positions in the euro, Mexican peso, Swiss franc, Brazilian real, and Czech koruna versus the U.S. dollar as the value of the U.S. dollar moved lower against its major rivals after consistently weak U.S. economic data reignited fears of an economic slowdown in the U.S., as well as following several interest rate cuts by the U.S. Federal Reserve. Additional gains were experienced, primarily during August and September, from short positions in the Australian dollar, Swiss franc, Taiwan dollar, New Zealand dollar, euro, and Brazilian real versus the U.S. dollar as the value of the U.S. dollar moved higher after U.S. consumer confidence increased in August. Furthermore, the value of the U.S. dollar moved higher in September amid a worldwide "flight-to-quality" due to fears of an intense credit crunch and subsequent fears of a global recession. Elsewhere in the currency sector, smaller gains were recorded from short positions in the Korean won versus the U.S. dollar throughout the first half of the year, as well as during September, as the value of the Korean won fell amid concerns of a rising Current-Account deficit out of Korea, as well as a slowing economy. Within the global stock index sector, gains of approximately 4.2% were achieved during January, March, June, and July from short positions in European and Asian stock index futures as prices moved lower on concerns that a persistent U.S. housing slump, mounting losses linked to U.S. sub-prime mortgage investments, and a weakening job market would restrain consumer spending. During September, Asian and European stock index futures prices moved sharply lower amid unprecedented U.S. financial market volatility and turmoil. Further gains of approximately 1.3% were also recorded within the global interest rate sector during May from short positions in short-term European and U.S. fixed-income futures as prices fell after a government report showed the U.S. economy had grown at a faster rate during the first quarter than previously stated. Additionally, prices fell further on news of accelerating inflation and better-than-expected growth in the Euro-Zone. During June, further gains were recorded from short positions in short-term European fixed-income futures as prices moved lower after the European Central Bank left its benchmark interest rate unchanged at 4% and signaled it might raise borrowing costs in July in order to combat accelerating inflation in the Euro-Zone. Smaller gains were recorded during August from long positions in U.S. fixed-income futures as prices increased on growing speculation that the U.S. Federal Reserve would not raise interest rates at its August policy meeting. Lastly, gains were recorded, during January, March, and August, from long positions in Japanese fixed-income futures as prices increased amid stronger demand and following a sharp decline in global equity markets. Smaller gains of approximately 0.2% were achieved within the energy sector during May and June from long positions in natural gas futures as prices increased amid declining production in Western Canada, forecasts for an active hurricane season in the Atlantic, and a drop in the value of the U.S. dollar. Newly established short positions in natural gas futures resulted in further gains during September as prices fell amid a strengthening U.S. dollar. For the Three and Nine Months Ended September 30, 2007 The Partnership recorded total trading results including interest income totaling $(215,394) and expenses totaling $197,659 resulting in a net loss of $413,053 for the three months ended September 30, 2007. The Partnership?s net asset value per Unit decreased from $3,519.86 at June 30, 2007, to $3,345.91 at September 30, 2007. The most significant trading losses of approximately 8.2% were recorded in the currency sector, primarily during July and August, from both short and long positions in the South African rand versus the U.S. dollar as the value of the rand moved without consistent direction amid uncertainty regarding the future interest rate policy of the South African Reserve Bank. Further losses were incurred primarily during July from short positions in the Japanese yen versus the U.S. dollar as the value of the Japanese yen corrected higher against most of its major rivals when traders reduced ?carry-trade? positions after the sell-off in the global equity markets resulted in investors? trimming ?riskier? assets funded by loans in Japan. During August, long positions in the Australian dollar and euro versus the U.S. dollar experienced losses during the first half of the month as the value of the U.S. dollar reversed higher against these currencies as continued extreme volatility in the global equity markets and widening credit losses tied to U.S. sub-prime loans resulted in substantially stronger demand for U.S. dollar- denominated government bonds. A portion of the Partnership?s losses during the quarter was offset by gains of approximately 1.2% recorded in the energy markets primarily during July and September from long futures positions in crude oil and its related products as prices moved higher amid worries that supplies of European North Sea oil were dwindling and concerns regarding U.S. refinery capacity, and after continuous hurricane activity in the Gulf of Mexico threatened production facilities. Within the global interest rate sector, short positions in U.S. and German fixed-income futures resulted in further gains of approximately 0.7% during July as prices declined due to investor sentiment that consistently strong economic data and rising global inflation would result in higher interest rates in the European Union and United States. Additional gains were experienced during August from newly established long positions in U.S. and German fixed-income futures as prices moved sharply higher in a worldwide ?flight-to-quality? after the significant decline in the global equity markets, spurred by losses in the U.S. sub-prime mortgage sector, caused investors to seek the ?safe haven? of government bonds. Smaller gains of approximately 0.5% were recorded in the global stock index sector primarily during September from long positions in U.S., Pacific Rim, and German equity index futures as prices moved higher leading up to and after the 50 basis point cut in interest rates by the U.S. Federal Reserve, as well as on sentiment that the easing U.S. Federal Reserve policy would continue. The Partnership recorded total trading results including interest income totaling $355,174 and expenses totaling $639,518, resulting in a net loss of $284,344 for the nine months ended September 30, 2007. The Partnership?s net asset value per Unit decreased from $3,453.29 at December 31, 2006, to $3,345.91 at September 30, 2007. The most significant trading losses of approximately 11.6% were incurred in the currency sector, primarily during January, March, July, and August, from both short and long positions in the South African rand versus the U.S. dollar as the value of the South African rand moved without consistent direction due to conflicting economic data out of South Africa. Further losses were recorded from short positions in the Mexican peso versus the U.S. dollar primarily during March and April as the value of the Mexican peso moved higher amid speculation of an interest rate hike by the Bank of Mexico. Finally, losses were experienced primarily during August from long positions in the British pound, euro, Australian dollar, and New Zealand dollar versus the U.S. dollar as the value of the U.S. dollar reversed higher against these currencies as continued extreme volatility in the global equity markets and widening credit losses tied to U.S. sub-prime loans resulted in substantially stronger demand for U.S. dollar- denominated government bonds. A portion of the Partnership?s losses in the first nine months of the year was offset by gains of approximately 5.5% recorded in the global interest rate sector primarily during January, May, and June from short positions in European fixed-income futures as prices fell initially after reports showed confidence in the Euro-Zone economy had stayed close to a six-year high in December 2006. Prices continued to fall after strong economic data reported in the United Kingdom and Germany increased inflation concerns. Elsewhere, gains were recorded during January, May, June, and July from short positions in U.S. interest rate futures as prices fell amid strength in the equity markets and consistently strong economic data out of the United States and Euro-Zone. Finally, newly established long positions in U.S. and German fixed-income futures resulted in gains during August as prices moved sharply higher in a worldwide "flight-to-quality" after the significant decline in the global equity markets, spurred by losses in the U.S. sub- prime mortgage sector, caused investors to seek the "safe haven" of government bonds. Additional gains of approximately 0.8% were experienced in the global stock index sector, primarily during April, May, June, and September, from long positions in German equity index futures as prices moved higher on continued strong corporate earnings and increased merger and acquisition activity. Furthermore, gains were recorded primarily during June and September from long positions in Taiwanese equity index futures as prices increased amid investor optimism regarding future earnings in the technology sector. Smaller gains of approximately 0.5% were recorded during January from short futures positions in crude oil and its related products as prices declined on skepticism that OPEC would cut production as much as originally pledged and after U.S. government data showed a larger-than-expected increase in domestic inventories of gasoline and heating oil. Newly established long futures positions in crude oil and its related products resulted in gains during February, July, and September as prices moved higher amid geopolitical uncertainty in Iraq and news that Iran would continue with its nuclear program. Furthermore, prices were pressured higher amid worries that supplies of European North Sea oil were dwindling, concerns regarding U.S. refinery capacity, and after continuous hurricane activity in the Gulf of Mexico threatened production facilities. Item 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Introduction The Partnership is a commodity pool engaged primarily in the speculative trading of futures, forwards, and options. The market-sensitive instruments held by the Partnership are acquired for speculative trading purposes only and, as a result, all or substantially all of the Partnership?s assets are at risk of trading loss. Unlike an operating company, the risk of market- sensitive instruments is inherent to the primary business activity of the Partnership. The futures, forwards, and options traded by the Partnership involve varying degrees of related market risk. Market risk is often dependent upon changes in the level or volatility of interest rates, exchange rates, and prices of financial instruments and commodities, factors that result in frequent changes in the fair value of the Partnership?s open positions, and consequently in its earnings, whether realized or unrealized, and cash flow. Gains and losses on open positions of exchange- traded futures, exchange-traded forward, and exchange-traded futures-styled options contracts are settled daily through variation margin. Gains and losses on off-exchange-traded forward currency contracts are settled upon termination of the contract. However, the Partnership is required to meet margin requirements equal to the net unrealized loss on open forward currency contracts in the Partnership accounts with the counterparty, which is accomplished by daily maintenance of the cash balance in a custody account held at MS&Co. The Partnership?s total market risk may increase or decrease as it is influenced by a wide variety of factors, including, but not limited to, the diversification among the Partnership?s open positions, the volatility present within the markets, and the liquidity of the markets. The face value of the market sector instruments held by the Partnership is typically many times the applicable margin requirements. Margin requirements generally range between 2% and 15% of contract face value. Additionally, the use of leverage causes the face value of the market sector instruments held by the Partnership typically to be many times the total capitalization of the Partnership. The Partnership?s past performance is no guarantee of its future results. Any attempt to numerically quantify the Partnership?s market risk is limited by the uncertainty of its speculative trading. The Partnership?s speculative trading and use of leverage may cause future losses and volatility (i.e., "risk of ruin") that far exceed the Partnership?s experiences to date under the "Partnership?s Value at Risk in Different Market Sectors" section and significantly exceed the Value at Risk ("VaR") tables disclosed. Limited partners will not be liable for losses exceeding the current net asset value of their investment. Quantifying the Partnership?s Trading Value at Risk The following quantitative disclosures regarding the Partnership?s market risk exposures contain "forward-looking statements" within the meaning of the safe harbor from civil liability provided for such statements by the Private Securities Litigation Reform Act of 1995 (set forth in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934). All quantitative disclosures in this section are deemed to be forward- looking statements for purposes of the safe harbor, except for statements of historical fact. The Partnership accounts for open positions on the basis of mark to market accounting principles. Any loss in the market value of the Partnership?s open positions is directly reflected in the Partnership?s earnings and cash flow. The Partnership?s risk exposure in the market sectors traded by the Trading Managers is estimated below in terms of VaR. The Partnership estimates VaR using a model based upon historical simulation (with a confidence level of 99%) which involves constructing a distribution of hypothetical daily changes in the value of a trading portfolio. The VaR model takes into account linear exposures to risk including equity and commodity prices, interest rates, foreign exchange rates, and correlation among these variables. The hypothetical changes in portfolio value are based on daily percentage changes observed in key market indices or other market factors ("market risk factors") to which the portfolio is sensitive. The one-day 99% confidence level of the Partnership?s VaR corresponds to the negative change in portfolio value that, based on observed market risk factors, would have been exceeded once in 100 trading days, or one day in 100. VaR typically does not represent the worst case outcome. Demeter uses approximately four years of daily market data (1,000 observations) and re-values its portfolio (using delta-gamma approximations) for each of the historical market moves that occurred over this time period. This generates a probability distribution of daily "simulated profit and loss" outcomes. The VaR is the appropriate percentile of this distribution. For example, the 99% one-day VaR would represent the 10th worst outcome from Demeter?s simulated profit and loss series. The Partnership?s VaR computations are based on the risk representation of the underlying benchmark for each instrument or contract and do not distinguish between exchange and non-exchange dealer-based instruments. They are also not based on exchange and/or dealer-based maintenance margin requirements. VaR models, including the Partnership?s, are continually evolving as trading portfolios become more diverse and modeling techniques and systems capabilities improve. Please note that the VaR model is used to numerically quantify market risk for historic reporting purposes only and is not utilized by either Demeter or the Trading Managers in their daily risk management activities. Please further note that VaR as described above may not be comparable to similarly-titled measures used by other entities. The Partnership?s Value at Risk in Different Market Sectors The following table indicates the VaR associated with the Partnership?s open positions as a percentage of total Net Assets by primary market risk category at September 30, 2008 and 2007. At September 30, 2008 and 2007, the Partnership?s total capitalization was approximately $6 million and $7 million, respectively. Primary Market September 30, 2008 September 30, 2007 Risk Category Value at Risk Value at Risk Currency (0.96)% (1.73)% Equity (0.24) (0.36) Interest Rate (0.22) (0.32) Commodity (0.16) (0.41) Aggregate Value at Risk (1.23)% (2.01)% The VaR for a market category represents the one-day downside risk for the aggregate exposures associated with this market category. The Aggregate Value at Risk listed above represents the VaR of the Partnership?s open positions across all the market categories, and is less than the sum of the VaRs for all such market categories due to the diversification benefit across asset classes. Because the business of the Partnership is the speculative trading of futures, forwards, and options, the composition of its trading portfolio can change significantly over any given time period, or even within a single trading day. Such changes could positively or negatively materially impact market risk as measured by VaR. The table below supplements the quarter-end VaR set forth above by presenting the Partnership?s high, low, and average VaR, as a percentage of total Net Assets for the four quarter-end reporting periods from October 1, 2007, through September 30, 2008. Primary Market Risk Category High Low Average Currency (1.17)% (0.60)% (0.93)% Equity (0.72) (0.11) (0.43) Interest Rate (0.45) (0.17) (0.27) Commodity (0.40) - (0.18) Aggregate Value at Risk (1.31)% (0.82)% (1.10)% Limitations on Value at Risk as an Assessment of Market Risk VaR models permit estimation of a portfolio?s aggregate market risk exposure, incorporating a range of varied market risks, reflect risk reduction due to portfolio diversification or hedging activities, and can cover a wide range of portfolio assets. However, VaR risk measures should be viewed in light of the methodology?s limitations, which include, but may not be limited to the following: * past changes in market risk factors will not always result in accurate predictions of the distributions and correlations of future market movements; * changes in portfolio value caused by market movements may differ from those of the VaR model; * VaR results reflect past market fluctuations applied to current trading positions while future risk depends on future positions; * VaR using a one-day time horizon does not fully capture the market risk of positions that cannot be liquidated or hedged within one day; and * the historical market risk factor data used for VaR estimation may provide only limited insight into losses that could be incurred under certain unusual market movements. In addition, the VaR tables above, as well as the past performance of the Partnership, give no indication of the Partnership?s potential "risk of ruin". The VaR tables provided present the results of the Partnership?s VaR for each of the Partnership?s market risk exposures and on an aggregate basis at September 30, 2008 and 2007, and for the four quarter-end reporting periods from October 1, 2007, through September 30, 2008. VaR is not necessarily representative of the Partnership?s historic risk, nor should it be used to predict the Partnership?s future financial performance or its ability to manage or monitor risk. There can be no assurance that the Partnership?s actual losses on a particular day will not exceed the VaR amounts indicated above or that such losses will not occur more than once in 100 trading days. Non-Trading Risk The Partnership has non-trading market risk on its foreign cash balances. These balances and any market risk they may represent are immaterial. The Partnership also maintains a substantial portion of its available assets in cash at MS&Co.; as of September 30, 2008, such amount was equal to approximately 105% of the Partnership?s net asset value. A decline in short-term interest rates would result in a decline in the Partnership?s cash management income. This cash flow risk is not considered to be material. Materiality, as used throughout this section, is based on an assessment of reasonably possible market movements and any associated potential losses, taking into account the leverage, optionality, and multiplier features of the Partnership?s market- sensitive instruments, in relation to the Partnership?s Net Assets. Qualitative Disclosures Regarding Primary Trading Risk Exposures The following qualitative disclosures regarding the Partnership?s market risk exposures - except for (A) those disclosures that are statements of historical fact and (B) the descriptions of how the Partnership manages its primary market risk exposures - constitute forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. The Partnership?s primary market risk exposures, as well as the strategies used and to be used by Demeter and the Trading Managers for managing such exposures, are subject to numerous uncertainties, contingencies and risks, any one of which could cause the actual results of the Partnership?s risk controls to differ materially from the objectives of such strategies. Government interventions, defaults and expropriations, illiquid markets, the emergence of dominant fundamental factors, political upheavals, changes in historical price relationships, an influx of new market participants, increased regulation, and many other factors could result in material losses, as well as in material changes to the risk exposures and the risk management strategies of the Partnership. Investors must be prepared to lose all or substantially all of their investment in the Partnership. The following were the primary trading risk exposures of the Partnership at September 30, 2008, by market sector. It may be anticipated, however, that these market exposures will vary materially over time. Currency. The largest market exposure of the Partnership at September 30, 2008, was to the currency sector. The Partnership?s currency exposure is to exchange rate fluctuations, primarily fluctuations which disrupt the historical pricing relationships between different currencies and currency pairs. Interest rate changes as well as political and general economic conditions influence these fluctuations. The Partnership?s primary exposure at September 30, 2008, was to outright U.S. dollar positions. Outright positions consist of the U.S. dollar vs. other currencies. These other currencies include major and minor currencies. Demeter does not anticipate that the risk associated with the Partnership?s currency trades will change significantly in the future. Equity. The second largest market exposure of the Partnership at September 30, 2008, was to the global stock index sector, primarily to equity price risk in the G-7 countries. The G-7 countries consist of France, the U.S., the United Kingdom, Germany, Japan, Italy, and Canada. The stock index futures traded by the Partnership are by law limited to futures on broadly-based indices. At September 30, 2008, the Partnership?s primary exposures were to the NASDAQ 100 (U.S.), DAX (Germany), EURO STOX 50 (Europe), and TAIWAN (Taiwan) stock indices. The Partnership is primarily exposed to the risk of adverse price trends or static markets in the U.S., European, and Asian stock indices. Static markets would not cause major market changes, but would make it difficult for the Partnership to avoid trendless price movements, resulting in numerous small losses. Interest Rate. The third largest market exposure of the Partnership at September 30, 2008, was to the global interest rate sector. This exposure was primarily spread across U.S., Japanese, and European interest rate sectors. Interest rate movements directly affect the price of the sovereign bond futures positions held by the Partnership and indirectly affect the value of its stock index and currency positions. Interest rate movements in one country, as well as relative interest rate movements between countries, materially impact the Partnership?s profitability. The Partnership?s primary interest rate exposure is generally to interest rate fluctuations in the U.S. and the other G-7 countries? interest rates. Demeter anticipates that the G-7 countries? interest rates will remain the primary interest rate exposures of the Partnership for the foreseeable future. The speculative futures positions held by the Partnership may range from short to long-term instruments. Consequently, changes in short, medium, or long-term interest rates may have an effect on the Partnership. Commodity. Energy. At September 30, 2008, the Partnership had market exposure to the energy sector. The Partnership?s primary energy exposure was to futures contracts in natural gas, as well as crude oil. Price movements in these markets result from geopolitical developments, particularly in the Middle East, as well as weather patterns and other economic fundamentals. Significant profits and losses, which have been experienced in the past, are expected to continue to be experienced in the future. Natural gas has exhibited volatility in price resulting from weather patterns and supply and demand factors and will likely continue in this choppy pattern. Qualitative Disclosures Regarding Non-Trading Risk Exposure The following was the only non-trading risk exposure of the Partnership at September 30, 2008: Foreign Currency Balances. The Partnership?s primary foreign currency balances at September 30, 2008, were in the euros, Japanese yen, Hong Kong dollars, and British pounds. The Partnership controls the non-trading risk of foreign currency balances by regularly converting them back into U.S. dollars upon liquidation of their respective positions. Qualitative Disclosures Regarding Means of Managing Risk Exposure The Partnership and the Trading Managers, separately, attempt to manage the risk of the Partnership?s open positions in essentially the same manner in all market categories traded. Demeter attempts to manage market exposure by diversifying the Partnership?s assets among different market sectors and trading approaches through the selection of Commodity Trading Managers and by daily monitoring their performance. In addition, the Trading Managers establish diversification guidelines, often set in terms of the maximum margin to be committed to positions in any one market sector or market-sensitive instrument. Demeter monitors and controls the risk of the Partnership?s non- trading instrument, cash. Cash is the only Partnership investment directed by Demeter, rather than the Trading Managers. Item 4. CONTROLS AND PROCEDURES As of the end of the period covered by this quarterly report, the President and Chief Financial Officer of Demeter, the general partner of the Partnership, have evaluated the effectiveness of the Partnership?s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act), and have judged such controls and procedures to be effective. Changes in International Control over Financial Reporting There have been no material changes during the period covered by this quarterly report in the Partnership?s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) or in other factors that could significantly affect these controls subsequent to the date of their evaluation. Item 4T. CONTROLS AND PROCEDURES Not applicable. PART II. OTHER INFORMATION Item 1A. RISK FACTORS Information regarding risk factors appears in Item 2. ?Management?s Discussion and Analysis of Financial Condition and Results of Operations? and Item 3. ?Quantitative and Qualitative Disclosures about Market Risk? of this Form 10-Q. There have been no other material changes from the risk factors previously referenced in the Partnership?s Report on Form 10-K for the fiscal year ended December 31, 2007, and the Partnership?s Reports on Form 10-Q for the quarters ended March 31, 2008 and June 30, 2008. Item 5. OTHER INFORMATION Limited Partners of the Partnership are advised that Demeter has determined to withdraw from the Partnership effective November 30, 2008, and thereafter will commence dissolution of the Partnership pursuant to the Partnership?s Limited Partnership Agreement. In connection with such withdrawal, Demeter terminated trading for the Partnership effective October 31, 2008. Following termination of trading for the Partnership, all Partnership assets will be paid interest at the rate equal to the average yield on 13-week U.S. Treasury Bills, with your share of interest credited to your Units. The management and brokerage fees on any assets remaining in the Partnership after October 31, 2008, will be waived, given the absence of any further futures trading by the Partnership. Through November 30, 2008, qualified Limited Partners may, under certain conditions, redeem some or all of their interest in the Partnership and use the proceeds of such redemption to purchase an interest in another Morgan Stanley managed futures partnership for which Demeter is the general partner (an offering in any such managed futures partnership is by prospectus or offering memorandum only). Otherwise, Limited Partners may simply redeem their interest in the Partnership and receive the proceeds of such redemption in cash. Whether you exchange or redeem your Partnership Units, there will be no minimum holding period requirement or redemption charge. Limited Partners who do not redeem their interest in the Partnership prior to November 30, 2008, should be aware that final distribution of any remaining Partnership assets is anticipated to be made on or about December 15, 2008. Item 6. EXHIBITS 31.01 Certification of President of Demeter Management Corporation, the general partner of the Partnership, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.02 Certification of Chief Financial Officer of Demeter Management Corporation, the general partner of the Partnership, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.01 Certification of President of Demeter Management Corporation, the general partner of the Partnership, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.02 Certification of Chief Financial Officer of Demeter Management Corporation, the general partner of the Partnership, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Morgan Stanley Cornerstone Fund II L.P. (Registrant) By: Demeter Management Corporation (General Partner) November 13, 2008 By: /s/Christian Angstadt Christian Angstadt Chief Financial Officer The General Partner which signed the above is the only party authorized to act for the Registrant. The Registrant has no principal executive officer, principal financial officer, controller, or principal accounting officer and has no Board of Directors.