-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CZdEgNl7SYM/KtOexvQDxiNaIzWHfqs/5h5APdaAeytjotC/1u9qrLasWzYCoWMn 0obgNFemys0ccFCExJsk/Q== 0000950136-02-000511.txt : 20020414 0000950136-02-000511.hdr.sgml : 20020414 ACCESSION NUMBER: 0000950136-02-000511 CONFORMED SUBMISSION TYPE: 497 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 20020225 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MORGAN STANLEY NORTH AMERICAN GOVERNMENT INCOME TR CENTRAL INDEX KEY: 0000884344 IRS NUMBER: 136993837 STATE OF INCORPORATION: MA FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: 497 SEC ACT: 1933 Act SEC FILE NUMBER: 033-46049 FILM NUMBER: 02557242 BUSINESS ADDRESS: STREET 1: TWO WORLD TRADE CENTER STREET 2: 70TH FLOOR CITY: NEW YORK STATE: NY ZIP: 10048 BUSINESS PHONE: 2123921600 MAIL ADDRESS: STREET 1: TWO WORLD TRADE CENTER STREET 2: 70TH FLOOR CITY: NEW YORK STATE: NY ZIP: 10048 FORMER COMPANY: FORMER CONFORMED NAME: TCW/DW NORTH AMERICAN GOVERNMENT INCOME TRUST DATE OF NAME CHANGE: 19930225 FORMER COMPANY: FORMER CONFORMED NAME: MORGAN STANLEY DEAN WITTER NORTH AMERICAN GOVERNMENT INCOME DATE OF NAME CHANGE: 19990628 497 1 file001.txt DEFINITIVE MATERIALS Filed Pursuant To Rule 497(c) Registration File No.: 33-46049 [GRAPHIC OMITTED] MorganStanley Morgan Stanley North American Government Income Trust A mutual fund that seeks to earn a high level of current income while maintaining relatively low volatility of principal [GRAPHIC OMITTED] Prospectus December 31, 2001 THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR DISAPPROVED THESE SECURITIES OR PASSED UPON THE ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. Contents
The Fund INVESTMENT OBJECTIVE..............................1 PRINCIPAL INVESTMENT STRATEGIES...................1 PRINCIPAL RISKS...................................3 PAST PERFORMANCE..................................6 FEES AND EXPENSES.................................7 ADDITIONAL INVESTMENT STRATEGY INFORMATION........7 ADDITIONAL RISK INFORMATION.......................8 FUND MANAGEMENT...................................9 Shareholder Information PRICING FUND SHARES..............................10 HOW TO BUY SHARES................................10 HOW TO EXCHANGE SHARES...........................12 HOW TO SELL SHARES...............................14 DISTRIBUTIONS....................................15 TAX CONSEQUENCES.................................16 Financial Highlights ................................................17 Morgan Stanley Funds .................................INSIDE BACK COVER THIS PROSPECTUS CONTAINS IMPORTANT INFORMATION ABOUT THE FUND. PLEASE READ IT CAREFULLY AND KEEP IT FOR FUTURE REFERENCE.
The Fund [GRAPHIC OMITTED] INVESTMENT OBJECTIVE - ---------------------------- Morgan Stanley North American Government Income Trust seeks to earn a high level of current income while maintaining relatively low volatility of principal. [GRAPHIC OMITTED] PRINCIPAL INVESTMENT STRATEGIES - --------------------------------------- The Fund will normally invest at least 80% of its assets in fixed-income securities issued or guaranteed by the United States, Canadian or Mexican governments, their subdivisions, agencies or instrumentalities. These securities are referred to generally as "government securities." In the case of the United States and Canada, a substantial portion of these securities will be mortgage-backed securities. [sidebar] INCOME An investment objective having the goal of selecting securities to pay out income rather than rise in price. [end sidebar] The Fund will normally invest at least 50% of its net assets in U.S. government securities, and no more than 25% each in Canadian or Mexican government securities. The Fund will invest in fixed-income securities that are investment grade; the Fund's investments in Canadian government securities, however, will be rated at least A by Moody's Investors Services Inc. ("Moody's") or Standard & Poor's Corporation ("S&P") or, if not rated, determined to be of comparable quality by the Fund's "Sub-Advisor," TCW Investment Management Company. The Sub-Advisor will allocate Fund assets among the three countries based on its analysis of market, economic and political conditions in those countries. When deciding whether to buy, hold or sell a security for the Fund, the Sub-Advisor will consider various factors, such as changes in interest rates and currency exchange rates, to attempt to take advantage of favorable investment opportunities in each country. The Sub-Advisor expects that, under normal circumstances, the weighted average maturity (or period until the next time the interest rate is reset) of the Fund's investment securities will be no greater than 3 years. In addition, the Fund will purchase Mexican government securities that have remaining maturities of one year or less. Mortgage-Backed Securities. One type of mortgage-backed security, in which the Fund may invest, is a mortgage pass-through security. These securities represent a participation interest in a pool of residential mortgage loans originated by governmental or private lenders such as banks. They differ from conventional debt securities, which provide for periodic payment of interest in fixed amounts and principal payments at maturity or on specified call dates. Mortgage pass-through securities provide for monthly payments that are a "pass-through" of the monthly interest and principal payments made by the individual borrowers on the pooled mortgage loans. The U.S. mortgage pass-through securities in which the Fund may invest include those issued or guaranteed by the Government National Mortgage Association ("GNMA" or "Ginnie Mae"), the Federal National Mortgage Association ("FNMA" or "Fannie Mae") and the Federal Home Loan Mortgage Corporation ("FHLMC" or "Freddie Mac"). GNMA certificates are backed by the "full faith 1 and credit" of the United States. FNMA and FHLMC certificates are not backed by the full faith and credit of the United States but the issuing agency or instrumentality has the right to borrow, to meet its obligations, from an existing line of credit with the U.S. Treasury. Collateralized Mortgage Obligations. The Fund may invest in "CMOs" -- collateralized mortgage obligations. CMOs are debt obligations collateralized by mortgage loans or mortgage pass-through securities (collectively "Mortgage Assets"). Payments of principal and interest on the Mortgage Assets and any reinvestment income are used to make payments on the CMOs. CMOs are issued in multiple classes. Each class has a specific fixed or floating coupon rate and a stated maturity or final distribution date. The principal and interest on the Mortgage Assets may be allocated among the classes in a number of different ways. Certain classes will, as a result of the collection, have more predictable cash flows than others. As a general matter, the more predictable the cash flow, the lower the yield relative to other Mortgage Assets. The less predictable the cash flow, the higher the yield and the greater the risk. The Fund may invest in any class of CMO. Inverse Floaters. The Fund may invest up to 10% of its net assets in inverse floaters. An inverse floater has a coupon rate that moves in the direction opposite to that of a designated interest rate index. Stripped Mortgage-Backed Securities. The Fund may purchase stripped mortgage-backed securities, which are usually structured in two classes. One class entitles the holder to receive all or most of the interest but little or none of the principal of a pool of Mortgage Assets (the interest-only or "IO" Class), while the other class entitles the holder to receive all or most of the principal but little or none of the interest (the principal-only or "PO" Class). Other Securities. The Fund may invest up to 20% of its assets in securities that are not government securities. This group of securities also will be issued by U.S., Canadian or Mexican issuers and may include corporate debt securities and securities backed by other assets, such as automobile or credit card receivables or home equity loans. They are rated at least Aa by Moody's or AA by S&P or, if not rated, determined to be of comparable quality by the Sub-Advisor. Fixed-income securities are debt securities and can take the form of bonds, notes or commercial paper. The issuer of the debt security borrows money from the investor who buys the security. Most debt securities pay either fixed or adjustable rates of interest at regular intervals until they mature, at which point investors get their principal back. The Fund's fixed-income investments may include zero coupon securities, which are purchased at a discount and either (i) pay no interest, or (ii) accrue interest, but make no payments until maturity. In addition, the Fund may invest in futures, options, reverse repurchase agreements and dollar rolls. In pursuing the Fund's investment objective, the Sub-Advisor has considerable leeway in deciding which investments it buys, holds or sells on a day-to-day basis -- and which trading or investment strategies it uses. For example, the Sub-Advisor in its discretion may determine to use some permitted trading or investment strategies while not using others. 2 [GRAPHIC OMITTED] PRINCIPAL RISKS - ---------------------- There is no assurance that the Fund will achieve its investment objective. The Fund's share price and yield will fluctuate with changes in the market value of the Fund's portfolio securities. When you sell Fund shares, they may be worth less than what you paid for them and, accordingly, you can lose money investing in this Fund. Fixed-Income Securities. All fixed-income securities are subject to two types of risk: credit risk and interest rate risk. Credit risk refers to the possibility that the issuer of a security will be unable to make interest payments and/or repay the principal on its debt. While the Fund invests in investment grade securities, these securities may have speculative characteristics. Interest rate risk refers to fluctuations in the value of a fixed-income security resulting from changes in the general level of interest rates. When the general level of interest rates goes up, the prices of most fixed-income securities go down. When the general level of interest rates goes down, the prices of most fixed-income securities go up. (Zero coupon securities are typically subject to greater price fluctuations than comparable securities that pay interest.) Mortgage-Backed Securities. Mortgage-backed securities have different risk characteristics than traditional debt securities. Although generally the value of fixed-income securities increases during periods of falling interest rates and decreases during periods of rising interest rates, this is not always the case with mortgage-backed securities. This is due to the fact that principal on underlying mortgages may be prepaid at any time as well as other factors. Generally, prepayments will increase during a period of falling interest rates and decrease during a period of rising interest rates. The rate of prepayments also may be influenced by economic and other factors. Prepayment risk includes the possibility that, as interest rates fall, securities with stated interest rates may have the principal prepaid earlier than expected, requiring the Fund to invest the proceeds at generally lower interest rates. Investments in mortgage-backed securities are made based upon, among other things, expectations regarding the rate of prepayments on underlying mortgage pools. Rates of prepayment, faster or slower than expected by the Sub-Advisor, could reduce the Fund's yield, increase the volatility of the Fund and/or cause a decline in net asset value. Certain mortgage-backed securities in which the Fund may invest may be more volatile and less liquid than other traditional types of debt securities. The Fund may be subject to a risk referred to as "extension risk," which is the possibility that rising interest rates may cause owners of the underlying mortgages to pay off their mortgages at a slower than expected rate. This risk may effectively change a security that was short or intermediate term into a long term security. Long term securities generally drop in value more dramatically when the general level of interest rates goes up. CMOs. Certain mortgage-backed securities in which the Fund may invest (e.g., certain classes of CMOs) may increase or decrease in value substantially with changes in interest rates and/or the rates of prepayment. In addition, if the collateral securing CMOs or any third party guarantees is insufficient to make payments, the Fund could sustain a loss. 3 Inverse Floaters. Like most other fixed-income securities, the value of inverse floaters will decrease as interest rates increase. They are more volatile, however, than most other fixed-income securities because the coupon rate on an inverse floater typically changes at a multiple of the change in the relevant index rate. Thus, any rise in the index rate (as a consequence of an increase in interest rates) causes a correspondingly greater drop in the coupon rate of an inverse floater while a drop in the index rate causes a correspondingly greater increase in the coupon of an inverse floater. The value of some inverse floaters may also increase or decrease substantially because of changes in the rate of prepayments. Stripped Mortgage-Backed Securities. IOs tend to decrease in value substantially if interest rates decline and prepayment rates become more rapid. POs tend to decrease in value substantially if interest rates increase and the rate of repayment decreases. Foreign Securities. The Fund's investments in foreign securities involve risks in addition to the risks associated with domestic securities. One additional risk is currency risk. While the price of Fund shares is quoted in U.S. dollars, the Fund generally converts U.S. dollars to a foreign market's local currency to purchase a security in that market. If the value of that local currency falls relative to the U.S. dollar, the U.S. dollar value of the foreign security will decrease. This is true even if the foreign security's local price remains unchanged. Foreign securities also have risks related to economic and political developments abroad, including effects of foreign social, economic or political instability. Foreign issuers, in general, are not subject to the regulatory requirements of U.S. issuers and, as such, there may be less publicly available information about these issuers. Moreover, foreign accounting, auditing and financial reporting standards generally are different from those applicable to U.S. issuers. Finally, in the event of a default of any foreign debt obligations, it may be more difficult for the Fund to obtain or enforce a judgment against the issuers of the securities. Securities of foreign issuers may be less liquid than comparable securities of U.S. issuers and, as such, their price changes may be more volatile. Furthermore, foreign exchanges and broker-dealers are generally subject to less government and exchange scrutiny and regulation than their U.S. counterparts. In addition, differences in clearance and settlement procedures in foreign markets may occasion delays in settlement of the Fund's trades effected in those markets and could result in losses to the Fund due to subsequent declines in the value of the securities subject to the trades. The Mexican securities in which the Fund may invest are issued by a developing country. Compared to the United States and other developed countries, developing countries may have relatively unstable governments, economies based on only a few industries and securities markets that trade a small number of securities. Prices of these securities tend to be especially volatile and, in the past, securities in these countries have offered greater potential loss than securities of companies located in developed countries. 4 Canadian and Mexican Securities. The Canadian debt securities market is significantly smaller than the U.S. debt securities market. In particular, the Canadian mortgage-backed securities market is of recent origin, and, although continued growth is anticipated, is less well developed and less liquid than its U.S. counterpart. Because the Fund may invest in Mexican debt instruments, investors in the Fund should be aware of certain special considerations associated with investing in debt obligations of the Mexican government. The Mexican government has exercised and continues to exercise a significant influence over many aspects of the private sector in Mexico. Mexican government actions concerning the economy could have a significant effect on market conditions and prices and yields of Mexican debt obligations, including those in which the Fund invests. Mexico is currently a major debtor nation (among developing countries) to commercial banks and foreign governments. The value of the Fund's investments may be affected by changes in oil prices, interest rates, taxation and other political or economic developments in Mexico, including recent rates of inflation which have exceeded the rates of inflation in the U.S. and Canada. The Fund can provide no assurance that future developments in the Mexican economy will not impair the Fund's investment flexibility, operations or ability to achieve its investment objective. Other Risks. The performance of the Fund also will depend on whether the Sub-Advisor is successful in applying the Fund's investment strategies. In addition, the Fund is subject to other risks from its permissible investments including those risks associated with futures, options and reverse repurchase agreements and dollar rolls. For information about these risks, see the "Additional Risk Information" section. Shares of the Fund are not bank deposits and are not guaranteed or insured by the FDIC or any other government agency. 5 [GRAPHIC OMITTED] PAST PERFORMANCE - ------------------------- The bar chart and table below provide some indication of the risks of investing in the Fund. The Fund's past performance does not indicate how the Fund will perform in the future. [GRAPHIC OMITTED] ANNUAL TOTAL RETURNS -- CALENDAR YEARS
1993 8.11% '94 -15.59% '95 16.00% Year-to-date total '96 4.01% return as of '97 7.89% September 30, 2001 '98 6.75% was 3.96%. '99 2.35% 2000 7.97%
During the periods shown in the bar chart, the highest return for a calendar quarter was 5.65% (quarter ended June 30, 1995) and the lowest return for a calendar quarter was -- 10.51% (quarter ended December 31, 1994). [sidebar] ANNUAL TOTAL RETURNS This chart shows how the performance of the Fund's shares has varied from year to year over the past 8 calendar years. [end sidebar] [sidebar] AVERAGE ANNUAL TOTAL RETURNS This table compares the Fund's average annual total returns with those of a broad measure of market performance over time. [end sidebar] AVERAGE ANNUAL TOTAL RETURNS (AS OF DECEMBER 31, 2000) - -------------------------------------------------------------------------------
LIFE OF FUND PAST 1 YEAR PAST 5 YEARS (SINCE 7/31/92) - ------------------------------------------------------------------------------- Morgan Stanley North American Government Income Trust 7.97% 5.77% 4.50% - ------------------------------------------------------------------------------- Lehman Brothers U.S. Credit Index (1-5 Year)(1) 8.48% 6.16% 6.50% - -------------------------------------------------------------------------------
(1) The Lehman Brothers U.S. Credit Index (1-5 Year) (formerly Lehman Brothers Mutual Fund Short (1-5) Investment Grade Debt Index) includes U.S. corporate and specified foreign debentures and secured notes with maturities of one to five years. The Index does not include any expenses, fees or charges. The Index is unmanaged and should not be considered an investment. 6 [GRAPHIC OMITTED] FEES AND EXPENSES - -------------------------- The table below briefly describes the fees and expenses that you may pay if you buy and hold shares of the Fund. The Fund does not impose any initial or deferred sales charges and does not charge account or exchange fees. [sidebar] ANNUAL FUND OPERATING EXPENSES These expenses are deducted from the Fund's assets and are based on expenses paid for the fiscal year ended October 31, 2001. [end sidebar] ANNUAL FUND OPERATING EXPENSES - ---------------------------------------------------------------
Management fee 0.65% - --------------------------------------------------------------- Distribution and service (12b-1) fees 0.73% - --------------------------------------------------------------- Other expenses 0.42% - --------------------------------------------------------------- Total annual Fund operating expenses 1.80% - ---------------------------------------------------------------
Example This example is intended to help you compare the cost of investing in the Fund with the cost of investing in other mutual funds. The example assumes that you invest $10,000 in the Fund, your investment has a 5% return each year, and the Fund's operating expenses remain the same. Although your actual costs may be higher or lower, the table below shows your costs at the end of each period based on these assumptions.
1 YEAR 3 YEARS 5 YEARS 10 YEARS - ------------------------------------------------- $183 $566 $975 $2,116 - -------------------------------------------------
[GRAPHIC OMITTED] ADDITIONAL INVESTMENT STRATEGY INFORMATION - ---------------------------------------------------- This section provides additional information relating to the Fund's principal investment strategies. Options and Futures. The Fund may invest in put and call options and futures with respect to financial instruments and interest rate indexes. The Fund may use options and futures to facilitate allocation of the Fund's investments among asset classes, to increase or decrease the Fund's exposure to a bond market, to generate income or to seek to protect against a decline in securities or an increase in prices of securities that may be purchased. Reverse Repurchase Agreements and Dollar Rolls. The Fund may use reverse repurchase agreements and dollar rolls as part of its investment strategy. Reverse repurchase agreements involve sales by the Fund of portfolio assets concurrently with an agreement by the Fund to repurchase the same assets at a later date at a fixed price. The Fund may enter into dollar rolls in which the Fund sells securities for delivery in the current month and simultaneously contracts to repurchase substantially similar (same type and coupon) securities on a specified future date. 7 Defensive Investing. The Fund may take temporary "defensive" positions in attempting to respond to adverse market conditions. The Fund may invest any amount of its assets in cash or money market instruments in a defensive posture when the Sub-Advisor believes it is advisable to do so. Although taking a defensive posture is designed to protect the Fund from an anticipated market downturn, it could have the effect of reducing the benefit from any upswing in the market. When the Fund takes a defensive position, it may not achieve its investment objective. The percentage limitations relating to the composition of the Fund's portfolio apply at the time the Fund acquires an investment. Subsequent percentage changes that result from market fluctuations will generally not require the Fund to sell any portfolio security. However, the Fund may be required to sell its illiquid securities holdings, if any, in response to fluctuations in the value of such holdings. The Fund may change its principal investment strategies without shareholder approval; however, you would be notified of any changes. [GRAPHIC OMITTED] ADDITIONAL RISK INFORMATION - ----------------------------------- This section provides additional information relating to the principal risks of investing in the Fund. Options and Futures. If the Fund invests in options and/or futures, its participation in these markets would subject it to certain risks. The Investment Manager's or Sub-Advisor's predictions of movements in the direction of the stock, bond or interest rate markets may be inaccurate, and the adverse consequences to the Fund (e.g., a reduction in the Fund's net asset value or a reduction in the amount of income available for distribution) may leave the Fund in a worse position than if these strategies were not used. Other risks inherent in the use of options and futures include, for example, the possible imperfect correlation between the price of options and futures contracts and movements in the prices of the securities being hedged, and the possible absence of a liquid secondary market for any particular instrument. Certain options may be over-the-counter options, which are options negotiated with dealers; there is no secondary market for these investments. Reverse Repurchase Agreements and Dollar Rolls. Reverse repurchase agreements and dollar rolls involve the risk that the market value of the securities the Fund is obligated to repurchase under the agreement may decline below the repurchase price. In the event the buyer of securities under a reverse repurchase agreement or dollar roll files for bankruptcy or becomes insolvent, the Fund's use of proceeds of the agreement may be restricted pending a determination by the other party, or its trustee or receiver, whether to enforce the Fund's obligation to repurchase the securities. Reverse repurchase agreements and dollar rolls are speculative techniques involving leverage, and are considered borrowings by the Fund. 8 [GRAPHIC OMITTED] FUND MANAGEMENT - ------------------------- The Fund has retained the Investment Manager -- Morgan Stanley Investment Advisors Inc. -- to provide administrative services, manage its business affairs and supervise the investment of its assets. The Investment Manager has, in turn, contracted with the Sub-Advisor -- TCW Investment Management Company -- to invest the Fund's assets, including the placing of orders for the purchase and sale of portfolio securities. The Investment Manager is a wholly-owned subsidiary of Morgan Stanley Dean Witter & Co., a preeminent global financial services firm that maintains leading market positions in each of its three primary businesses: securities, asset management and credit services. Its address is 1221 Avenue of the Americas, New York, NY 10020. [sidebar] MORGAN STANLEY INVESTMENT ADVISORS INC. The Investment Manager is widely recognized as a leader in the mutual fund industry and together with Morgan Stanley Services Company Inc., its wholly-owned subsidiary, had approximately $135 billion in assets under management as of November 30, 2001. [end sidebar] The Sub-Advisor, together with its affiliated companies, manages approximately $79.5 billion, at November 30, 2001, primarily for institutional investors. The Sub-Advisor's main business office is located at 865 South Figueroa Street, Suite 1800, Los Angeles, California 90017. The Sub-Advisor is a wholly-owned subsidiary of the TCW Group, Inc. ("TCW Group"), whose direct and indirect subsidiaries provide a variety of trust, investment management and investment advisory services. Societe Generale Asset Management, S.A., a wholly-owned subsidiary of Societe Generale, S.A., owns a majority interest in TCW Group. Philip A. Barach and Jeffrey E. Gundlach, Group Managing Directors of the Sub-Advisor, and Frederick H. Horton, Managing Director of the Sub-Advisor, are the Fund's primary portfolio managers, and have been so for over five years. Messrs. Barach, Gundlach and Horton have each been portfolio managers with affiliates of the Sub-Advisor for over five years. The Fund pays the Investment Manager a monthly management fee as full compensation for the services and facilities furnished to the Fund, and for Fund expenses assumed by the Investment Manager. The fee is based on the Fund's average daily net assets. For the fiscal year ended October 31, 2001, the Fund accrued total compensation to the Investment Manager amounting to 0.65% of the Fund's average daily net assets. The Investment Manager pays the Sub-Advisor compensation equal to 40% of its compensation for services and facilities furnished to the Fund. 9 Shareholder Information [GRAPHIC OMITTED] PRICING FUND SHARES - --------------------------- The price of Fund shares, called "net asset value," is based on the value of the Fund's portfolio securities. The net asset value per share of the Fund is determined once daily at 4:00 p.m. Eastern time on each day that the New York Stock Exchange is open (or, on days when the New York Stock Exchange closes prior to 4:00 p.m., at such earlier time). Shares will not be priced on days that the New York Stock Exchange is closed. The value of the Fund's portfolio securities is based on the securities' market price when available. When a market price is not readily available, including circumstances under which the Investment Manager and/or Sub-Advisor determines that a security's market price is not accurate, a portfolio security is valued at its fair value, as determined under procedures established by the Fund's Board of Trustees. In these cases, the Fund's net asset value will reflect certain portfolio securities' fair value rather than their market price. With respect to securities that are primarily listed on foreign exchanges, the value of the Fund's portfolio securities may change on days when you will not be able to purchase or sell your shares. An exception to the Fund's general policy of using market prices concerns its short-term debt portfolio securities. Debt securities with remaining maturities of sixty days or less at the time of purchase are valued at amortized cost. However, if the cost does not reflect the securities' market value, these securities will be valued at their fair value. [GRAPHIC OMITTED] HOW TO BUY SHARES - -------------------------- You may open a new account to buy Fund shares or buy additional Fund shares for an existing account by contacting your Morgan Stanley Financial Advisor or other authorized financial representative. Your Financial Advisor will assist you, step-by-step, with the procedures to invest in the Fund. You may also purchase shares directly by calling the Fund's transfer agent and requesting an application. [sidebar] CONTACTING A FINANCIAL ADVISOR If you are new to the Morgan Stanley Family of Funds and would like to contact a Financial Advisor, call (toll-free) 1-866-MORGAN8 for the telephone number of the Morgan Stanley office nearest you. You may also access our office locator on our Internet site at: www.morganstanley.com/funds [end sidebar] When you buy Fund shares, the shares are purchased at the next share price calculated after we receive your purchase order. Your payment is due on the third business day after you place your purchase order. We reserve the right to reject any order for the purchase of Fund shares. 10 [sidebar] EASYINVEST(Service Mark) A purchase plan that allows you to transfer money automatically from your checking or savings account or from a Money Market Fund on a semi-monthly, monthly or quarterly basis. Contact your Morgan Stanley Financial Advisor for further information about this service. [end sidebar] MINIMUM INVESTMENT AMOUNTS - -------------------------------------------------------------------------------
MINIMUM INVESTMENT ------------------------ INVESTMENT OPTIONS INITIAL ADDITIONAL - ------------------------------------------------------------------------------- Regular accounts $ 1,000 $ 100 - ------------------------------------------------------------------------------- Individual Retirement Accounts: Regular IRAs $ 1,000 $ 100 Education IRAs $ 500 $ 100 - ------------------------------------------------------------------------------- EasyInvest(Service Mark) (Automatically from your checking or savings account or Money Market Fund) $ 100* $ 100* - -------------------------------------------------------------------------------
* Provided your schedule of investments totals $1,000 in twelve months. There is no minimum investment amount if you purchase Fund shares through: (1) the Investment Manager's mutual fund asset allocation plan, (2) a program, approved by the Fund's distributor, in which you pay an asset-based fee for advisory, administrative and/or brokerage services, (3) the following programs approved by the Fund's distributor: (i) qualified state tuition plans described in Section 529 of the Internal Revenue Code and (ii) certain other investment programs that do not charge an asset-based fee, or (4) employer-sponsored employee benefit plan accounts. Subsequent Investments Sent Directly to the Fund. In addition to buying additional Fund shares for an existing account by contacting your Morgan Stanley Financial Advisor, you may send a check directly to the Fund. To buy additional shares in this manner: o Write a "letter of instruction" to the Fund specifying the name(s) on the account, the account number, the social security or tax identification number, and the investment amount. The letter must be signed by the account owner(s). o Make out a check for the total amount payable to: Morgan Stanley North American Government Income Trust. o Mail the letter and check to Morgan Stanley Trust at P.O. Box 1040, Jersey City, NJ 07303. PLAN OF DISTRIBUTION (RULE 12b-1 FEES) The Fund has adopted a Plan of Distribution in accordance with Rule 12b-1 under the Investment Company Act of 1940. The Plan allows the Fund to pay distribution fees of up to 0.75% for the sale and distribution of these shares. It also allows the Fund to pay for services to shareholders. Because these fees are paid out of the Fund's assets on an ongoing basis, over time these fees will increase the cost of your investment and may cost you more than paying other types of sales charges. 11 [GRAPHIC OMITTED] HOW TO EXCHANGE SHARES - -------------------------------- Permissible Fund Exchanges. You may only exchange shares of the Fund for shares of other continuously offered Morgan Stanley Funds if the Fund shares were acquired in an exchange of shares initially purchased in a Multi-Class Fund or an FSC Fund (subject to a front-end sales charge). In that case, the shares may be subsequently re-exchanged for shares of the same Class of any Multi-Class Fund or FSC Fund or for shares of a No-Load Fund, a Money Market Fund or Short-Term U.S. Treasury Trust. Of course, if an exchange is not permitted, you may sell shares of the Fund and buy another Fund's shares with the proceeds. See the inside back cover of this Prospectus for each Morgan Stanley Fund's designation as a Multi-Class Fund, No-Load Fund, Money Market Fund or FSC Fund. If a Morgan Stanley Fund is not listed, consult the inside back cover of that fund's current prospectus for its designation. The current prospectus for each fund describes its investment objective(s), policies and investment minimums, and should be read before investment. Since exchanges are available only into continuously offered Morgan Stanley Funds, exchanges are not available into any new Morgan Stanley Fund during its initial offering period, or when shares of a particular Morgan Stanley Fund are not being offered for purchase. Exchange Procedures. You can process an exchange by contacting your Morgan Stanley Financial Advisor or other authorized financial representative. Otherwise, you must forward an exchange privilege authorization form to the Fund's transfer agent -- Morgan Stanley Trust -- and then write the transfer agent or call (800) 869-NEWS to place an exchange order. You can obtain an exchange privilege authorization form by contacting your Financial Advisor or other authorized financial representative, or by calling (800) 869-NEWS. If you hold share certificates, no exchanges may be processed until we have received all applicable share certificates. An exchange to any Morgan Stanley Fund (except a Money Market Fund) is made on the basis of the next calculated net asset values of the funds involved after the exchange instructions are accepted. When exchanging into a Money Market Fund, the Fund's shares are sold at their next calculated net asset value and the Money Market Fund's shares are purchased at their net asset value on the following business day. The Fund may terminate or revise the exchange privilege upon required notice. The check writing privilege is not available for Money Market Fund shares you acquire in an exchange. Telephone Exchanges. For your protection when calling Morgan Stanley Trust, we will employ reasonable procedures to confirm that exchange instructions communicated over the telephone are genuine. These procedures may include requiring various forms of personal identification such as name, mailing address, social security or other tax identification number. Telephone instructions also may be recorded. Telephone instructions will be accepted if received by the Fund's transfer agent between 9:00 a.m. and 4:00 p.m. Eastern time on any day the New York Stock Exchange is open for business. During periods 12 of drastic economic or market changes, it is possible that the telephone exchange procedures may be difficult to implement, although this has not been the case with the Fund in the past. Exchanging Shares of Another Fund Subject to a Contingent Deferred Sales Charge ("CDSC"). There are special considerations when you exchange shares subject to a CDSC of another Morgan Stanley Fund for shares of the Fund. When determining the length of time you held the shares and the corresponding CDSC rate, any period (starting at the end of the month) during which you held shares of the Fund will not be counted. Thus, in effect the "holding period" for purposes of calculating the CDSC is frozen upon exchanging into the Fund. Nevertheless, if shares subject to a CDSC are exchanged for shares of the Fund, you will receive a credit when you sell the shares equal to the distribution (12b-1) fees, if any, you paid on those shares while in the Fund up to the amount of any applicable CDSC. See the prospectus of the fund that charges the CDSC for more details. Margin Accounts. If you have pledged your Fund shares in a margin account, contact your Morgan Stanley Financial Advisor or other authorized financial representative regarding restrictions on the exchange of such shares. Tax Considerations of Exchanges. If you exchange shares of the Fund for shares of another Morgan Stanley Fund there are important tax considerations. For tax purposes, the exchange out of the Fund is considered a sale of Fund shares -- and the exchange into the other fund is considered a purchase. As a result, you may realize a capital gain or loss. You should review the "Tax Consequences" section and consult your own tax professional about the tax consequences of an exchange. Limitations on Exchanges. Certain patterns of past exchanges and/or purchase or sale transactions involving the Fund or other Morgan Stanley Funds may result in the Fund limiting or prohibiting, at its discretion, additional purchases and/or exchanges. Determinations in this regard may be made based on the frequency or dollar amount of the previous exchanges or purchase or sale transactions. You will be notified in advance of limitations on your exchange privileges. For further information regarding exchange privileges, you should contact your Morgan Stanley Financial Advisor or call (800) 869-NEWS. 13 [GRAPHIC OMITTED] HOW TO SELL SHARES - --------------------------- You can sell some or all of your Fund shares at any time. Your shares will be sold at the next price calculated after we receive your order to sell as described below.
OPTIONS PROCEDURES - ------------------ --------------------------------------------------------------------------------------------------- Contact Your To sell your shares, simply call your Morgan Stanley Financial Advisor or other authorized Financial Advisor financial representative. --------------------------------------------------------------------------------------------------- [GRAPHIC OMITTED] Payment will be sent to the address to which the account is registered, or deposited in your brokerage account. --------------------------------------------------------------------------------------------------- By Letter You can also sell your shares by writing a "letter of instruction" that includes: [GRAPHIC OMITTED] o your account number; o the name of the Fund; o the dollar amount or the number of shares you wish to sell; and o the signature of each owner as it appears on the account. --------------------------------------------------------------------------------------------------- If you are requesting payment to anyone other than the registered owner(s) or that payment be sent to any address other than the address of the registered owner(s) or pre-designated bank account, you will need a signature guarantee. You can generally obtain a signature guarantee from an eligible guarantor acceptable to Morgan Stanley Trust. (You should contact Morgan Stanley Trust at (800) 869-NEWS for determination as to whether a particular institution is an eligible guarantor.) A notary public cannot provide a signature guarantee. Additional documentation may be required for shares held by a corporation, partnership, trustee or executor. --------------------------------------------------------------------------------------------------- Mail the letter to Morgan Stanley Trust at P.O. Box 983, Jersey City, NJ 07303. If you hold share certificates, you must return the certificates, along with the letter and any required additional documentation. --------------------------------------------------------------------------------------------------- A check will be mailed to the name(s) and address in which the account is registered, or otherwise according to your instructions. --------------------------------------------------------------------------------------------------- Systematic If your investment in all of the Morgan Stanley Family of Funds has a total market value of at Withdrawal Plan least $10,000, you may elect to withdraw amounts of $25 or more, or in any whole percentage [GRAPHIC OMITTED] of a fund's balance (provided the amount is at least $25), on a monthly, quarterly, semi-annual or annual basis, from any fund with a balance of at least $1,000. Each time you add a fund to the plan, you must meet the plan requirements. --------------------------------------------------------------------------------------------------- To sign up for the Systematic Withdrawal Plan, contact your Morgan Stanley Financial Advisor or call (800) 869-NEWS. You may terminate or suspend your plan at any time. Please remember that withdrawals from the plan are sales of shares, not Fund "distributions," and ultimately may exhaust your account balance. The Fund may terminate or revise the plan at any time. ---------------------------------------------------------------------------------------------------
Payment for Sold Shares. After we receive your complete instructions to sell as described above, a check will be mailed to you within seven days, although we will attempt to make payment within one business day. Payment may also be sent to your brokerage account. 14 Payment may be postponed or the right to sell your shares suspended under unusual circumstances. If you request to sell shares that were recently purchased by check, your sale will not be effected until it has been verified that the check has been honored. Tax Considerations. Normally, your sale of Fund shares is subject to federal and state income tax. You should review the "Tax Consequences" section of this Prospectus and consult your own tax professional about the tax consequences of a sale. Involuntary Sales. The Fund reserves the right, on sixty days' notice, to sell the shares of any shareholder (other than shares held in an IRA or 403(b) Custodial Account) whose shares, due to sales by the shareholder, have a value below $100, or in the case of an account opened through EasyInvest(SM), if after 12 months the shareholder has invested less than $1,000 in the account. However, before the Fund sells your shares in this manner, we will notify you and allow you sixty days to make an additional investment in an amount that will increase the value of your account to at least the required amount before the sale is processed. Margin Accounts. If you have pledged your Fund shares in a margin account, contact your Morgan Stanley Financial Advisor or other authorized financial representative regarding restrictions on the sale of such shares. [GRAPHIC OMITTED] DISTRIBUTIONS - -------------------- The Fund passes substantially all of its earnings from income and capital gains along to its investors as "distributions." The Fund earns interest from fixed-income investments. These amounts are passed along to Fund shareholders as "income dividend distributions." The Fund realizes capital gains whenever it sells securities for a higher price than it paid for them. These amounts may be passed along as "capital gain distributions." [sidebar] TARGETED DIVIDENDS(Service Mark) You may select to have your Fund distributions automatically invested in another Morgan Stanley Fund that you own. Contact your Morgan Stanley Financial Advisor for further information about this service. [end sidebar] Normally, income dividends are distributed to shareholders monthly. Capital gains, if any, are usually distributed in December. The Fund, however, may retain and reinvest any long-term capital gains. The Fund may at times make payments from sources other than income or capital gains that represent a return of a portion of your investment. Distributions are reinvested automatically in additional shares of the Fund and automatically credited to your account, unless you request in writing that all distributions be paid in cash. If you elect the cash option, the Fund will mail a check to you no later than seven business days after the distribution is declared. However, if you purchase Fund shares through a Financial Advisor within three business days prior to the record date for the distribution, the distribution will automatically be paid to you in cash, even if you did not request to receive all distributions in cash. No interest will accrue on uncashed 15 checks. If you wish to change how your distributions are paid, your request should be received by the Fund's transfer agent, Morgan Stanley Trust, at least five business days prior to the record date of the distributions. [GRAPHIC OMITTED] TAX CONSEQUENCES - ------------------------- As with any investment, you should consider how your Fund investment will be taxed. The tax information in this Prospectus is provided as general information. You should consult your own tax professional about the tax consequences of an investment in the Fund. Unless your investment in the Fund is through a tax-deferred retirement account, such as a 401(k) plan or IRA, you need to be aware of the possible tax consequences when: o The Fund makes distributions; and o You sell Fund shares, including an exchange to another Morgan Stanley Fund. Taxes on Distributions. Your distributions are normally subject to federal and state income tax when they are paid, whether you take them in cash or reinvest them in Fund shares. A distribution also may be subject to local income tax. Any income dividend distributions and any short-term capital gain distributions are taxable to you as ordinary income. Any long-term capital gain distributions are taxable as long-term capital gains, no matter how long you have owned shares in the Fund. Every January, you will be sent a statement (IRS Form 1099-DIV) showing the taxable distributions paid to you in the previous year. The statement provides information on your dividends and capital gains for tax purposes. Taxes on Sales. Your sale of Fund shares normally is subject to federal and state income tax and may result in a taxable gain or loss to you. A sale also may be subject to local income tax. Your exchange of Fund shares for shares of another Morgan Stanley Fund is treated for tax purposes like a sale of your original shares and a purchase of your new shares. Thus, the exchange may, like a sale, result in a taxable gain or loss to you and will give you a new tax basis for your new shares. When you open your Fund account, you should provide your social security or tax identification number on your investment application. By providing this information, you will avoid being subject to a federal backup withholding tax (approximately 30% currently) on taxable distributions and redemption proceeds. Any withheld amount would be sent to the IRS as an advance tax payment. 16 Financial Highlights The financial highlights table is intended to help you understand the Fund's financial performance for the periods indicated. Certain information reflects financial results for a single Fund share throughout each period. The total returns in the table represent the rate an investor would have earned or lost on an investment in the Fund (assuming reinvestment of all dividends and distributions). This information has been audited by Deloitte & Touche LLP, independent auditors, whose report, along with the Fund's financial statements, is included in the annual report, which is available upon request.
FOR THE YEAR ENDED OCTOBER 31, - ---------------------------------------------------------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 SELECTED PER SHARE DATA: Net asset value, beginning of period $8.60 $8.50 $8.60 $8.59 $8.39 - ------------------------------------------------------------------------------------------------------------------------- INCOME (LOSS) FROM INVESTMENT OPERATIONS: Net investment income 0.40 0.40 0.44 0.49 0.44 Net realized and unrealized gain (loss) 0.22 0.06 (0.09) (0.05) 0.19 Total income from investment operations 0.62 0.46 0.35 0.44 0.63 - ------------------------------------------------------------------------------------------------------------------------- LESS DIVIDENDS AND DISTRIBUTIONS FROM: Net investment income (0.40) (0.36) (0.38) (0.43) (0.43) Paid-in-capital -- -- (0.07) -- -- Total dividends and distributions (0.40) (0.36) (0.45) (0.43) (0.43) - -------------------------------------------------------------------------------------------------------------------------- Net asset value, end of period $8.82 $8.60 $8.50 $8.60 $8.59 - -------------------------------------------------------------------------------------------------------------------------- TOTAL RETURN+ 7.43% 5.55% 4.30% 5.13% 7.80% - -------------------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS: Expenses (before expense offset) 1.80%(1) 1.76%(1) 1.81%(1) 1.69%(1) 1.65% Net investment income 4.51% 4.58% 5.11% 5.52% 5.18% - -------------------------------------------------------------------------------------------------------------------------- SUPPLEMENTAL DATA: Net assets, end of period, in thousands $90,611 $ 91,695 $120,303 $150,441 $212,040 Portfolio turnover rate 19% -- 43% 8% -- - --------------------------------------------------------------------------------------------------------------------------
+ Calculated based on the net asset value as of the last business day of the period. 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-------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 20 Morgan Stanley Funds - -------------------------------------------------------------------------------- O GLOBAL/INTERNATIONAL FUNDS Competitive Edge Fund - "Best Ideas" Portfolio European Growth Fund Fund of Funds - International Portfolio Global Dividend Growth Securities Global Utilities Fund International Fund International SmallCap Fund International Value Equity Fund Japan Fund Latin American Growth Fund Pacific Growth Fund O GROWTH FUNDS 21st Century Trend Fund Aggressive Equity Fund All Star Growth Fund American Opportunities Fund Capital Growth Securities Developing Growth Securities Trust Financial Services Trust Growth Fund Health Sciences Trust Information Fund KLD Social Index Fund Market Leader Trust Mid-Cap Equity Trust Mid-Cap Value Fund Nasdaq-100 Index Fund Natural Resource Development Securities New Discoveries Fund Next Generation Trust Small Cap Growth Fund Special Value Fund Tax-Managed Growth Fund Technology Fund O GROWTH + INCOME FUNDS Balanced Growth Fund Balanced Income Fund Convertible Securities Trust Dividend Growth Securities Equity Fund Fund of Funds - Domestic Portfolio Income Builder Fund Real Estate Fund S&P 500 Index Fund S&P 500 Select Fund Strategist Fund Total Market Index Fund Total Return Trust Utilities Fund Value Fund Value-Added Market Series/ Equity Portfolio O INCOME FUNDS Diversified Income Trust Federal Securities Trust High Yield Securities Intermediate Income Securities Limited Duration Fund(NL) Liquid Asset Fund(MM) North American Government Income Trust Short-Term U.S. Treasury Trust U.S. Government Money Market Trust(MM) U.S. Government Securities Trust O TAX-FREE INCOME FUNDS California Tax-Free Daily Income Trust(MM) California Tax-Free Income Fund Hawaii Municipal Trust(FSC) Limited Term Municipal Trust(NL) Multi-State Municipal Series Trust(FSC) New York Municipal Money Market Trust(MM) New York Tax-Free Income Fund Tax-Exempt Securities Trust Tax-Free Daily Income Trust(MM) - -------------------------------------------------------------------------------- There may be funds created after this Prospectus was published. Please consult the inside back cover of a new fund's prospectus for its designations, e.g., Multi-Class Fund or Money Market Fund. Unless otherwise noted, each listed Morgan Stanley Fund, except for North American Government Income Trust and Short-Term U.S. Treasury Trust, is a Multi-Class Fund. A Multi-Class Fund is a mutual fund offering multiple Classes of shares. The other types of funds are: NL -- No-Load (Mutual) Fund; MM -- Money Market Fund; FSC -- A mutual fund sold with a front-end sales charge and a distribution (12b-1) fee. [GRAPHIC OMITTED] Additional information about the Fund's investments is available in the Fund's Annual and Semi-Annual Reports to Shareholders. In the Fund's Annual Report, you will find a discussion of the market conditions and investment strategies that significantly affected the Fund's performance during its last fiscal year. The Fund's Statement of Additional Information also provides additional information about the Fund. The Statement of Additional Information is incorporated herein by reference (legally is part of this Prospectus). For a free copy of any of these documents to request other information about the Fund, or to make shareholder inquiries, please call: (800) 869-NEWS You also may obtain information about the Fund by calling your Morgan Stanley Financial Advisor or by visiting our Internet site at: www.morganstanley.com/funds Information about the Fund (including the Statement of Additional Information) can be viewed and copied at the Securities and Exchange Commission's Public Reference Room in Washington, DC. Information about the Reference Room's operations may be obtained by calling the SEC at (202)942-8090. Reports and other information about the Fund are available on the EDGAR Database on the SEC's Internet site (www.sec.gov) and copies of this information may be obtained, after paying a duplicating fee, by electronic request at the following E-mail address: publicinfo@sec.gov, or by writing the Public Reference Section of the SEC, Washington, DC 20549-0102. TICKER SYMBOL: NGTVX (THE FUND'S INVESTMENT COMPANY ACT FILE NO. IS 811-6572) [GRAPHIC OMITTED] MorganStanley Morgan Stanley North American Government Income Trust A mutual fund that seeks to earn a high level of current income while maintaining relatively low volatility of principal Prospectus December 31, 2001 STATEMENT OF ADDITIONAL INFORMATION MORGAN STANLEY NORTH AMERICAN GOVERNMENT December 31, 2001 INCOME TRUST - -------------------------------------------------------------------------------- This Statement of Additional Information is not a prospectus. The Prospectus dated December 31, 2001 for Morgan Stanley North American Government Income Trust may be obtained without charge from the Fund at its address or telephone number listed below or from Morgan Stanley DW Inc. at any of its branch offices. Morgan Stanley North American Government Income Trust c/o Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, NJ 07311 (800) 869-NEWS TABLE OF CONTENTS - --------------------------------------------------------------------------------
I. Fund History .......................................................... 4 II. Description of the Fund and Its Investments and Risks ................. 4 A. Classification .................................................. 4 B. Investment Strategies and Risks ................................. 4 C. Fund Policies/Investment Restrictions ........................... 12 III. Management of the Fund ................................................ 13 A. Board of Trustees ............................................... 13 B. Management Information .......................................... 13 C. Compensation .................................................... 18 IV. Control Persons and Principal Holders of Securities ................... 20 V. Management, Investment Advice and Other Services ...................... 20 A. The Investment Manager and Sub-Advisor .......................... 20 B. Principal Underwriter ........................................... 20 C. Services Provided by the Investment Manager and the Sub-Advisor . 21 D. Rule 12b-1 Plan ................................................. 22 E. Other Service Providers ......................................... 24 F. Codes of Ethics ................................................. 24 VI. Brokerage Allocation and Other Practices .............................. 24 A. Brokerage Transactions .......................................... 24 B. Commissions ..................................................... 25 C. Brokerage Selection ............................................. 25 D. Directed Brokerage .............................................. 26 E. Regular Broker-Dealers .......................................... 26 VII. Capital Stock and Other Securities .................................... 26 VIII. Purchase, Redemption and Pricing of Shares ............................ 27 A. Purchase/Redemption of Shares ................................... 27 B. Offering Price .................................................. 27 IX. Taxation of the Fund and Shareholders ................................. 28 X. Underwriters .......................................................... 30 XI. Calculation of Performance Data ....................................... 30 XII. Financial Statements .................................................. 31
2 GLOSSARY OF SELECTED DEFINED TERMS The terms defined in this glossary are frequently used in this Statement of Additional Information (other terms used occasionally are defined in the text of the document). "Custodian" - The Bank of New York. "Distributor" - Morgan Stanley Distributors Inc., a wholly-owned broker-dealer subsidiary of Morgan Stanley. "Financial Advisors" - Morgan Stanley authorized financial services representatives. "Fund" - Morgan Stanley North American Government Income Trust, a registered open-end investment company. "Independent Trustees" - Trustees who are not "interested persons" (as defined by the Investment Company Act) of the Fund. "Investment Manager" - Morgan Stanley Investment Advisors Inc., a wholly-owned investment advisor subsidiary of Morgan Stanley. "Morgan Stanley" - Morgan Stanley Dean Witter & Co., a preeminent global financial services firm. "Morgan Stanley & Co." - Morgan Stanley & Co. Incorporated, a wholly-owned broker-dealer subsidiary of Morgan Stanley. "Morgan Stanley DW" - Morgan Stanley DW Inc., a wholly-owned broker-dealer subsidiary of Morgan Stanley. "Morgan Stanley Funds" - Registered investment companies (i) for which the Investment Manager serves as the investment advisor; and (ii) that hold themselves out to investors as related companies for investment and investor services. "Morgan Stanley Services" - Morgan Stanley Services Company Inc., a wholly-owned fund services subsidiary of the Investment Manager. "Sub-Advisor" - TCW Investment Management Company, a wholly-owned subsidiary of TCW. "TCW" - The TCW Group, Inc., a preeminent investment management and investment advisory services firm. "Transfer Agent" - Morgan Stanley Trust, a wholly-owned transfer agent subsidiary of Morgan Stanley. "Trustees" - The Board of Trustees of the Fund. 3 I. FUND HISTORY - -------------------------------------------------------------------------------- The Fund was organized as a Massachusetts business trust, under a Declaration of Trust, on February 19, 1992, with the name "TCW/DW North American Government Income Trust." Effective June 28, 1999, the Fund's name was changed to Morgan Stanley Dean Witter North American Government Income Trust. Effective June 18, 2001, the Fund's name was changed to Morgan Stanley North American Government Income Trust. II. DESCRIPTION OF THE FUND AND ITS INVESTMENTS AND RISKS - -------------------------------------------------------------------------------- A. CLASSIFICATION The Fund is an open-end, management investment company whose investment objective is to earn a high level of current income while maintaining relatively low volatility of principal. The Fund is a "non-diversified" mutual fund and, as such, its investments are not required to meet certain diversification requirements under federal securities law. Compared with "diversified" funds, the Fund may invest a greater percentage of its assets in the securities of an individual corporation or governmental entity. Thus, the Fund's assets may be concentrated in fewer securities than other funds. A decline in the value of those investments would cause the Fund's overall value to decline to a greater degree. The Fund's investments, however, are currently diversified and may remain diversified in the future. B. INVESTMENT STRATEGIES AND RISKS The following discussion of the Fund's investment strategies and risks should be read with the sections of the Fund's Prospectus titled "Principal Investment Strategies," "Principal Risks," "Additional Investment Strategy Information" and "Additional Risk Information." FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS. The Fund may enter into forward foreign currency exchange contracts ("forward contracts") to facilitate settlement or in an attempt to limit the effect of changes in the relationship between the U.S. dollar and the foreign currency during the period between the date on which the security is purchased or sold and the date on which payment is made or received. The Fund may conduct its foreign currency exchange transactions either on a spot (i.e., cash) basis at the spot rate prevailing in the foreign currency exchange market, or through entering into forward contracts to purchase or sell foreign currencies. A forward contract involves an obligation to purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract agreed upon by the parties, at a price set at the time of the contract. These contracts are traded in the interbank market conducted directly between currency traders (usually large commercial and investment banks) and their customers. Forward contracts will only be entered into with United States banks and their foreign branches, insurance companies or other dealers or foreign banks whose assets total $1 billion or more. A forward contract generally has no deposit requirement, and no commissions are charged at any stage for trades. The Fund will not enter into forward currency contracts or maintain a net exposure to these contracts where the consummation of the contracts would obligate the Fund to deliver an amount of foreign currency in excess of the value of the Fund's portfolio securities. When required by law, the Fund will cause its custodian bank to earmark cash, U.S. government securities or other appropriate liquid portfolio securities in an amount equal to the value of the Fund's total assets committed to the consummation of forward contracts entered into under the circumstances set forth above. If the value of the securities so earmarked declines, additional cash or securities will be placed in the account on a daily basis so that the value of such securities will equal the amount of the Fund's commitments with respect to such contracts. Although the Fund values its assets daily in terms of U.S. dollars, it does not intend to convert its holdings of foreign currencies into U.S. dollars on a daily basis. It will, however, do so from time to time, and investors should be aware of the costs of currency conversion. Although foreign exchange dealers do not charge a fee for conversion, they do realize a profit based on the spread between the prices at 4 which they are buying and selling various currencies. Thus, a dealer may offer to sell a foreign currency to the Fund at one rate, while offering a lesser rate of exchange should the Fund desire to resell that currency to the dealer. The Fund may be limited in its ability to enter into hedging transactions involving forward contracts by the Internal Revenue Code requirements relating to qualification as a regulated investment company. Forward contracts may limit gains on portfolio securities that could otherwise be realized had they not been utilized and could result in losses. The contracts also may increase the Fund's volatility and may involve a significant amount of risk relative to the investment of cash. OPTION AND FUTURES TRANSACTIONS. The Fund may engage in transactions in listed and OTC options. Listed options are issued or guaranteed by the exchange on which they are traded or by a clearing corporation such as the Options Clearing Corporation ("OCC"). Ownership of a listed call option gives the Fund the right to buy from the OCC (in the U.S.) or other clearing corporation or exchange, the underlying security covered by the option at the stated exercise price (the price per unit of the underlying security) by filing an exercise notice prior to the expiration date of the option. The writer (seller) of the option would then have the obligation to sell to the OCC (in the U.S.) or other clearing corporation or exchange, the underlying security at that exercise price prior to the expiration date of the option, regardless of its then current market price. Ownership of a listed put option would give the Fund the right to sell the underlying security to the OCC (in the U.S.) or other clearing corporation or exchange, at the stated exercise price. Upon notice of exercise of the put option, the writer of the put would have the obligation to purchase the underlying security from the OCC (in the U.S.) or other clearing corporation or exchange, at the exercise price. Covered Call Writing. The Fund is permitted to write covered call options on portfolio securities, without limit. The Fund will receive from the purchaser, in return for a call it has written, a "premium;" i.e., the price of the option. Receipt of these premiums may better enable the Fund to earn a higher level of current income than it would earn from holding the underlying securities alone. Moreover, the premium received will offset a portion of the potential loss incurred by the Fund if the securities underlying the option decline in value. The Fund may be required, at any time during the option period, to deliver the underlying security against payment of the exercise price on any calls it has written. This obligation is terminated upon the expiration of the option period or at such earlier time when the writer effects a closing purchase transaction. A closing purchase transaction is accomplished by purchasing an option of the same series as the option previously written. However, once the Fund has been assigned an exercise notice, the Fund will be unable to effect a closing purchase transaction. A call option is "covered" if the Fund owns the underlying security subject to the option or has an absolute and immediate right to acquire that security without additional cash consideration (or for additional consideration (in cash, Treasury bills or other liquid portfolio securities) held in a segregated account on the Fund's books) upon conversion or exchange of other securities held in its portfolio. A call option is also covered if the Fund holds a call on the same security as the call written where the exercise price of the call held is (i) equal to or less than the exercise price of the call written or (ii) greater than the exercise price of the call written if the difference is maintained by the Fund in cash, Treasury bills or other liquid portfolio securities in a segregated account on the Fund's books. Options written by the Fund normally have expiration dates of up to eighteen months from the date written. The exercise price of a call option may be below, equal to or above the current market value of the underlying security at the time the option is written. Covered Put Writing. A writer of a covered put option incurs an obligation to buy the security underlying the option from the purchaser of the put, at the option's exercise price at any time during the option period, at the purchaser's election. Through the writing of a put option, the Fund would receive income from the premium paid by purchasers. The potential gain on a covered put option is limited to the premium received on the option (less the commissions paid on the transaction). During the option period, the Fund may be required to make payment of the exercise price against delivery of the underlying 5 security. A put option is "covered" if the Fund maintains cash, Treasury bills or other liquid portfolio securities with a value equal to the exercise price in a segregated account on the Fund's books, or holds a put on the same security as the put written where the exercise price of the put held is equal to or greater than the exercise price of the put written. The aggregate value of the obligations underlying puts may not exceed 50% of the Fund's net assets. The operation of and limitations on covered put options in other respects are substantially identical to those of call options. Purchasing Call and Put Options. The Fund may purchase listed and OTC call and put options in amounts equaling up to 5% of its total assets. The purchase of a call option would enable the Fund, in return for the premium paid to lock in a purchase price for a security during the term of the option. The purchase of a put option would enable the Fund, in return for a premium paid, to lock in a price at which it may sell a security during the term of the option. OTC Options. OTC options are purchased from or sold (written) to dealers or financial institutions which have entered into direct agreements with the Fund. With OTC options, such variables as expiration date, exercise price and premium will be agreed upon between the Fund and the transacting dealer, without the intermediation of a third party such as the OCC. The Fund may engage in OTC option transactions only with member banks of the Federal Reserve Bank System or primary dealers in U.S. Government securities or with affiliates of such banks or dealers. Risks of Options Transactions. The successful use of options depends on the ability of the Investment Manager or the Sub-Advisor, to forecast correctly interest rates and/or market movements. If the market value of the portfolio securities upon which call options have been written increases, the Fund may receive a lower total return from the portion of its portfolio upon which calls have been written than it would have had such calls not been written. During the option period, the covered call writer has, in return for the premium on the option, given up the opportunity for capital appreciation above the exercise price should the market price of the underlying security increase, but has retained the risk of loss should the price of the underlying security decline. The covered put writer also retains the risk of loss should the market value of the underlying security decline below the exercise price of the option less the premium received on the sale of the option. In both cases, the writer has no control over the time when it may be required to fulfill its obligation as a writer of the option. Prior to exercise or expiration, an option position can only be terminated by entering into a closing purchase or sale transaction. Once an option writer has received an exercise notice, it cannot effect a closing purchase transaction in order to terminate its obligation under the option and must deliver or receive the underlying securities at the exercise price. The Fund's ability to close out its position as a writer of an option is dependent upon the existence of a liquid secondary market on option exchanges. There is no assurance that such a market will exist, particularly in the case of OTC options. In the event of the bankruptcy of a broker through which the Fund engages in transactions in options, the Fund could experience delays and/or losses in liquidating open positions purchased or sold through the broker and/or incur a loss of all or part of its margin deposits with the broker. In the case of OTC options, if the transacting dealer fails to make or take delivery of the securities underlying an option it has written, in accordance with the terms of that option, due to insolvency or otherwise, the Fund would lose the premium paid for the option as well as any anticipated benefit of the transaction. Each of the exchanges has established limitations governing the maximum number of call or put options on the same underlying security which may be written by a single investor, whether acting alone or in concert with others (regardless of whether such options are written on the same or different exchanges or are held or written on one or more accounts or through one or more brokers). An exchange may order the liquidation of positions found to be in violation of these limits and it may impose other sanctions or restrictions. These position limits may restrict the number of listed options which the Fund may write. The hours of trading for options may not conform to the hours during which the underlying securities are traded. To the extent that the option markets close before the markets for the underlying securities, significant price and rate movements can take place in the underlying markets that cannot be reflected in the option markets. 6 There can be no assurance that a liquid secondary market will exist for a particular option at any specific time. Futures Contracts. The Fund may purchase and sell interest rate and index futures contracts that are traded on U.S. commodity exchanges on such underlying securities as U.S. Treasury bonds, notes, bills, GNMA Certificates and on any foreign government fixed-income security, and on such indexes of U.S. securities (and, if applicable, foreign securities) as may exist or come into existence. A futures contract purchaser incurs an obligation to take delivery of a specified amount of the obligation underlying the contract at a specified time in the future for a specified price. A seller of a futures contract incurs an obligation to deliver the specified amount of the underlying obligation at a specified time in return for an agreed upon price. The purchase of a futures contract enables the Fund, during the term of the contract, to lock in a price at which it may purchase a security and protect against a rise in prices pending purchase of portfolio securities. The sale of a futures contract enables the Fund to lock in a price at which it may sell a security and protect against declines in the value of portfolio securities. Although most futures contracts call for actual delivery or acceptance of securities, the contracts usually are closed out before the settlement date without the making or taking of delivery. Index futures contracts provide for the delivery of an amount of cash equal to a specified dollar amount times the difference between the index value at the open or close of the last trading day of the contract and the futures contract price. A futures contract sale is closed out by effecting a futures contract purchase for the same aggregate amount of the specific type of security and the same delivery date. If the sale price exceeds the offsetting purchase price, the seller would be paid the difference and would realize a gain. If the offsetting purchase price exceeds the sale price, the seller would pay the difference and would realize a loss. Similarly, a futures contract purchase is closed out by effecting a futures contract sale for the same aggregate amount of the specific type of security and the same delivery date. If the offsetting sale price exceeds the purchase price, the purchaser would realize a gain, whereas if the purchase price exceeds the offsetting sale price, the purchaser would realize a loss. There is no assurance that the Fund will be able to enter into a closing transaction. Margin. If the Fund enters into a futures contract, it is initially required to deposit an "initial margin" of cash, U.S. government securities or other liquid portfolio securities ranging from approximately 2% to 5% of the contract amount. Initial margin requirements are established by the exchanges on which futures contracts trade and may, from time to time, change. In addition, brokers may establish margin deposit requirements in excess of those required by the exchanges. Initial margin in futures transactions is different from margin in securities transactions in that initial margin does not involve the borrowing of funds by a broker's client but is, rather, a good faith deposit on the futures contract which will be returned to the Fund upon the proper termination of the futures contract. The margin deposits made are marked to market daily and the Fund may be required to make subsequent deposits of cash, U.S. government securities or other liquid portfolio securities, called "variation margin," which are reflective of price fluctuations in the futures contract. Options on Futures Contracts. The Fund may purchase and write call and put options on futures contracts and enter into closing transactions with respect to such options to terminate an existing position. An option on a futures contract gives the purchaser the right (in return for the premium paid), and the writer the obligation, to assume a position in a futures contract (a long position if the option is a call and a short position if the option is a put) at a specified exercise price at any time during the term of the option. Upon exercise of the option, the delivery of the futures position by the writer of the option to the holder of the option is accompanied by delivery of the accumulated balance in the writer's futures margin account, which represents the amount by which the market price of the futures contract at the time of exercise exceeds, in the case of a call, or is less than, in the case of a put, the exercise price of the option on the futures contract. The writer of an option on a futures contract is required to deposit initial and variation margin pursuant to requirements similar to those applicable to futures contracts. Premiums received from the writing of an option on a futures contract are included in initial margin deposits. 7 Limitations on Futures Contracts and Options on Futures. The Fund may not enter into futures contracts or purchase related options thereon if, immediately thereafter, the amount committed to margin plus the amount paid for premiums for unexpired options on futures contracts exceeds 5% of the value of the Fund's total assets, after taking into account unrealized gains and unrealized losses on such contracts into which it has entered; provided, however, that in the case of an option that is in-the-money (the exercise price of the call (put) option is less (more) than the market price of the underlying security) at the time of purchase, the in-the-money amount may be excluded in calculating the 5%. However, there is no overall limitation on the percentage of the Fund's net assets which may be subject to a hedge position. Risks of Transactions in Futures Contracts and Related Options. The prices of securities and indexes subject to futures contracts (and thereby the futures contract prices) may correlate imperfectly with the behavior of the cash prices of the Fund's securities. Also, prices of futures contracts may not move in tandem with the changes in prevailing interest rates, market movements and/or currency exchange rates against which the Fund seeks a hedge. A correlation may also be distorted (a) temporarily, by short-term traders seeking to profit from the difference between a contract or security price objective and their cost of borrowed funds; (b) by investors in futures contracts electing to close out their contracts through offsetting transactions rather than meet margin deposit requirements; (c) by investors in futures contracts opting to make or take delivery of underlying securities rather than engage in closing transactions, thereby reducing liquidity of the futures market; and (d) temporarily, by speculators who view the deposit requirements in the futures markets as less onerous than margin requirements in the cash market. Due to the possibility of price distortion in the futures market and because of the possible imperfect correlation between movements in the prices of securities and movements in the prices of futures contracts, a correct forecast of interest rate and/or market movement trends by the Investment Manager and/or the Sub-Advisor may still not result in a successful hedging transaction. There is no assurance that a liquid secondary market will exist for futures contracts and related options in which the Fund may invest. In the event a liquid market does not exist, it may not be possible to close out a futures position and, in the event of adverse price movements, the Fund would continue to be required to make daily cash payments of variation margin. The absence of a liquid market in futures contracts might cause the Fund to make or take delivery of the underlying securities at a time when it may be disadvantageous to do so. Exchanges also limit the amount by which the price of a futures contract may move on any day. If the price moves equal the daily limit on successive days, then it may prove impossible to liquidate a futures position until the daily limit moves have ceased. In the event of adverse price movements, the Fund would continue to be required to make daily cash payments of variation margin on open futures positions. In these situations, if the Fund has insufficient cash, it may have to sell portfolio securities to meet daily variation margin requirements at a time when it may be disadvantageous to do so. In addition, the Fund may be required to take or make delivery of the instruments underlying interest rate futures contracts it holds at a time when it is disadvantageous to do so. The inability to close out options and futures positions could also have an adverse impact on the Fund's ability to effectively hedge its portfolio. Futures contracts and options thereon which are purchased or sold on foreign commodities exchanges may have greater price volatility than their U.S. counterparts. Furthermore, foreign commodities exchanges may be less regulated and under less governmental scrutiny than U.S. exchanges. Brokerage commissions, clearing costs and other transaction costs may be higher on foreign exchanges. Greater margin requirements may limit the Fund's ability to enter into certain commodity transactions on foreign exchanges. Moreover, differences in clearance and delivery requirements on foreign exchanges may occasion delays in the settlement of the Fund's transactions effected on foreign exchanges. In the event of the bankruptcy of a broker through which the Fund engages in transactions in futures or options thereon, the Fund could experience delays and/or losses in liquidating open positions purchased or sold through the broker and/or incur a loss of all or part of its margin deposits with the broker. 8 If the Fund maintains a short position in a futures contract or has sold a call option in a futures contract, it will cover this position by holding, in a segregated account maintained on the books of the Fund, cash, U.S. government securities or other liquid portfolio securities equal in value (when added to any initial or variation margin on deposit) to the market value of the securities underlying the futures contract or the exercise price of the option. Such a position may also be covered by owning the securities underlying the futures contract (in the case of a stock index futures contract a portfolio of securities substantially replicating the relevant index), or by holding a call option permitting the Fund to purchase the same contract at a price no higher than the price at which the short position was established. In addition, if the Fund holds a long position in a futures contract or has sold a put option on a futures contract, it will hold cash, U.S. government securities or other liquid portfolio securities equal to the purchase price of the contract or the exercise price of the put option (less the amount of initial or variation margin on deposit) in a segregated account maintained on the books of the Fund. Alternatively, the Fund could cover its long position by purchasing a put option on the same futures contract with an exercise price as high or higher than the price of the contract held by the Fund. MONEY MARKET SECURITIES. The Fund may invest in various money market securities for cash management purposes or when assuming a temporary defensive position, which among others may include commercial paper, bank acceptances, bank obligations, corporate debt securities, certificates of deposit, U.S. government securities and obligations of savings institutions and repurchase agreements. Such securities are limited to: U.S. Government Securities. Obligations issued or guaranteed as to principal and interest by the United States or its agencies (such as the Export-Import Bank of the United States, Federal Housing Administration and Government National Mortgage Association) or its instrumentalities (such as the Federal Home Loan Bank), including Treasury bills, notes and bonds; Bank Obligations. Obligations (including certificates of deposit and bankers' acceptances) of banks subject to regulation by the U.S. government and having total assets of $1 billion or more, and instruments secured by such obligations, not including obligations of foreign branches of domestic banks except to the extent below; Eurodollar Certificates of Deposit. Eurodollar certificates of deposit issued by foreign branches of domestic banks having total assets of $1 billion or more; Obligations of Savings Institutions. Certificates of deposit of savings banks and savings and loan associations, having total assets of $1 billion or more; Fully Insured Certificates of Deposit. Certificates of deposit of banks and savings institutions having total assets of less than $1 billion, if the principal amount of the obligation is federally insured by the Bank Insurance Fund or the Savings Association Insurance Fund (each of which is administered by the FDIC), limited to $100,000 principal amount per certificate and to 15% or less of the Fund's net assets in all such obligations and in all illiquid assets, in the aggregate; Commercial Paper. Commercial paper rated within the two highest grades by Standard & Poor's Corporation ("S&P") or by Moody's Investor's Service, Inc. ("Moody's") or, if not rated, issued by a company having an outstanding debt issue rated at least AAA by S&P or Aaa by Moody's; and Repurchase Agreements. The Fund may invest in repurchase agreements. When cash may be available for only a few days, it may be invested by the Fund in repurchase agreements until such time as it may otherwise be invested or used for payments of obligations of the Fund. These agreements, which may be viewed as a type of secured lending by the Fund, typically involve the acquisition, by the Fund, of debt securities from a selling financial institution such as a bank, savings and loan association or broker-dealer. The agreement provides that the Fund will sell back to the institution, and that the institution will repurchase, the underlying security serving as collateral at a specified price and at a fixed time in the future, usually not more than seven days from the date of purchase. The collateral will be marked-to-market daily to determine that the value of the collateral, as specified in the agreement, does not decrease below the purchase price plus accrued interest. If such decrease occurs, additional 9 collateral will be requested and, when received, added to the account to maintain full collateralization. The Fund will accrue interest from the institution until the time when the repurchase is to occur. Although this date is deemed by the Fund to be the maturity date of a repurchase agreement, the maturities of securities subject to repurchase agreements are not subject to any limits. While repurchase agreements involve certain risks not associated with direct investments in debt securities, the Fund follows procedures approved by the Trustees designed to minimize such risks. These procedures include effecting repurchase transactions only with large, well-capitalized and well-established financial institutions whose financial condition will be continually monitored by the Investment Manager and/or Sub-Advisor subject to procedures established by the Trustees. In addition, as described above, the value of the collateral underlying the repurchase agreement will be at least equal to the repurchase price, including any accrued interest earned on the repurchase agreement. In the event of a default or bankruptcy by a selling financial institution, the Fund will seek to liquidate such collateral. However, the exercising of the Fund's right to liquidate such collateral could involve certain costs or delays and, to the extent that proceeds from any sale upon a default of the obligation to repurchase were less than the repurchase price, the Fund could suffer a loss. It is the current policy of the Fund not to invest in repurchase agreements that do not mature within seven days if any such investment, together with any other illiquid assets held by the Fund, amounts to more than 15% of its net assets. REVERSE REPURCHASE AGREEMENTS AND DOLLAR ROLLS. The Fund may use reverse repurchase agreements as part of its investment strategy and may also use dollar rolls as part of its investment strategy. Reverse repurchase agreements involve sales by the Fund of assets concurrently with an agreement by the Fund to repurchase the same assets at a later date at a fixed price. Reverse repurchase agreements involve the risk that the market value of the securities the Fund is obligated to purchase under the agreement may decline below the repurchase price. In the event the buyer of securities under a reverse repurchase agreement files for bankruptcy or becomes insolvent, the Fund's use of the proceeds of the agreement may be restricted pending a determination by the other party, or its trustee or receiver, whether to enforce the Fund's obligation to repurchase the securities. Dollar rolls involve the Fund selling securities for delivery in the current month and simultaneously contracting to repurchase substantially similar (same type and coupon) securities on a specified future date. During the roll period, the Fund will forgo principal and interest paid on the securities. The Fund is compensated by the difference between the current sales price and the lower forward price for the future purchase (often referred to as the "drop") as well as by the interest earned on the cash proceeds of the initial sale. Reverse repurchase agreements and dollar rolls are speculative techniques involving leverage and are considered borrowings by the Fund. LENDING PORTFOLIO SECURITIES. The Fund may lend its portfolio securities to brokers, dealers and other financial institutions, provided that the loans are callable at any time by the Fund, and are at all times secured by cash or cash equivalents, which are maintained in a segregated account pursuant to applicable regulations and that are equal to at least 100% of the market value, determined daily, of the loaned securities. The advantage of these loans is that the Fund continues to receive the income on the loaned securities while at the same time earning interest on the cash amounts deposited as collateral, which will be invested in short-term obligations. The Fund will not lend more than 25% of the value of its total assets. As with any extensions of credit, there are risks of delay in recovery and, in some cases, even loss of rights in the collateral should the borrower of the securities fail financially. However, these loans of portfolio securities will only be made to firms deemed by the Fund's management to be creditworthy and when the income which can be earned from such loans justifies the attendant risks. Upon termination of the loan, the borrower is required to return the securities to the Fund. Any gain or loss in the market price during the loan period would inure to the Fund. 10 When voting or consent rights which accompany loaned securities pass to the borrower, the Fund will follow the policy of calling the loaned securities, to be delivered within one day after notice, to permit the exercise of the rights if the matters involved would have a material effect on the Fund's investment in the loaned securities. The Fund will pay reasonable finder's, administrative and custodial fees in connection with a loan of its securities. WHEN-ISSUED AND DELAYED DELIVERY SECURITIES AND FORWARD COMMITMENTS. The Fund may purchase securities on a when-issued or delayed delivery basis or may purchase or sell securities on a forward commitment basis. When these transactions are negotiated, the price is fixed at the time of the commitment, but delivery and payment can take place a month or more after the date of commitment. While the Fund will only purchase securities on a when-issued, delayed delivery or forward commitment basis with the intention of acquiring the securities, the Fund may sell the securities before the settlement date, if it is deemed advisable. The securities so purchased or sold are subject to market fluctuation and no interest or dividends accrue to the purchaser prior to the settlement date. At the time the Fund makes the commitment to purchase or sell securities on a when-issued, delayed delivery or forward commitment basis, it will record the transaction and thereafter reflect the value, each day, of such security purchased, or if a sale, the proceeds to be received, in determining its net asset value. At the time of delivery of the securities, their value may be more or less than the purchase or sale price. An increase in the percentage of the Fund's assets committed to the purchase of securities on a when-issued, delayed delivery or forward commitment basis may increase the volatility of its net asset value. The Fund will also establish a segregated account on the Fund's books in which it will continually maintain cash or cash equivalents or other liquid portfolio securities equal in value to commitments to purchase securities on a when-issued, delayed delivery or forward commitment basis. WHEN, AS AND IF ISSUED SECURITIES. The Fund may purchase securities on a "when, as and if issued" basis under which the issuance of the security depends upon the occurrence of a subsequent event, such as approval of a merger, corporate reorganization or debt restructuring. The commitment for the purchase of any such security will not be recognized in the portfolio of the Fund until the Investment Manager and/or Sub-Advisor determines that issuance of the security is probable. At that time, the Fund will record the transaction and, in determining its net asset value, will reflect the value of the security daily. At that time, the Fund will also establish a segregated account on the Fund's books in which it will maintain cash or cash equivalents or other liquid portfolio securities equal in value to recognized commitments for such securities. An increase in the percentage of the Fund's assets committed to the purchase of securities on a "when, as and if issued" basis may increase the volatility of its net asset value. The Fund may also sell securities on a "when, as and if issued" basis provided that the issuance of the security will result automatically from the exchange or conversion of a security owned by the Fund at the time of sale. PRIVATE PLACEMENTS AND RESTRICTED SECURITIES. The Fund may invest up to 15% of its net assets in securities which are subject to restrictions on resale because they have not been registered under the Securities Act of 1933 (the "Securities Act"), or which are otherwise not readily marketable. (Securities eligible for resale pursuant to Rule 144A under the Securities Act, and determined to be liquid pursuant to the procedures discussed in the following paragraph, are not subject to the foregoing restriction.) These securities are generally referred to as "private placements" or "restricted securities." Limitations on the resale of these securities may have an adverse effect on their marketability, and may prevent the Fund from disposing of them promptly at reasonable prices. The Fund may have to bear the expense of registering the securities for resale and the risk of substantial delays in effecting the registration. Rule 144A permits the Fund to sell restricted securities to qualified institutional buyers without limitation. The Investment Manager and/or Sub-Advisor, pursuant to procedures adopted by the Trustees, will make a determination as to the liquidity of each restricted security purchased by the Fund. If a restricted security is determined to be "liquid," the security will not be included within the category "illiquid securities," which may not exceed 15% of the Fund's net assets. However, investing in Rule 144A securities could have the effect of increasing the level of Fund illiquidity to the extent the Fund, at a particular point in time, may be unable to find qualified institutional buyers interested in purchasing such securities. 11 C. FUND POLICIES/INVESTMENT RESTRICTIONS The investment objective, policies and restrictions listed below have been adopted by the Fund as fundamental policies. Under the Investment Company Act of 1940, as amended (the "Investment Company Act"), a fundamental policy may not be changed without the vote of a majority of the outstanding voting securities of the Fund. The Investment Company Act defines a majority as the lesser of (a) 67% or more of the shares present at a meeting of shareholders, if the holders of 50% of the outstanding shares of the Fund are present or represented by proxy; or (b) more than 50% of the outstanding shares of the Fund. For purposes of the following restrictions: (i) all percentage limitations apply immediately after a purchase or initial investment; and (ii) any subsequent change in any applicable percentage resulting from market fluctuations or other changes in total or net assets does not require elimination of any security from the portfolio. The Fund will: 1. Seek to earn a high level of current income while maintaining relatively low volatility of principal. The Fund may not: 1. Invest 25% or more of the value of its total assets in securities of issuers in any one industry, except that the Fund will concentrate in mortgage-backed securities (unless it has adopted a temporary "defensive" posture). This restriction does not apply to obligations issued or guaranteed by the United States Government, its agencies or instrumentalities. 2. Invest more than 5% of the value of its total assets in securities of issuers having a record, together with predecessors, of less than three years of continuous operation. This restriction shall not apply to mortgage-backed securities or asset-backed securities or to any obligation of the United States Government, its agencies or instrumentalities. 3. Purchase or sell commodities or commodities contracts except that the Fund may purchase and sell financial futures contracts and related options thereon. 4. Purchase or sell real estate or interests therein (including limited partnership interests), although the Fund may purchase securities of issuers which engage in real estate operations and securities secured by real estate or interests therein. 5. Purchase oil, gas or other mineral leases, rights or royalty contracts or exploration or development programs, except that the Fund may invest in the securities of companies which operate, invest in, or sponsor such programs. 6. Borrow money, except that the Fund (i) may borrow from a bank for temporary or emergency purposes in amounts not exceeding 5% (taken at the lower of cost or current value) of its total assets (not including the amount borrowed), and (ii) may engage in reverse repurchase agreements and dollar rolls. 7. Pledge its assets or assign or otherwise encumber them except to secure permitted borrowings. For the purpose of this restriction, collateral arrangements with respect to initial or variation margin for futures are not deemed to be pledges of assets. 8. Issue senior securities as defined in the Act except insofar as the Fund may be deemed to have issued a senior security by reason of (a) entering into any repurchase agreement; (b) purchasing any securities on a when-issued or delayed delivery basis; (c) purchasing or selling any financial futures contracts or options thereon; (d) borrowing money; or (e) lending portfolio securities. 9. Make loans of money or securities, except: (a) by the purchase of portfolio securities; (b) by investment in repurchase agreements; or (c) by lending its portfolio securities. 10. Make short sales of securities. 12 11. Purchase securities on margin, except for such short-term loans as are necessary for the clearance of portfolio securities. The deposit or payment by the Fund of initial or variation margin in connection with futures contracts is not considered the purchase of a security on margin. 12. Engage in the underwriting of securities, except insofar as the Fund may be deemed an underwriter under the Securities Act in disposing of a portfolio security. 13. Invest for the purpose of exercising control or management of any other issuer. As a non-fundamental policy, the Fund may not, as to 75% of its total assets, purchase more than 10% of the voting securities of any issuer. III. MANAGEMENT OF THE FUND - -------------------------------------------------------------------------------- A. BOARD OF TRUSTEES The Board of Trustees of the Fund oversees the management of the Fund but does not itself manage the Fund. The Trustees review various services provided by or under the direction of the Investment Manager to ensure that the Fund's general investment policies and programs are properly carried out. The Trustees also conduct their review to ensure that administrative services are provided to the Fund in a satisfactory manner. Under state law, the duties of the Trustees are generally characterized as a duty of loyalty and a duty of care. The duty of loyalty requires a Trustee to exercise his or her powers in the interest of the Fund and not the Trustee's own interest or the interest of another person or organization. A Trustee satisfies his or her duty of care by acting in good faith with the care of an ordinarily prudent person and in a manner the Trustee reasonably believes to be in the best interest of the Fund and its shareholders. B. MANAGEMENT INFORMATION TRUSTEES AND OFFICERS. The Board of the Fund consists of nine (9) Trustees. These same individuals also serve as directors or trustees for all of the Morgan Stanley Funds. Six Trustees (67% of the total number) have no affiliation or business connection with the Investment Manager or any of its affiliated persons and do not own any stock or other securities issued by the Investment Manager's parent company, Morgan Stanley or the Sub-Advisor's parent company, TCW. These are the "disinterested" or "independent" Trustees. The other three Trustees (the "management Trustees") are affiliated with the Investment Manager. The Trustees and executive officers of the Fund, their principal business occupations during the last five years and their affiliations, if any, with the Investment Manager or the Sub-Advisor, and with the Morgan Stanley Funds (there were 97 such Funds as of the calendar year ended December 31, 2000) are shown below.
NAME, AGE, POSITION WITH FUND AND ADDRESS PRINCIPAL OCCUPATIONS DURING LAST FIVE YEARS - ------------------------------------------- --------------------------------------------------- Michael Bozic (60) ........................ Retired; Director or Trustee of the Morgan Stanley Trustee Funds; formerly Vice Chairman of Kmart c/o Mayer, Brown & Platt Corporation (December 1998-October 2000), Counsel to the Independent Trustees Chairman and Chief Executive Officer of Levitz 1675 Broadway Furniture Corporation (November 1995-November New York, New York 1998) and President and Chief Executive Officer of Hills Department Stores (May 1991-July 1995); formerly variously Chairman, Chief Executive Officer, President and Chief Operating Officer (1987-1991) of the Sears Merchandise Group of Sears, Roebuck and Co.; Director of Weirton Steel Corporation.
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NAME, AGE, POSITION WITH FUND AND ADDRESS PRINCIPAL OCCUPATIONS DURING LAST FIVE YEARS - ------------------------------------------- ------------------------------------------------------ Charles A. Fiumefreddo* (68) .............. Chairman, Director or Trustee and Chief Executive Chairman of the Board, Officer of the Morgan Stanley Funds; formerly c/o Morgan Stanley Trust Chairman, Chief Executive Officer and Director of Harborside Financial Center, Plaza Two the Investment Manager, the Distributor and Jersey City, New Jersey Morgan Stanley Services, Executive Vice President and Director of Morgan Stanley DW, Chairman and Director of the Transfer Agent, and Director and/or officer of various Morgan Stanley subsidiaries (until June 1998). Edwin J. Garn (69) ........................ Director or Trustee of the Morgan Stanley Funds; Trustee formerly United States Senator (R-Utah) (1974- c/o Summit Ventures LLC 1992) and Chairman, Senate Banking Committee 1 Utah Center (1980-1986); formerly Mayor of Salt Lake City, 201 S. Main Street Utah (1971-1974); formerly Astronaut, Space Salt Lake City, Utah Shuttle Discovery (April 12-19, 1985); Vice Chairman, Huntsman Corporation (chemical company); Director of Franklin Covey (time management systems), BMW Bank of North America, Inc. (industrial loan corporation), United Space Alliance (joint venture between Lockheed Martin and the Boeing Company) and Nuskin Asia Pacific (multilevel marketing); member of the Utah Regional Advisory Board of Pacific Corp.; member of the board of various civic and charitable organizations. Wayne E. Hedien (67) ...................... Retired; Director or Trustee of the Morgan Stanley Trustee Funds; Director of The PMI Group, Inc. (private c/o Mayer, Brown & Platt mortgage insurance); Trustee and Vice Chairman Counsel to the Independent Trustees of The Field Museum of Natural History; formerly 1675 Broadway associated with the Allstate Companies (1966- New York, New York 1994), most recently as Chairman of The Allstate Corporation (March 1993-December 1994) and Chairman and Chief Executive Officer of its wholly- owned subsidiary, Allstate Insurance Company (July 1989-December 1994); director of various other business and charitable organizations. James F. Higgins* (53) .................... Chairman of the Individual Investor Group of Trustee Morgan Stanley (since August 2000); Director of c/o Morgan Stanley Trust the Transfer Agent, the Distributor and Dean Witter Harborside Financial Center, Plaza Two Realty Inc.; Director or Trustee of the Morgan Jersey City, New Jersey Stanley Funds (since June 2000); previously President and Chief Operating Officer of the Private Client Group of Morgan Stanley (May 1999-August 2000), President and Chief Operating Officer of Individual Securities of Morgan Stanley (February 1997-May 1999), President and Chief Operating Officer of Dean Witter Securities of Morgan Stanley (1995-February 1997), and Director (1985-1997) of Morgan Stanley.
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NAME, AGE, POSITION WITH FUND AND ADDRESS PRINCIPAL OCCUPATIONS DURING LAST FIVE YEARS - ------------------------------------------- ---------------------------------------------------- Dr. Manuel H. Johnson (52) ................ Senior Partner, Johnson Smick International, Inc., Trustee a consulting firm; Co-Chairman and a founder of c/o Johnson Smick International, Inc. the Group of Seven Council (G7C), an international 1133 Connecticut Avenue, N.W. economic commission; Chairman of the Audit Washington, D.C. Committee and Director or Trustee of the Morgan Stanley Funds; Director of NVR, Inc. (home construction); Chairman and Trustee of the Financial Accounting Foundation (oversight organization of the Financial Accounting Standards Board); formerly Vice Chairman of the Board of Governors of the Federal Reserve System and Assistant Secretary of the U.S. Treasury. Michael E. Nugent (65) .................... General Partner, Triumph Capital, L.P., a private Trustee investment partnership; Chairman of the Insurance c/o Triumph Capital, L.P. Committee and Director or Trustee of the Morgan 237 Park Avenue Stanley Funds; director/trustee of various New York, New York investment companies managed by Morgan Stanley Investment Management Inc. and Morgan Stanley Investments LP (since July 2001); formerly Vice President, Bankers Trust Company and BT Capital Corporation; director of various business organizations. Philip J. Purcell* (58) ................... Chairman of the Board of Directors and Chief Trustee Executive Officer of Morgan Stanley, Morgan 1585 Broadway Stanley DW and Novus Credit Services Inc.; New York, New York Director of the Distributor; Director or Trustee of the Morgan Stanley Funds; Director of American Airlines, Inc. and its parent company, AMR Corporation; Director and/or officer of various Morgan Stanley subsidiaries. John L. Schroeder (71) .................... Retired; Chairman of the Deriatives Committee Trustee and Director or Trustee of the Morgan Stanley c/o Mayer, Brown & Platt Funds; Director of Citizens Communications Counsel to the Independent Trustees Company (telecommunications company); formerly 1675 Broadway Executive Vice President and Chief Investment New York, New York Officer of Home Insurance Company (August 1991- September 1995).
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NAME, AGE, POSITION WITH FUND AND ADDRESS PRINCIPAL OCCUPATIONS DURING LAST FIVE YEARS - ------------------------------------------- ------------------------------------------------------ Mitchell M. Merin (48) .................... President and Chief Operating Officer of Morgan President Stanley Investment Management (since December 1221 Avenue of the Americas 1998); President and Director (since April 1997) New York, New York and Chief Executive Officer (since June 1998) of the Investment Manager and Morgan Stanley Services; Chairman, Chief Executive Officer and Director of the Distributor (since June 1998); Chairman and Chief Executive Officer (since June 1998) and Director (since January 1998) of the Transfer Agent; Director of various Morgan Stanley subsidiaries; President of the Morgan Stanley Funds (since May 1999); Trustee of various Van Kampen investment companies (since December 1999); previously Chief Strategic Officer of the Investment Manager and Morgan Stanley Services and Executive Vice President of the Distributor (April 1997-June 1998), Vice President of the Morgan Stanley Funds (May 1997-April 1999), and Executive Vice President of Morgan Stanley. Barry Fink (46) ........................... General Counsel (since May 2000) and Managing Vice President, Director (since December 2000) of Morgan Stanley Secretary and General Counsel Investment Management; Managing Director (since 1221 Avenue of the Americas December 2000) and Secretary and General New York, New York Counsel (since February 1997) and Director (since July 1998) of the Investment Manager and Morgan Stanley Services; Vice President, Secretary and General Counsel of the Morgan Stanley Funds (since February 1997); Vice President and Secretary of the Distributor; previously, Senior Vice President (March 1997-December 1999), First Vice President, Assistant Secretary and Assistant General Counsel of the Investment Manager and Morgan Stanley Services. Philip A. Barach (49) ..................... Group Managing Director and Chief Investment Vice President Officer-Investment Grade Fixed-Income of the 865 South Figueroa Street Sub-Advisor, Trust Company of the West and TCW Los Angeles, California Asset Management Company. Jeffrey E. Gundlach (42) .................. Group Managing Director and Chairman, Multi- Vice President Strategy Fixed Income Committee of the Sub- 865 South Figueroa Street Advisor, Trust Company of the West and TCW Los Angeles, California Asset Management Company. Frederick H. Horton (43) .................. Managing Director of the Sub-Advisor, Trust Vice President Company of the West and TCW Asset Management 865 South Figueroa Street Company. Los Angeles, California Thomas F. Caloia (55) ..................... First Vice President and Assistant Treasurer of the Treasurer Investment Manager, the Distributor and Morgan c/o Morgan Stanley Trust Stanley Services; Treasurer of the Morgan Stanley Harborside Financial Center, Plaza Two Funds. Jersey City, New Jersey
- ---------- * Denotes Trustees who are "interested persons" of the Fund as defined by the Investment Company Act. 16 Ronald E. Robison, Managing Director, Chief Administrative Officer and Director of the Investment Manager and Morgan Stanley Services and Chief Executive Officer and Director of the Transfer Agent, Robert S. Giambrone, Executive Director of the Investment Manager, Morgan Stanley Services, the Distributor and the Transfer Agent and Director of the Transfer Agent, and Joseph J. McAlinden, Managing Director and Chief Investment Officer of the Investment Manager and Director of the Transfer Agent, are Vice Presidents of the Fund. In addition, A. Thomas Smith III, Managing Director and General Counsel of the Investment Manager and Morgan Stanley Services, is a Vice President and Assistant Secretary of the Fund, and Todd Lebo, Lou Anne D. McInnis, Carsten Otto and Ruth Rossi, Executive Directors and Assistant General Counsels of the Investment Manager and Morgan Stanley Services, Marilyn K. Cranney, First Vice President and Assistant General Counsel of the Investment Manager and Morgan Stanley Services, and Natasha Kassian and George Silfen, Vice Presidents and Assistant General Counsels of the Investment Manager and Morgan Stanley Services, are Assistant Secretaries of the Fund. INDEPENDENT DIRECTORS/TRUSTEES AND THE COMMITTEES. Law and regulation establish both general guidelines and specific duties for the independent directors/trustees. The Morgan Stanley Funds seek as independent directors/trustees individuals of distinction and experience in business and finance, government service or academia; these are people whose advice and counsel are in demand by others and for whom there is often competition. To accept a position on the Funds' boards, such individuals may reject other attractive assignments because the Funds make substantial demands on their time. All of the independent directors/trustees serve as members of the Audit Committee. In addition, three of the directors/trustees, including two independent directors/trustees, serve as members of the Derivatives Committee and the Insurance Committee. The independent directors/trustees are charged with recommending to the full board approval of management, advisory and administration contracts, Rule 12b-1 plans and distribution and underwriting agreements; continually reviewing Fund performance; checking on the pricing of portfolio securities, brokerage commissions, transfer agent costs and performance, and trading among Funds in the same complex; and approving fidelity bond and related insurance coverage and allocations, as well as other matters that arise from time to time. The independent directors/trustees are required to select and nominate individuals to fill any independent directors/trustees vacancy on the board of any Fund that has a Rule 12b-1 plan of distribution. Most of the Morgan Stanley Funds have a Rule 12b-1 plan. The Audit Committee is charged with recommending to the full board the engagement or discharge of the Fund's independent auditors; directing investigations into matters within the scope of the independent auditors' duties, including the power to retain outside specialists; reviewing with the independent auditors the audit plan and results of the auditing engagement; approving professional services provided by the independent auditors and other accounting firms prior to the performance of the services; reviewing the independence of the independent auditors; considering the range of audit and non-audit fees; reviewing the adequacy of the Fund's system of internal controls; and preparing and submitting Committee meeting minutes to the full board. The board of each Fund has a Derivatives Committee to approve parameters for and monitor the activities of the Fund with respect to derivative investments, if any, made by the Fund. Finally, the board of each Fund has formed an Insurance Committee to review and monitor the insurance coverage maintained by the Fund. ADVANTAGES OF HAVING SAME INDIVIDUALS AS INDEPENDENT DIRECTORS/TRUSTEES FOR ALL MORGAN STANLEY FUNDS. The independent directors/trustees and the Funds' management believe that having the same independent directors/trustees for each of the Morgan Stanley Funds avoids the duplication of effort that would arise from having different groups of individuals serving as independent directors/ trustees for each of the funds or even of sub-groups of funds. They believe that having the same individuals serve as independent directors/trustees of all the Funds tends to increase their knowledge and expertise regarding matters which affect the Fund complex generally and enhances their ability to negotiate on behalf of each fund with the fund's service providers. This arrangement also precludes the 17 possibility of separate groups of independent directors/trustees arriving at conflicting decisions regarding operations and management of the funds and avoids the cost and confusion that would likely ensue. Finally, having the same independent directors/trustees serve on all fund boards enhances the ability of each fund to obtain, at modest cost to each separate fund, the services of independent directors/ trustees, of the caliber, experience and business acumen of the individuals who serve as independent directors/trustees of the Morgan Stanley Funds. TRUSTEE AND OFFICER INDEMNIFICATION. The Fund's Declaration of Trust provides that no Trustee, officer, employee or agent of the Fund is liable to the Fund or to a shareholder, nor is any Trustee, officer, employee or agent liable to any third persons in connection with the affairs of the Fund, except as such liability may arise from his/her or its own bad faith, willful misfeasance, gross negligence or reckless disregard of his/her or its duties. It also provides that all third persons shall look solely to the Fund property for satisfaction of claims arising in connection with the affairs of the Fund. With the exceptions stated, the Declaration of Trust provides that a Trustee, officer, employee or agent is entitled to be indemnified against all liability in connection with the affairs of the Fund. C. COMPENSATION The Fund pays each Independent Trustee an annual fee of $800 plus a per meeting fee of $50 for meetings of the Board of Trustees, the Independent Trustees or Committees of the Board of Trustees attended by the Trustee (the Fund pays the Chairman of the Audit Committee an additional annual fee of $750, and the Chairman of the Derivatives and Insurance Committees additional annual fees of $500). If a Board meeting and a meeting of the Independent Trustees or a Committee meeting, or a meeting of the Independent Trustees and/or more than one Committee meeting, take place on a single day, the Trustees are paid a single meeting fee by the Fund. The Fund also reimburses such Trustees for travel and other out-of-pocket expenses incurred by them in connection with attending such meetings. Trustees and officers of the Fund who are or have been employed by the Investment Manager or an affiliated company receive no compensation or expense reimbursement from the Fund for their services as Trustee. The following table illustrates the compensation that the Fund paid to its Independent Trustees for the fiscal year ended October 31, 2001. FUND COMPENSATION
AGGREGATE COMPENSATION NAME OF INDEPENDENT TRUSTEE FROM THE FUND - ------------------------------- -------------- Michael Bozic ................. $1,650 Edwin J. Garn ................. 1,650 Wayne E. Hedien ............... 1,650 Dr. Manuel H. Johnson ......... 2,400 Michael E. Nugent ............. 2,150 John L. Schroeder ............. 2,150
The following table illustrates the compensation paid to the Fund's Independent Trustees for the calendar year ended December 31, 2000 for services to the 97 Morgan Stanley Funds that were in operation at December 31, 2000. 18 CASH COMPENSATION FROM MORGAN STANLEY FUNDS
TOTAL CASH COMPENSATION FOR SERVICES TO 97 MORGAN NAME OF INDEPENDENT TRUSTEE STANLEY FUNDS - ------------------------------- ---------------- Michael Bozic ................. $146,917 Edwin J. Garn ................. 151,717 Wayne E. Hedien ............... 151,567 Dr. Manuel H. Johnson ......... 223,655 Michael E. Nugent ............. 199,759 John L. Schroeder ............. 194,809
As of the date of this Statement of Additional Information, 53 of the Morgan Stanley Funds, not including the Fund, have adopted a retirement program under which an independent director/trustee who retires after serving for at least five years (or such lesser period as may be determined by the Board) as an independent director/trustee of any Morgan Stanley Fund that has adopted the retirement program (each such Fund referred to as an "Adopting Fund" and each such trustee referred to as an "Eligible Trustee") is entitled to retirement payments upon reaching the eligible retirement age (normally, after attaining age 72), Annual payments are based upon length of service. Currently, upon retirement, each Eligible Trustee is entitled to receive from the Adopting Fund, commencing as of his or her retirement date and continuing for the remainder of his or her life, an annual retirement benefit (the "Regular Benefit") equal to 30.22% of his or her Eligible Compensation plus 0.5036667% of such Eligible Compensation for each full month of service as an independent director/trustee of any Adopting Fund in excess of five years up to a maximum of 60.44% after ten years of service. The foregoing percentages may be changed by the Board(1). "Eligible Compensation" is one-fifth of the total compensation earned by such Eligible Trustee for service to the Adopting Fund in the five year period prior to the date of the Eligible Trustee's retirement. Benefits under the retirement program are accrued as expenses on the books of the Adopting Funds. Such benefits are not secured or funded by the Adopting Funds. The following table illustrates the retirement benefits accrued to the Fund's Independent Trustees by the 53 Morgan Stanley Funds (not including the Fund) for the year ended December 31, 2000, and the estimated retirement benefits for the Independent Trustees, to commence upon their retirement, from the 53 Morgan Stanley Funds as of December 31, 2000. RETIREMENT BENEFITS FROM ALL MORGAN STANLEY FUNDS
FOR ALL ADOPTING FUNDS --------------------------------- ESTIMATED CREDITED YEARS ESTIMATED RETIREMENT BENEFITS ESTIMATED ANNUAL OF SERVICE AT PERCENTAGE OF ACCRUED AS EXPENSES BENEFITS UPON RETIREMENT RETIREMENT ELIGIBLE BY ALL FROM ALL NAME OF INDEPENDENT TRUSTEE (MAXIMUM 10) COMPENSATION ADOPTING FUNDS ADOPTING FUNDS(2) - ----------------------------- --------------- --------------- --------------------- ------------------------- Michael Bozic ............... 10 60.44% $20,001 $52,885 Edwin J. Garn ............... 10 60.44 29,348 52,817 Wayne E. Hedien ............. 9 51.37 37,886 44,952 Dr. Manuel H. Johnson ....... 10 60.44 21,187 77,817 Michael E. Nugent ........... 10 60.44 36,202 69,506 John L. Schroeder ........... 8 50.37 65,337 53,677
- ---------- (1) An Eligible Trustee may elect alternative payments of his or her retirement benefits based upon the combined life expectancy of the Eligible Trustee and his or her spouse on the date of such Eligible Trustee's retirement. In addition, the Eligible Trustee may elect that the surviving spouse's periodic payment of benefits will be equal to a lower percentage of the periodic amount when both spouses were alive. The amount estimated to be payable under this method, through the remainder of the later of the lives of the Eligible Trustee and spouse, will be the actuarial equivalent of the Regular Benefit. (2) Based on current levels of compensation. Amount of annual benefits also varies depending on the Trustee's elections described in Footnote (1) above. 19 IV. CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES - -------------------------------------------------------------------------------- No persons owned 5% or more of the shares of the Fund as of December 7, 2001. As of the date of this Statement of Additional Information, the aggregate number of shares of beneficial interest of the Fund owned by the Fund's officers and Trustees as a group was less than 1% of the Fund's shares of beneficial interest outstanding. V. INVESTMENT MANAGEMENT AND OTHER SERVICES - -------------------------------------------------------------------------------- A. INVESTMENT MANAGER AND SUB-ADVISOR The Investment Manager to the Fund is Morgan Stanley Investment Advisors Inc., a Delaware corporation, whose address is 1221 Avenue of the Americas, New York, NY 10020. The Investment Manager is a wholly-owned subsidiary of Morgan Stanley, a Delaware corporation. Morgan Stanley is a preeminent global financial services firm that maintains leading market positions in each of its three primary businesses: securities, asset management and credit services. The Sub-Advisor is TCW Investment Management Company, a wholly-owned subsidiary of TCW, whose direct and indirect subsidiaries provide a variety of trust, investment management and investment advisory services. The Sub-Advisor is headquartered at 865 South Figueroa Street, Suite 1800, Los Angeles, California 90017. Robert A. Day, who is Chairman of the Board of Directors of TCW, may be deemed to be a control person of the Sub-Advisor by virtue of the aggregate ownership by Mr. Day and his family of more than 25% of the outstanding voting stock of TCW. Societe Generale Asset Management, S.A., a wholly-owned subsidiary of Societe Generale, S.A., owns a majority interest in TCW. Pursuant to an Investment Management Agreement (the "Management Agreement") with the Investment Manager, the Fund has retained the Investment Manager to provide administrative services and manage its business affairs. The Fund pays the Investment Manager monthly compensation calculated daily by applying the following annual rates to the net assets of the Fund determined as of the close of each business day: 0.65% to the portion of daily net assets not exceeding $500 million; and 0.60% to the portion of daily net assets exceeding $500 million. The Investment Manager has retained its wholly-owned subsidiary, Morgan Stanley Services, to perform administrative services for the Fund. Under a Sub-Advisory Agreement (the "Sub-Advisory Agreement") between the Sub-Advisor and the Investment Manager, the Sub-Advisor provides the Fund with investment advice and portfolio management relating to the Fund's investments in securities, subject to the overall supervision of the Investment Manager. The Investment Manager pays the Sub-Advisor monthly compensation equal to 40% of the Investment Manager's fee. Prior to June 28, 1999, the Fund was managed by Morgan Stanley Services, pursuant to a management agreement between the Fund and Morgan Stanley Services and was advised by TCW Investment Management Company pursuant to an advisory agreement between the Fund and TCW Investment Management Company. For the fiscal period November 1, 1998 through June 28, 1999, Morgan Stanley Services accrued total compensation under the old management agreement in the amount of $363,182. For the same period, TCW Investment Management Company accrued total compensation in its former capacity as advisor to the Fund in the amount of $242,121. For the period June 28, 1999 through October 31, 1999 and for the fiscal years ended October 31, 2000 and 2001, the Investment Manager accrued total compensation under the new Management Agreement in the amounts of $293,087, $685,082 and $587,228, respectively, of which $117,235, $274,032 and $234,891 were paid to the Sub-Advisor for the same periods, respectively. B. PRINCIPAL UNDERWRITER The Fund's principal underwriter is the Distributor (which has the same address as the Investment Manager). In this capacity, the Fund's shares are distributed by the Distributor. The Distributor has 20 entered into a Selected Dealer Agreement with Morgan Stanley DW, which through its own sales organization sells shares of the Fund. In addition, the Distributor may enter into similar agreements with other selected broker-dealers. The Distributor, a Delaware corporation, is a wholly-owned subsidiary of Morgan Stanley. The Distributor bears all expenses it may incur in providing services under the Distribution Agreement. These expenses include the payment of commissions for sales of the Fund's shares and incentive compensation to Financial Advisors, the cost of educational and/or business-related trips, and educational and/or promotional and business-related expenses. The Distributor also pays certain expenses in connection with the distribution of the Fund's shares, including the costs of preparing, printing and distributing advertising or promotional materials, and the costs of printing and distributing prospectuses and supplements thereto used in connection with the offering and sale of the Fund's shares. The Fund bears the costs of initial typesetting, printing and distribution of prospectuses and supplements thereto to shareholders. The Fund also bears the costs of registering the Fund and its shares under federal and state securities laws and pays filing fees in accordance with state securities laws. The Fund and the Distributor have agreed to indemnify each other against certain liabilities, including liabilities under the Securities Act. Under the Distribution Agreement, the Distributor uses its best efforts in rendering services to the Fund, but in the absence of willful misfeasance, bad faith, gross negligence or reckless disregard of its obligations, the Distributor is not liable to the Fund or any of its shareholders for any error of judgment or mistake of law or for any act or omission or for any losses sustained by the Fund or its shareholders. C. SERVICES PROVIDED BY THE INVESTMENT MANAGER AND THE SUB-ADVISOR The Investment Manager manages the Fund's business affairs and supervises the investment of the Fund's assets. The Sub-Advisor manages the investment of the Fund's assets, including the placing of orders for the purchase and sale of portfolio securities. The Sub-Advisor obtains and evaluates the information and advice relating to the economy, securities markets, and specific securities as it considers necessary or useful to continuously manage the assets of the Fund in a manner consistent with its investment objective. Under the terms of the Management Agreement, the Investment Manager also maintains certain of the Fund's books and records and furnishes, at its own expense, the office space, facilities, equipment, clerical help, bookkeeping and certain legal services as the Fund may reasonably require in the conduct of its business, including the preparation of prospectuses, proxy statements and reports required to be filed with federal and state securities commissions (except insofar as the participation or assistance of independent auditors and attorneys is, in the opinion of the Investment Manager, necessary or desirable). The Investment Manager also bears the cost of telephone service, heat, light, power and other utilities provided to the Fund. Pursuant to the Sub-Advisory Agreement, the Sub-Advisor has been retained, subject to the overall supervision of the Investment Manager, to continuously furnish investment advice concerning individual security selections, asset allocations and overall economic trends. Expenses not expressly assumed by the Investment Manager or the Sub-Advisor under the Management Agreement and the Sub-Advisory Agreement or by the Distributor, will be paid by the Fund. Such expenses include, but are not limited to: expenses of the Plan of Distribution pursuant to Rule 12b-1; charges and expenses of any registrar, custodian, stock transfer and dividend disbursing agent; brokerage commissions; taxes; engraving and printing share certificates; registration costs of the Fund and its shares under federal and state securities laws; the cost and expense of printing, including typesetting, and distributing prospectuses of the Fund and supplements thereto to the Fund's shareholders; all expenses of shareholders' and Trustees' meetings and of preparing, printing and mailing of proxy statements and reports to shareholders; fees and travel expenses of Trustees or members of any advisory board or committee who are not employees of the Investment Manager or the Sub-Advisor or any corporate affiliate of the Investment Manager or the Sub-Advisor; all expenses 21 incident to any dividend, withdrawal or redemption options; charges and expenses of any outside service used for pricing of the Fund's shares; fees and expenses of legal counsel, including counsel to the Trustees who are not interested persons of the Fund or of the Investment Manager (not including compensation or expenses of attorneys who are employees of the Investment Manager or Sub-Advisor); fees and expenses of the Fund's independent auditors; membership dues of industry associations; interest on Fund borrowings; postage; insurance premiums on property or personnel (including officers and Trustees) of the Fund which inure to its benefit; extraordinary expenses (including, but not limited to, legal claims and liabilities and litigation costs and any indemnification relating thereto); and all other costs of the Fund's operation. The Management Agreement provides that in the absence of willful misfeasance, bad faith, gross negligence or reckless disregard of its obligations thereunder, the Investment Manager is not liable to the Fund or any of its investors for any act or omission by the Investment Manager or for any losses sustained by the Fund or its investors. The Management Agreement will remain in effect from year to year, provided continuance of the Management Agreement is approved at least annually by the vote of the holders of a majority, as defined in the Investment Company Act, of the outstanding shares of the Fund, or by the Trustees; provided that in either event such continuance is approved annually by the vote of a majority of the Trustees, including a majority of the Independent Trustees. D. RULE 12B-1 PLAN In accordance with a Plan of Distribution pursuant to Rule 12b-1 under the Investment Company Act between the Fund and the Distributor, the Distributor provides certain services in connection with the promotion of sales of Fund shares (the "Plan"). The Plan provides that the Distributor bears the expense of all promotional and distribution related activities on behalf of the Fund, except for expenses that the Trustees determine to reimburse, as described below. The following activities and services may be provided by the Distributor under the Plan: (1) compensation to, and expenses of, Morgan Stanley DW's Financial Advisors and other Selected Broker-Dealers' account executives and other employees, including overhead and telephone expenses (expenses may include the cost of Fund-related educational and/or business-related trips or payment of Fund-related educational and/or promotional expenses; for example, the Distributor has implemented a compensation program available only to Financial Advisors meeting specified criteria under which certain marketing and/or promotional expenses of those Financial Advisors are paid by the Distributor out of compensation it receives under the Plan); (2) sales incentives and bonuses to sales representatives and to marketing personnel in connection with promoting sales of the Fund's shares; (3) expenses incurred in connection with promoting sales of the Fund's shares; (4) preparing and distributing sales literature; and (5) providing advertising and promotional activities, including direct mail solicitation and television, radio, newspaper, magazine and other media advertisements. The Investment Manager pays a retention fee to Financial Advisors at an annual rate of 0.05% of the value of shares of the Fund held for at least one year. Shares purchased through the reinvestment of dividends will be eligible for a retention fee, provided that such dividends were earned on shares otherwise eligible for a retention fee payment. Shares owned in variable annuities, closed-end fund shares and shares held in 401(k) plans where the Transfer Agent or Morgan Stanley's Retirement Plan Services is either recordkeeper or trustee are not eligible for a retention fee. The retention fees are paid by the Investment Manager from its own assets, which may include profits from investment management fees payable under the Management Agreement, as well as from borrowed funds. The Fund is authorized to reimburse specific expenses incurred or to be incurred in promoting the distribution of the Fund's shares. Reimbursement is made through payments at the end of each month. The amount of each monthly payment may in no event exceed an amount equal to a payment at the annual rate of 0.75 of 1% of the Fund's average daily net assets during the month. No interest or other financing charges will be incurred for which reimbursement payments under the Plan will be made. In 22 addition, no interest charges, if any, incurred on any distribution expenses will be reimbursable under the Plan. In the case of all expenses other than expenses representing a residual to Financial Advisors and other authorized financial representatives, such amounts shall be determined at the beginning of each calendar quarter by the Trustees, including a majority of the Independent Trustees. Expenses representing a residual to Financial Advisors and other authorized financial representatives, may be reimbursed without prior determination. In the event that the Distributor proposes that monies shall be reimbursed for other than such expenses, then in making quarterly determinations of the amounts that may be expended by the Fund, the Investment Manager provides and the Trustees review a quarterly budget of projected incremental distribution expenses to be incurred on behalf of the Fund, together with a report explaining the purposes and anticipated benefits of incurring such expenses. The Trustees determine which particular expenses, and the portions thereof, that may be borne by the Fund, and in making such a determination shall consider the scope of the Distributor's commitment to promoting the distribution of the Fund's shares. The Fund accrued a total of $663,568 pursuant to the Plan of Distribution for the fiscal year ended October 31, 2001. It is estimated that the amounts paid by the Fund for distribution were for expenses which relate to compensation of sales personnel and associated overhead expenses. Under the Plan, the Distributor uses its best efforts in rendering services to the Fund, but in the absence of willful misfeasance, bad faith, gross negligence or reckless disregard of its obligations, the Distributor is not liable to the Fund or any of its shareholders for any error of judgment or mistake of law or for any act or omission or for any losses sustained by the Fund or its shareholders. Under the Plan, the Distributor provides the Fund, for review by the Trustees, and the Trustees review, promptly after the end of each calendar quarter, a written report regarding the incremental distribution expenses incurred on behalf of the Fund during such calendar quarter, which report includes (1) an itemization of the types of expenses and the purposes therefore; (2) the amounts of such expenses; and (3) a description of the benefits derived by the Fund. In the Trustees' quarterly review of the Plan they consider its continued appropriateness and the level of compensation provided therein. No interested person of the Fund nor any Independent Trustee has any direct financial interest in the operation of the Plan except to the extent that the Distributor, the Investment Manager, Morgan Stanley DW, Morgan Stanley Services or certain of their employees may be deemed to have such an interest as a result of benefits derived from the successful operation of the Plan or as a result of receiving a portion of the amounts expended thereunder by the Fund. On an annual basis, the Trustees, including a majority of the Independent Trustees, consider whether the Plan should be continued. Prior to approving the last continuation of the Plan, the Trustees requested and received from the Distributor and reviewed all the information which they deemed necessary to arrive at an informed determination. In making their determination to continue the Plan, the Trustees considered: (1) the Fund's experience under the Plan and whether such experience indicates that the Plan is operating as anticipated; (2) the benefits the Fund had obtained, was obtaining and would be likely to obtain under the Plan, including that: the Plan is essential in order to enable the Fund to continue to grow and avoid a pattern of net redemptions which, in turn, is essential for effective investment management; and without the compensation to individual brokers and the reimbursement of distribution and account maintenance expenses of Morgan Stanley DW's branch offices made possible by the 12b-1 fees, Morgan Stanley DW could not establish and maintain an effective system for distribution, servicing of Fund shareholders and maintenance of shareholder accounts; and (3) what services had been provided and were continuing to be provided under the Plan to the Fund and its shareholders. Based upon their review, the Trustees, including each of the Independent Trustees, determined that continuation of the Plan would be in the best interest of the Fund and would have a reasonable likelihood of continuing to benefit the Fund and its shareholders. In the Trustees' quarterly review of the Plan, they will consider its continued appropriateness and the level of compensation provided therein. The Plan may not be amended to increase materially the amount to be spent for the services described therein without approval by the shareholders of the Fund, and all material amendments to the 23 Plan must also be approved by the Trustees. The Plan may be terminated at any time, without payment of any penalty, by vote of a majority of the Independent Trustees or by a vote of a majority of the outstanding voting securities of the Fund (as defined in the Investment Company Act) on not more than thirty days' written notice to any other party to the Plan. So long as the Plan is in effect, the election and nomination of Independent Trustees shall be committed to the discretion of the Independent Trustees. E. OTHER SERVICE PROVIDERS (1) TRANSFER AGENT/DIVIDEND-PAYING AGENT Morgan Stanley Trust is the Transfer Agent for the Fund's shares and the Dividend Disbursing Agent for payment of dividends and distributions on Fund shares and Agent for shareholders under various investment plans. The principal business address of the Transfer Agent is Harborside Financial Center, Plaza Two, 2nd Floor, Jersey City, NJ 07311. (2) CUSTODIAN AND INDEPENDENT AUDITORS The Bank of New York, 100 Church Street, New York, NY 10007, is the Custodian of the Fund's assets. Any of the Fund's cash balances with the Custodian in excess of $100,000 are unprotected by federal deposit insurance. These balances may, at times, be substantial. Deloitte & Touche LLP, Two World Financial Center, New York, NY 10281, serves as the independent auditors of the Fund. The independent auditors are responsible for auditing the annual financial statements of the Fund. (3) AFFILIATED PERSONS The Transfer Agent is an affiliate of the Investment Manager, and of the Distributor. As Transfer Agent and Dividend Disbursing Agent, the Transfer Agent's responsibilities include maintaining shareholder accounts, disbursing cash dividends and reinvesting dividends, processing account registration changes, handling purchase and redemption transactions, mailing prospectuses and reports, mailing and tabulating proxies, processing share certificate transactions, and maintaining shareholder records and lists. For these services, the Transfer Agent receives a per shareholder account fee from the Fund and is reimbursed for its out-of-pocket expenses in connection with such services. F. CODES OF ETHICS The Fund, the Investment Manager, the Sub-Advisor and the Distributor have each adopted a Code of Ethics pursuant to Rule 17j-1 under the Investment Company Act. The Codes of Ethics are designed to detect and prevent improper personal trading. The Codes of Ethics permit personnel subject to the Codes to invest in securities, including securities that may be purchased, sold or held by the Fund, subject to a number of restrictions and controls including prohibitions against purchases of securities in an Initial Public Offering and a preclearance requirement with respect to personal securities transactions. VI. BROKERAGE ALLOCATION AND OTHER PRACTICES - -------------------------------------------------------------------------------- A. BROKERAGE TRANSACTIONS Subject to the general supervision of the Trustees, the Investment Manager and/or Sub-Advisor are responsible for decisions to buy and sell securities for the Fund, the selection of brokers and dealers to effect the transactions, and the negotiation of brokerage commissions, if any. The Fund expects that the primary market for the securities in which it invests will generally be the over-the-counter market. In the over-the-counter market, securities are generally traded on a "net" basis with dealers acting as principal for their own accounts without a stated commission, although the price of the security usually includes a profit to the dealer. The Fund also expects that securities will be purchased at times in underwritten offerings where the price includes a fixed amount of compensation, generally referred to as the underwriter's concession or discount. On occasion, the Fund may also purchase certain money market instruments directly from an issuer, in which case no commissions or discounts are paid. 24 During the fiscal years ended October 31, 1999, 2000 and 2001, the Fund paid no brokerage commissions. B. COMMISSIONS Pursuant to an order of the SEC, the Fund may effect principal transactions in certain money market instruments with Morgan Stanley DW. The Fund will limit its transactions with Morgan Stanley DW to U.S. government and government agency securities, bank money instruments (i.e., certificates of deposit and bankers' acceptances) and commercial paper. The transactions will be effected with Morgan Stanley DW only when the price available from Morgan Stanley DW is better than that available from other dealers. During the fiscal years ended October 31, 1999, 2000 and 2001, the Fund did not effect any principal transactions with Morgan Stanley DW. Brokerage transactions in securities listed on exchanges or admitted to unlisted trading privileges may be effected through Morgan Stanley DW, Morgan Stanley & Co. and other affiliated brokers and dealers. In order for an affiliated broker or dealer to effect any portfolio transactions on an exchange for the Fund, the commissions, fees or other remuneration received by the affiliated broker or dealer must be reasonable and fair compared to the commissions, fees or other remuneration paid to other brokers in connection with comparable transactions involving similar securities being purchased or sold on an exchange during a comparable period of time. This standard would allow the affiliated broker or dealer to receive no more than the remuneration which would be expected to be received by an unaffiliated broker in a commensurate arm's-length transaction. Furthermore, the Trustees, including the Independent Trustees, have adopted procedures which are reasonably designed to provide that any commissions, fees or other remuneration paid to an affiliated broker or dealer are consistent with the foregoing standard. The Fund does not reduce the management fee it pays to the Investment Manager by any amount of the brokerage commissions it may pay to an affiliated broker or dealer. C. BROKERAGE SELECTION The policy of the Fund regarding purchases and sales of securities for its portfolio is that primary consideration will be given to obtaining the most favorable prices and efficient executions of transactions. Consistent with this policy, when securities transactions are effected on a stock exchange, the Fund's policy is to pay commissions which are considered fair and reasonable without necessarily determining that the lowest possible commissions are paid in all circumstances. The Fund believes that a requirement always to seek the lowest possible commission cost could impede effective portfolio management and preclude the Fund and the Investment Manager and/or the Sub-Advisor from obtaining a high quality of brokerage and research services. In seeking to determine the reasonableness of brokerage commissions paid in any transaction, the Investment Manager and/or the Sub-Advisor relies upon its experience and knowledge regarding commissions generally charged by various brokers and on its judgment in evaluating the brokerage and research services received from the broker effecting the transaction. These determinations are necessarily subjective and imprecise, as in most cases an exact dollar value for those services is not ascertainable. In seeking to implement the Fund's policies, the Investment Manager and the Sub-Advisor effect transactions with those brokers and dealers who they believe provide the most favorable prices and are capable of providing efficient executions. If the Investment Manager and/or the Sub-Advisor believes the prices and executions are obtainable from more than one broker or dealer, it may give consideration to placing portfolio transactions with those brokers and dealers who also furnish research and other services to the Fund or the Investment Manager and the Sub-Advisor. The services may include, but are not limited to, any one or more of the following: information as to the availability of securities for purchase or sale; statistical or factual information or opinions pertaining to investment; wire services; and appraisals or evaluations of portfolio securities. The information and services received by the Investment Manager and/or Sub-Advisor from brokers and dealers may be utilized by them and any of their asset management affiliates in the management of accounts of some of their other clients and may not in all cases benefit the Fund directly. 25 The Investment Manager, the Sub-Advisor and certain of their affiliates currently serve as investment manager to a number of clients, including other investment companies, and may in the future act as investment manager or advisor to others. It is the practice of the Investment Manager, the Sub-Advisor or their affiliates to cause purchase and sale transactions to be allocated among the clients whose assets they manage (including the Fund) in such manner as they deem equitable. In making such allocations among the Fund and other client accounts, various factors may be considered, including the respective investment objectives, the relative size of portfolio holdings of the same or comparable securities, the availability of cash for investment, the size of investment commitments generally held and the opinions of the persons responsible for managing the portfolios of the Fund and other client accounts. The Investment Manager, the Sub-Advisor and their affiliates may operate one or more order placement facilities and each facility will implement order allocation in accordance with the procedures described above. From time to time, each facility may transact in a security at the same time as other facilities are trading in that security. D. DIRECTED BROKERAGE During the fiscal year ended October 31, 2001, the Fund did not pay any brokerage commissions to brokers because of research services provided. E. REGULAR BROKER-DEALERS During the fiscal year ended October 31, 2001, the Fund did not purchase securities issued by brokers or dealers that were among the ten brokers or the ten dealers that executed transactions for or with the Fund in the largest dollar amounts during the year. At October 31, 2001, the Fund did not own any securities issued by any of such issuers. VII. CAPITAL STOCK AND OTHER SECURITIES - -------------------------------------------------------------------------------- The shareholders of the Fund are entitled to a full vote for each full share of beneficial interest held. The Fund is authorized to issue an unlimited number of shares of beneficial interest. All shares of beneficial interest of the Fund are of $0.01 par value and are equal as to earnings, assets and voting privileges. The Fund's Declaration of Trust permits the Trustees to authorize the creation of additional series of shares (the proceeds of which would be invested in separate, independently managed portfolios) and additional Classes of shares within any series. The Trustees have not presently authorized any such additional series or Classes of shares other than as set forth in the Prospectus. The Fund is not required to hold annual meetings of shareholders and in ordinary circumstances the Fund does not intend to hold such meetings. The Trustees may call special meetings of shareholders for action by shareholder vote as may be required by the Investment Company Act or the Declaration of Trust. Under certain circumstances the Trustees may be removed by action of the Trustees. In addition, under certain circumstances, the shareholders may call a meeting to remove the Trustees and the Fund is required to provide assistance in communicating with shareholders about such a meeting. The voting rights of shareholders are not cumulative, so that holders of more than 50 percent of the shares voting can, if they choose, elect all Trustees being selected, while the holders of the remaining shares would be unable to elect any Trustees. Under Massachusetts law, shareholders of a business trust may, under certain limited circumstances, be held personally liable as partners for the obligations of the Fund. However, the Declaration of Trust contains an express disclaimer of shareholder liability for acts or obligations of the Fund, requires that notice of such Fund obligations include such disclaimer, and provides for indemnification out of the Fund's property for any shareholder held personally liable for the obligations of the Fund. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which the Fund itself would be unable to meet its obligations. Given the above limitations on shareholder personal liability, and the nature of the Fund's assets and operations, the possibility of the Fund being unable to meet its obligations is remote and thus, in the opinion of Massachusetts counsel to the Fund, the risk to Fund shareholders of personal liability is remote. 26 All of the Trustees, except for James F. Higgins, have been elected by the shareholders of the Fund, most recently at a Special Meeting of Shareholders held on June 8, 1999. The Trustees themselves have the power to alter the number and the terms of office of the Trustees (as provided for in the Declaration of Trust), and they may at any time lengthen or shorten their own terms or make their terms of unlimited duration and appoint their own successors, provided that always at least a majority of the Trustees has been elected by the shareholders of the Fund. VIII. PURCHASE, REDEMPTION AND PRICING OF SHARES - -------------------------------------------------------------------------------- A. PURCHASE/REDEMPTION OF SHARES Information concerning how Fund shares are offered to the public (and how they are redeemed and exchanged) is provided in the Fund's Prospectus. TRANSFER AGENT AS AGENT. With respect to the redemption or repurchase of Fund shares, the application of proceeds to the purchase of new shares in the Fund or any other Morgan Stanley Fund and the general administration of the exchange privilege, the Transfer Agent acts as agent for the Distributor and for the shareholder's authorized broker-dealer, if any, in the performance of such functions. With respect to exchanges, redemptions or repurchases, the Transfer Agent shall be liable for its own negligence and not for the default or negligence of its correspondents or for losses in transit. The Fund is not liable for any default or negligence of the Transfer Agent, the Distributor or any authorized broker-dealer. The Distributor and any authorized broker-dealer have appointed the Transfer Agent to act as their agent in connection with the application of proceeds of any redemption of Fund shares to the purchase of shares of any other continuously offered Morgan Stanley Fund and the general administration of the exchange privilege. No commission or discounts will be paid to the Distributor or any authorized broker-dealer for any transaction pursuant to the exchange privilege. OUTSIDE BROKERAGE ACCOUNTS. If a shareholder wishes to maintain his or her fund account through a brokerage company other than Morgan Stanley DW, he or she may do so only if the Distributor has entered into a selected dealer agreement with that brokerage company. Accounts maintained through a brokerage company other than Morgan Stanley DW may be subject to certain restrictions on subsequent purchases and exchanges. Please contact your brokerage company or the Transfer Agent for more information. B. OFFERING PRICE The price of Fund shares, called "net asset value," is based on the value of the Fund's portfolio securities. Net asset value per Fund share is calculated by dividing the value of the Fund's securities and other assets, less the liabilities, by the number of shares outstanding. In the calculation of the Fund's net asset value all portfolio securities for which over-the-counter market quotations are readily available are valued at the latest bid price. When market quotations are not readily available, including circumstances under which it is determined by the Investment Manager or the Sub-Advisor that sale or bid prices are not reflective of a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees. For valuation purposes, quotations of foreign portfolio securities, other assets and liabilities and forward contracts stated in foreign currency are translated into U.S. dollar equivalents at the prevailing market rates prior to the close of the New York Stock Exchange. Short-term debt securities with remaining maturities of sixty days or less at the time of purchase are valued at amortized cost, unless the Trustees determine such does not reflect the securities' market value, in which case these securities will be valued at their fair value as determined by the Trustees. Certain of the Fund's portfolio securities may be valued by an outside pricing service approved by the Fund's Trustees. The pricing service may utilize a matrix system incorporating security quality, 27 maturity and coupon as the evaluation model parameters, and/or research evaluations by its staff, including review of broker-dealer market price quotations in determining what it believes is the fair valuation of the portfolio securities valued by such pricing service. Generally, trading in foreign securities, as well as corporate bonds, U.S. government securities and money market instruments, is substantially completed each day at various times prior to the close of the New York Stock Exchange. The values of such securities used in computing the net asset value of the Fund's shares are determined as of such times. Foreign currency exchange rates are also generally determined prior to the close of the New York Stock Exchange. Occasionally, events which may affect the values of such securities and such exchange rates may occur between the times at which they are determined and the close of the New York Stock Exchange and will therefore not be reflected in the computation of the Fund's net asset value. If events that may affect the value of such securities occur during such period, then these securities may be valued at their fair value as determined in good faith under procedures established by and under the supervision of the Trustees. IX. TAXATION OF THE FUND AND SHAREHOLDERS - -------------------------------------------------------------------------------- The Fund generally will make two basic types of distributions: ordinary dividends and long-term capital gain distributions. These two types of distributions are reported differently on a shareholder's income tax return and they are also subject to different rates of tax. The tax treatment of the investment activities of the Fund will affect the amount, timing and character of the distributions made by the Fund. Tax issues relating to the Fund are not generally a consideration for shareholders such as tax- exempt entities and tax-advantaged retirement vehicles such as an IRA or 401(k) plan. Shareholders are urged to consult their own tax professionals regarding specific questions as to federal, state or local taxes. INVESTMENT COMPANY TAXATION. The Fund intends to remain qualified as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended. As such, the Fund will not be subject to federal income tax on its net investment income and capital gains, if any, to the extent that it distributes such income and capital gains to its shareholders. The Fund generally intends to distribute sufficient income and gains so that the Fund will not pay corporate income tax on its earnings. The Fund also generally intends to distribute to its shareholders in each calendar year a sufficient amount of ordinary income and capital gains to avoid the imposition of a 4% excise tax. However, the Fund may instead determine to retain all or part of any net long-term capital gains in any year for reinvestment. In such event, the Fund will pay federal income tax (and possibly excise tax) on such retained gains. Gains or losses on sales of securities by the Fund will be long-term capital gains or losses if the securities have a tax holding period of more than one year at the time of such sale. Gains or losses on the sale of securities with a tax holding period of one year or less will be short-term capital gains or losses. Special tax rules may change the normal treatment of gains and losses recognized by the Fund when the Fund invests in forward foreign currency exchange contracts, options, futures transactions, and non-U.S. corporations classified as "passive foreign investment companies." Those special tax rules can, among other things, affect the treatment of capital gain or loss as long-term or short-term and may result in ordinary income or loss rather than capital gain or loss. The application of these special rules would therefore also affect the character of distributions made by the Fund. Under certain tax rules, the Fund may be required to accrue a portion of any discount at which certain securities are purchased as income each year even though the Fund receives no payments in cash on the security during the year. To the extent that the Fund invests in such securities, it would be required to pay out such income as an income distribution in each year in order to avoid taxation at the Fund level. Such distributions will be made from the available cash of the Fund or by liquidation of portfolio securities if necessary. If a distribution of cash necessitates the liquidation of portfolio securities, the Investment Manager and/or Sub-Advisor will select which securities to sell. The Fund may realize a gain or loss from such sales. In the event the Fund realizes net capital gains from such transactions, its shareholders may receive a larger capital gain distribution, if any, than they would in the absence of such transactions. 28 TAXATION OF DIVIDENDS AND DISTRIBUTIONS. Shareholders normally will have to pay federal income taxes, and any state and/or local income taxes, on the dividends and other distributions they receive from the Fund. Such dividends and distributions, to the extent that they are derived from net investment income or short-term capital gains, are taxable to the shareholder as ordinary income regardless of whether the shareholder receives such payments in additional shares or in cash. Distributions of net long-term capital gains, if any, are taxable to shareholders as long-term capital gains regardless of how long a shareholder has held the Fund's shares and regardless of whether the distribution is received in additional shares or in cash. Under current law, the maximum tax rate on long-term capital gains realized by non-corporate shareholders generally is 20%. A special lower tax rate of 18% on long-term capital gains is available to non-corporate shareholders to the extent the distributions of long-term capital gains are derived from securities which the Fund purchased after December 31, 2000, and held for more than five years. Shareholders are generally taxed on any ordinary dividend or capital gain distributions from the Fund in the year they are actually distributed. However, if any such dividends or distributions are declared in October, November or December and paid in January then such amounts will be treated for tax purposes as received by the shareholders on December 31, to shareholders of record of such month. Shareholders who are not citizens or residents of the United States and certain foreign entities may be subject to withholding of United States tax on distributions made by the Fund of investment income and short term capital gains. After the end of each calendar year, shareholders will be sent information on their dividends and capital gain distributions for tax purposes, including the portion taxable as ordinary income and the portion taxable as long-term capital gains. PURCHASES AND REDEMPTIONS AND EXCHANGES OF FUND SHARES. Any dividend or capital gains distribution received by a shareholder from any investment company will have the effect of reducing the net asset value of the shareholder's stock in that company by the exact amount of the dividend or capital gains distribution. Furthermore, such dividends and capital gains distributions are subject to federal income taxes. If the net asset value of the shares should be reduced below a shareholder's cost as a result of the payment of dividends or the distribution of realized long-term capital gains, such payment or distribution would be in part a return of the shareholder's investment but nonetheless would be taxable to the shareholder. Therefore, an investor should consider the tax implications of purchasing Fund shares immediately prior to a distribution record date. In general, a sale of shares results in capital gain or loss, and for individual shareholders, is taxable at a federal rate dependent upon the length of time the shares were held. A redemption of a shareholder's Fund shares is normally treated as a sale for tax purposes. Fund shares held for a period of one year or less at the time of such sale or redemption will, for tax purposes, generally result in short-term capital gains or losses and those held for more than one year generally result in long-term capital gains or losses. Under current law, the maximum tax rate on long-term capital gains realized by non-corporate shareholders generally is 20%. A special lower tax rate of 18% on long-term capital gains is available for non-corporate shareholders who purchased shares after December 31, 2000, and held such shares for more than five years. This special lower tax rate of 18% for five-year property does not apply to non-corporate shareholders holding Fund shares which were purchased on or prior to December 31, 2000, unless such shareholders make an election to treat the Fund shares as being sold and reacquired on January 1, 2001. A shareholder making such election may realize capital gains. Any loss realized by shareholders upon a sale or redemption of shares within six months of the date of their purchase will be treated as a long-term capital loss to the extent of any distributions of net long-term capital gains with respect to such shares during the six-month period. Gain or loss on the sale or redemption of shares in the Fund is measured by the difference between the amount received and the tax basis of the shares. Shareholders should keep records of investments made (including shares acquired through reinvestment of dividends and distributions) so they can compute the tax basis of their shares. Under certain circumstances a shareholder may compute and use an average cost basis in determining the gain or loss on the sale or redemption of shares. 29 Exchanges of Fund shares for shares of another fund, including shares of other Morgan Stanley Funds, are also subject to similar tax treatment. Such an exchange is treated for tax purposes as a sale of the original shares in the first fund, followed by the purchase of shares in the second fund. If a shareholder realizes a loss on the redemption or exchange of a fund's shares and reinvests in that fund's shares within 30 days before or after the redemption or exchange, the transactions may be subject to the "wash sale" rules, resulting in a postponement of the recognition of such loss for tax purposes. X. UNDERWRITERS - -------------------------------------------------------------------------------- The Fund's shares are offered to the public on a continuous basis. The Distributor, as the principal underwriter of the shares, has certain obligations under the Distribution Agreement concerning the distribution of the shares. These obligations and the compensation the Distributor receives are described above in the sections titled "Principal Underwriter" and "Rule 12b-1 Plan". XI. CALCULATION OF PERFORMANCE DATA - -------------------------------------------------------------------------------- From time to time the Fund may quote its "yield" and/or its "total return" in advertisements and sales literature. Yield is calculated for any 30-day period as follows: the amount of interest income for each security in the Fund's portfolio is determined as described below; the total for the entire portfolio constitutes the Fund's gross income for the period. Expenses accrued during the period are subtracted to arrive at "net investment income." The resulting amount is divided by the product of the maximum offering price per share on the last day of the period (reduced by any undeclared earned income per share that is expected to be declared shortly after the end of the period) multiplied by the average number of Fund shares outstanding during the period that were entitled to dividends. This amount is added to 1 and raised to the sixth power. 1 is then subtracted from the result and the difference is multiplied by 2 to arrive at the annualized yield. To determine interest income from debt obligations, a yield-to-maturity, expressed as a percentage, is determined for obligations held at the beginning of the period, based on the current market value of the security plus accrued interest, generally as of the end of the month preceding the 30-day period, or, for obligations purchased during the period, based on the cost of the security (including accrued interest). The yield-to-maturity is multiplied by the market value (plus accrued interest) for each security and the result is divided by 360 and multiplied by 30 days or the number of days the security was held during the period, if less. Modifications are made for determining yield-to-maturity on certain tax-exempt securities. For the 30-day period ended October 31, 2001, the Fund's yield, calculated pursuant to the formula described above was 3.11%. The Fund's "average annual total return" represents an annualization of the Fund's total return over a particular period and is computed by finding the annual percentage rate which will result in the ending redeemable value of a hypothetical $1,000 investment made at the beginning of a one, five or ten year period, or for the period from the date of commencement of the Fund's operations, if shorter than any of the foregoing. For the purpose of this calculation, it is assumed that all dividends and distributions are reinvested. The formula for computing the average annual total return involves a percentage obtained by dividing the ending redeemable value by the amount of the initial investment (which is reduced by the initial sales charge), taking a root of the quotient (where the root is equivalent to the number of years in the period) and subtracting 1 from the result. Based on this calculation, the average annual total returns of the Fund for the one and five year periods ended October 31, 2001 and for the period July 31, 1992 (commencement of operations) through October 31, 2001 were 7.43%, 6.03% and 4.66%, respectively. In addition, the Fund may compute its aggregate total return for specified periods by determining the aggregate percentage rate which will result in the ending value of a hypothetical $1,000 investment made at the beginning of the period. For the purpose of this calculation, it is assumed that all dividends and distributions are reinvested. The formula for computing aggregate total return involves a percentage obtained by dividing the ending value (without reduction for any sales charge) by the initial $1,000 30 investment and subtracting 1 from the result. Based on this calculation, the Fund's total returns for the one and five year periods ended October 31, 2001 and for the period July 31, 1992 through October 31, 2001 were 7.43%, 34.04% and 52.36%, respectively. The Fund may also advertise the growth of hypothetical investments of $10,000, $50,000 and $100,000 in shares of the Fund by adding 1 to the Fund's aggregate total return to date and multiplying $10,000, $50,000 or $100,000. Investments of $10,000, $50,000 and $100,000 in the Fund since inception would have grown to $15,236, $76,180, and $152,360, respectively, at October 31, 2001. The after-tax returns of the Fund may also be advertised or otherwise reported. This is generally calculated in a manner similar to the computation of average annual total returns discussed above, except that the calculation also reflects the effect of taxes on returns. The Fund from time to time may also advertise its performance relative to certain performance rankings and indexes compiled by recognized organizations. XII. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- EXPERTS. The financial statements of the Fund for the fiscal year ended Ocrober 31, 2001 included in this Statement of Additional Information and incorporated by reference in the Prospectus have been so included and incorporated in reliance on the report of Deloitte & Touche LLP, independent auditors, given on the authority of said firm as experts in auditing and accounting. * * * * * This Statement of Additional Information and the Prospectus do not contain all of the information set forth in the Registration Statement the Fund has filed with the SEC. The complete Registration Statement may be obtained from the SEC. 31 Morgan Stanley North American Government Income Trust PORTFOLIO OF INVESTMENTS o OCTOBER 31, 2001
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------------------- U.S. Government Agency Mortgage-Backed Securities (59.7%) $ 5,000 Federal Farm Credit Bank ................................... 6.25 % 12/02/02 $5,215,915 5,000 Federal Home Loan Mortgage Corp. ........................... 4.50 08/15/04 5,169,575 1,467 Federal Home Loan Mortgage Corp. ARM ....................... 7.035 03/01/25 1,503,383 4,087 Federal National Mortgage Assoc. ........................... 5.876 07/01/31 4,158,695 4,743 Federal National Mortgage Assoc. ........................... 7.00 01/01/04 5,012,770 464 Federal National Mortgage Assoc. ........................... 9.50 06/01/20 516,803 8,760 Government National Mortgage Assoc. II ARM ................. 6.375 06/20/22- 06/20/25 8,973,913 8,218 Government National Mortgage Assoc. II ARM ................. 6.50 08/20/29 8,375,144 4,261 Government National Mortgage Assoc. II ARM ................. 7.00 07/20/29- 09/20/29 4,356,565 2,164 Government National Mortgage Assoc. II ARM ................. 7.625 10/20/24- 12/20/24 2,225,930 8,341 Government National Mortgage Assoc. II ARM ................. 7.75 08/20/22 8,581,233 ---------- Total U.S. Government Agency Mortgage Backed-Securities (Cost $52,830,255) .................................................................. 54,089,926 ---------- Collateralized Mortgage Obligations (16.0%) U.S. Government Agencies 5 Federal Home Loan Mortgage Corp. 1370 K (PAC IO) ........... 1,089.16 09/15/22 79,763 8,186 Federal Home Loan Mortgage Corp. G 21 M .................... 6.50 10/25/23 8,648,329 404 Federal National Mortgage Assoc. 1993-167 M (PAC) .......... 6.00 09/25/23 404,279 5,000 Federal National Mortgage Assoc. G96-1 PJ (PAC) ............ 7.50 11/17/25 5,345,300 ---------- Total Collateralized Mortgage Obligations (Cost $13,970,383)......................... 14,477,671 ---------- Short-Term Investments (24.6%) Commercial Paper (a) (21.8%) Finance/Rental/Leasing (18.5%) 12,000 International Lease Finance Corp. .......................... 2.48 11/05/01 11,996,693 4,800 International Lease Finance Corp. .......................... 2.50 11/06/01 4,798,333 ---------- 16,795,026 ---------- Insurance (3.3%) 3,000 American General Corp. ..................................... 2.47 11/06/01 2,998,971 ---------- Total Commercial Paper (Cost $19,793,997)............................................ 19,793,997 ----------
See Notes to Financial Statements 32 Morgan Stanley North American Government Income Trust PORTFOLIO OF INVESTMENTS o OCTOBER 31, 2001 CONTINUED
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE - ------------------------------------------------------------------------------------------------------- Repurchase Agreement (2.8%) $ 2,557 The Bank of New York (dated 10/31/01; proceeds $2,557,353) (b) (Cost $2,557,175)................. 2.5 % 11/01/01 $ 2,557,175 ----------- Total Short-Term Investments (Cost $22,351,172)......................... 22,351,172 ----------- Total Investments (Cost $89,151,810) (c).......... 100.3 % 90,918,769 Liabilities in Excess of Other Assets ............ (0.3) (307,495) ------- ----------- Net Assets ....................................... 100.0 % $90,611,274 ======= ===========
- ------------ ARM Adjustable Rate Mortgage. IO Interest-only securities. PAC Planned Amortization Class. (a) Purchased on a discount basis. The interest rate shown has been adjusted to reflect a money market equivalent yield. (b) Collateralized by $1,896,866 U.S. Treasury Bond 7.875% due 02/15/21 valued at $2,608,323. (c) The aggregate cost for federal income tax purposes approximates the aggregate cost for book purposes. The aggregate gross unrealized appreciation is $2,228,467 and the aggregate gross unrealized depreciation is $461,508, resulting in net unrealized appreciation of $1,766,959. See Notes to Financial Statements 33 Morgan Stanley North American Government Income Trust FINANCIAL STATEMENTS Statement of Assets and Liabilities October 31, 2001
Assets: Investments in securities, at value (cost $89,151,810) ............................... $ 90,918,769 Receivable for: Interest ...................................... 513,178 Shares of beneficial interest sold ............ 80,037 Principal paydowns ............................ 56,078 Prepaid expenses ................................... 15,229 ------------ Total Assets .................................... 91,583,291 ------------ Liabilities: Payable for: Shares of beneficial interest repurchased ..... 736,504 Distribution fee .............................. 59,057 Investment management fee ..................... 51,183 Payable to bank .................................... 68,845 Accrued expenses ................................... 56,428 ------------ Total Liabilities ............................... 972,017 ------------ Net Assets ...................................... $ 90,611,274 ============ Composition of Net Assets: Paid-in-capital .................................... $320,616,404 Net unrealized appreciation ........................ 1,766,959 Accumulated undistributed net investment income ........................................... 329,619 Accumulated net realized loss ...................... (232,101,708) ------------ Net Assets ...................................... $ 90,611,274 ============ Net Asset Value Per Share, 10,278,823 shares outstanding (unlimited shares authorized of $.01 par value) .......... $8.82 =====
Statement of Operations For the year ended October 31, 2001
Net Investment Income: Interest Income ............................... $5,715,195 ---------- Expenses Distribution fee .............................. 663,568 Investment management fee ..................... 587,228 Transfer agent fees and expenses .............. 180,881 Professional fees ............................. 68,090 Shareholder reports and notices ............... 50,430 Registration fees ............................. 40,483 Custodian fees ................................ 14,262 Trustees' fees and expenses ................... 12,511 Other ......................................... 11,976 ---------- Total Expenses ............................. 1,629,429 Less: expense offset .......................... (13,363) ---------- Net Expenses ............................... 1,616,066 ---------- Net Investment Income ...................... 4,099,129 ---------- Net change in unrealized depreciation ......... 2,295,697 ---------- Net Increase .................................. $6,394,826 ==========
See Notes to Financial Statements 34 Morgan Stanley North American Government Income Trust FINANCIAL STATEMENTS continued Statement of Changes in Net Assets
FOR THE YEAR FOR THE YEAR ENDED ENDED OCTOBER 31, 2001 OCTOBER 31, 2000 ------------------ ----------------- Increase (Decrease) in Net Assets: Operations: Net investment income ....................................................... $ 4,099,129 $ 4,837,596 Net realized gain ........................................................... - 792,094 Net change in unrealized depreciation ....................................... 2,295,697 (109,419) ------------ ------------- Net Increase .............................................................. 6,394,826 5,520,271 Dividends to shareholders from net investment income ........................ (4,171,176) (4,457,000) Net decrease from transactions in shares of beneficial interest ............. (3,307,860) (29,670,526) ------------ ------------- Net Decrease .............................................................. (1,084,210) (28,607,255) Net Assets: Beginning of period ......................................................... 91,695,484 120,302,739 ------------ ------------- End of Period (Including accumulated undistributed net investment income of $329,619 and $504,364, respectively)...................................................... $ 90,611,274 $ 91,695,484 ============ =============
See Notes to Financial Statements 35 Morgan Stanley North American Government Income Trust NOTES TO FINANCIAL STATEMENTS o OCTOBER 31, 2001 1. Organization and Accounting Policies Morgan Stanley North American Government Income Trust (the "Fund"), formerly Morgan Stanley Dean Witter North American Government Income Trust, is registered under the Investment Company Act of 1940, as amended (the "Act"), as a non-diversified, open-end management investment company. The Fund's investment objective is to earn a high level of income while maintaining relatively low volatility of principal. The Fund was organized as a Massachusetts business trust on February 19, 1992 and commenced operations on July 31, 1992. The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts and disclosures. Actual results could differ from those estimates. The following is a summary of significant accounting policies: A. Valuation of Investments - (1) portfolio securities for which over-the-counter market quotations are readily available are valued at the latest available bid price prior to the time of valuation; (2) when market quotations are not readily available, including circumstances under which it is determined by Morgan Stanley Investment Advisors Inc. (the "Investment Manager"), formerly Morgan Stanley Dean Witter Advisors Inc., or TCW Investment Management Company (the "Sub-Advisor") that sale or bid prices are not reflective of a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Trustees (valuation of debt securities for which market quotations are not readily available may be based upon current market prices of securities which are comparable in coupon, rating and maturity or an appropriate matrix utilizing similar factors); and (3) short-term debt securities having a maturity date of more than sixty days at time of purchase are valued on a mark-to-market basis until sixty days prior to maturity and thereafter at amortized cost based on their value on the 61st day. Short-term debt securities having a maturity date of sixty days or less at the time of purchase are valued at amortized cost. B. Accounting for Investments - Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Realized gains and losses on security transactions are determined by the identified cost method. The Fund amortizes premiums and accretes discounts based on the respective life of the securities. Interest income is accrued daily. C. Foreign Currency Translation - The books and records of the Fund are maintained in U.S. dollars as follows: (1) the foreign currency market value of investment securities, other assets and liabilities and forward foreign currency contracts ("forward contracts") are translated at the exchange rates prevailing at the end of the period; and (2) purchases, sales, income and expenses are translated at the exchange rates prevailing on the respective dates of such transactions. The resultant exchange gains and losses are 36 Morgan Stanley North American Government Income Trust NOTES TO FINANCIAL STATEMENTS o OCTOBER 31, 2001 continued included in the Statement of Operations as realized and unrealized gain/loss on foreign exchange transactions. Pursuant to U.S. federal income tax regulations, certain foreign exchange gains/losses included in realized and unrealized gain/loss are included in or are a reduction of ordinary income for federal income tax purposes. The Fund does not isolate that portion of the results of operations arising as a result of changes in the foreign exchange rates from the changes in the market prices of the securities. D. Forward Foreign Currency Contracts - The Fund may enter into forward contracts which are valued daily at the appropriate exchange rates. The resultant unrealized exchange gains and losses are included in the Statement of Operations as unrealized foreign currency gain or loss. The Fund records realized gains or losses on delivery of the currency or at the time the forward contract is extinguished (compensated) by entering into a closing transaction prior to delivery. E. Dollar Rolls - The Fund may enter into dollar rolls in which the Fund sells securities for delivery and simultaneously contracts to repurchase substantially similar securities at the current sales price on a specified future date. The difference between the current sales price and the lower forward price for the future purchase (often referred to as the "drop") is amortized over the life of the dollar roll. F. Federal Income Tax Status - It is the Fund's policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute substantially all of its taxable income to its shareholders. Accordingly, no federal income tax provision is required. G. Dividends and Distributions to Shareholders - The Fund records dividends and distributions to its shareholders on the ex-dividend date. The amount of dividends and distributions from net investment income and net realized capital gains are determined in accordance with federal income tax regulations which may differ from generally accepted accounting principles. These "book/tax" differences are either considered temporary or permanent in nature. To the extent these differences are permanent in nature, such amounts are reclassified within the capital accounts based on their federal tax-basis treatment; temporary differences do not require reclassification. Dividends and distributions which exceed net investment income and net realized capital gains for tax purposes are reported as distributions of paid-in-capital. 2. Investment Management and Sub-Advisory Agreements Pursuant to an Investment Management Agreement, the Fund pays the Investment Manager a management fee, accrued daily and payable monthly, by applying the following annual rates to the net assets of the Fund determined as of the close of each business day: 0.65% to the portion of the daily net assets not exceeding $500 million and 0.60% to the portion of the daily net assets exceeding $500 million. 37 Morgan Stanley North American Government Income Trust NOTES TO FINANCIAL STATEMENTS o OCTOBER 31, 2001 continued Under a Sub-Advisory Agreement between the Investment Manager and the Sub-Advisor, the Sub-Advisor provides the Fund with investment advice and portfolio management relating to the Fund's investments in securities, subject to the overall supervision of the Investment Manager. As compensation for its services provided pursuant to the Sub-Advisory Agreement, the Investment Manager pays the Sub-Advisor compensation equal to 40% of its monthly compensation. 3. Plan of Distribution Morgan Stanley Distributors Inc. (the "Distributor"), an affiliate of the Investment Manager, is the distributor of the Fund's shares and, in accordance with a Plan of Distribution (the "Plan") pursuant to Rule 12b-1 under the Act, finances certain expenses in connection with the distribution of shares of the Fund. The Fund is authorized to reimburse the Distributor for specific expenses the Distributor incurs or plans to incur in promoting the distribution of the Fund's shares. The amount of each monthly reimbursement payment may in no event exceed an amount equal to a payment at the annual rate of 0.75% of the Fund's average daily net assets during the month. Expenses incurred pursuant to the Plan in any fiscal year in excess of 0.75% of the Fund's average daily net assets will not be reimbursed by the Fund through payments accrued in any subsequent fiscal year. For the year ended October 31, 2001, the distribution fee was accrued at the annual rate of 0.73%. 4. Security Transactions and Transactions with Affiliates The purchases and proceeds from prepayments of portfolio securities, excluding short-term investments, for the year ended October 31, 2001 were as follows:
PURCHASES PREPAYMENTS -------------- -------------- U.S. Government Agencies ......................................................... $14,444,850 $31,100,601 Private Issue CMOs ............................................................... -- 1,781,743
Morgan Stanley Trust, an affiliate of the Investment Manager and Distributor, is the Fund's transfer agent. At October 31, 2001, the Fund had transfer agent fees and expenses payable of approximately $8,100. 38 Morgan Stanley North American Government Income Trust NOTES TO FINANCIAL STATEMENTS [|] OCTOBER 31, 2001 continued 5. Shares of Beneficial Interest Transactions in shares of beneficial interest were as follows:
FOR THE YEAR FOR THE YEAR ENDED ENDED OCTOBER 31, 2001 OCTOBER 31, 2000 ---------------------------------- ---------------------------------- SHARES AMOUNT SHARES AMOUNT ---------------- ----------------- ---------------- ----------------- Sold .............................. 13,631,877 $ 119,393,140 27,659,513 $ 235,059,575 Reinvestment of dividends ......... 359,700 3,137,960 390,253 3,309,760 Repurchased ....................... (14,370,369) (125,838,960) (31,548,244) (268,039,861) ----------- -------------- ----------- -------------- Net decrease ...................... (378,792) $ (3,307,860) (3,498,478) $ (29,670,526) =========== ============== =========== ==============
6. Federal Income Tax Status During the year ended October 31, 2001, the Fund utilized approximately $103,000 of its net capital loss carryover. At October 31, 2001, the Fund had a net capital loss carryover of approximately $232,102,000, to offset future capital gains to the extent provided by regulations, available through October 31 of the following years:
AMOUNT IN THOUSANDS - -------------------------------------------------------------------------------- 2002 2003 2004 2005 2006 2007 2008 - ------------ ----------- ---------- --------- ------ --------- ----- $ 52,983 $160,560 $14,716 $2,013 $152 $1,657 $21 ========= ======== ======= ====== ==== ====== ===
As of October 31, 2001, the Fund had permanent book/tax differences attributable to reclassifications of net gains on paydowns. To reflect reclassifications arising from these differences, accumulated undistributed net investment income was charged $102,698 and accumulated net realized loss was credited $102,698. 7. Reverse Repurchase and Dollar Roll Agreements Reverse repurchase and dollar roll agreements involve the risk that the market value of the securities the Fund is obligated to repurchase under the agreement may decline below the repurchase price. In the event the buyer of securities under a reverse repurchase or dollar roll agreement files for bankruptcy or becomes insolvent, the Fund's use of proceeds of the agreement may be restricted pending a determination by the other party, its trustee or receiver, whether to enforce the Fund's obligation to repurchase the securities. Reverse repurchase agreements are collateralized by Fund securities with a market value in excess of the Fund's obligation under the contract. At October 31, 2001, there were no outstanding reverse repurchase or dollar roll agreements. 39 Morgan Stanley North American Government Income Trust NOTES TO FINANCIAL STATEMENTS o OCTOBER 31, 2001 continued 8. Expense Offset The expense offset represents a reduction of the custodian fees for earnings on cash balances maintained by the Fund. 9. Purposes of and Risks Relating to Certain Financial Instruments The Fund may enter into forward contracts to facilitate settlement of foreign currency denominated portfolio transactions or to manage foreign currency exposure associated with foreign currency denominated securities. Forward contracts involve elements of market risk in excess of the amounts reflected in the Statement of Assets and Liabilities. The Fund bears the risk of an unfavorable change in the foreign exchange rates underlying the forward contracts. Risks may also arise upon entering into these contracts from the potential inability of the counterparties to meet the terms of their contracts. At October 31, 2001, there were no outstanding forward contracts. 10. Change in Accounting Policy Effective November 1, 2001, the Fund will adopt the provisions of the AICPA Audit and Accounting Guide for Investment Companies, as revised, related to premiums and discounts on debt securities. The cumulative effect of this accounting change will have no impact on the net assets of the Fund, but will result in an adjustment to the cost of securities and a corresponding adjustment to undistributed net investment income based on securities held as of October 31, 2001. 40 Morgan Stanley North American Government Income Trust FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE YEAR ENDED OCTOBER 31 ---------------------------------- 2001 2000 ----------------- ---------------- Selected Per Share Data: Net asset value, beginning of period ............. $8.60 $8.50 ----- ----- Income (loss) from investment operations: Net investment income ........................... 0.40 0.40 Net realized and unrealized gain (loss) ......... 0.22 0.06 ----- ----- Total income from investment operations .......... 0.62 0.46 ----- ----- Less dividends and distributions from: Net investment income ........................... (0.40) (0.36) Paid-in-capital ................................. - - ----- ----- Total dividends and distributions ................ (0.40) (0.36) ----- ----- Net asset value, end of period ................... $8.82 $8.60 ===== ===== Total Return+ ................................... 7.43% 5.55% Ratios to Average Net Assets: Expenses (before expense offset) ................. 1.80%(1) 1.76%(1) Net investment income ............................ 4.51% 4.58% Supplemental Data: Net assets, end of period, in thousands .......... $90,611 $91,695 Portfolio turnover rate .......................... 19% - FOR THE YEAR ENDED OCTOBER 31 ---------------------------------------------------- 1999 1998 1997 ----------------- ------------------ --------------- Selected Per Share Data: Net asset value, beginning of period ............. $8.60 $8.59 $8.39 ----- ----- ----- Income (loss) from investment operations: Net investment income ........................... 0.44 0.49 0.44 Net realized and unrealized gain (loss) ......... (0.09) (0.05) 0.19 ----- ----- ----- Total income from investment operations .......... 0.35 0.44 0.63 ----- ----- ----- Less dividends and distributions from: Net investment income ........................... (0.38) (0.43) (0.43) Paid-in-capital ................................. (0.07) - - ----- ----- ----- Total dividends and distributions ................ (0.45) (0.43) (0.43) ----- ----- ----- Net asset value, end of period ................... $8.50 $8.60 $8.59 ===== ===== ===== Total Return+ ................................... 4.30% 5.13% 7.80% Ratios to Average Net Assets: Expenses (before expense offset) ................. 1.81%(1) 1.69%(1) 1.65% Net investment income ............................ 5.11% 5.52% 5.18% Supplemental Data: Net assets, end of period, in thousands .......... $120,303 $150,441 $212,040 Portfolio turnover rate .......................... 43% 8% -
- ----------- + Calculated based on the net asset value as of the last business day of the period. (1) Does not reflect the effect of expense offset of 0.01%. See Notes to Financial Statements 41 Morgan Stanley North American Government Income Trust INDEPENDENT AUDITORS' REPORT To the Shareholders and Board of Trustees of Morgan Stanley North American Government Income Trust: We have audited the accompanying statement of assets and liabilities of Morgan Stanley North American Government Income Trust (the "Fund"), formerly Morgan Stanley Dean Witter North American Government Income Trust, including the portfolio of investments, as of October 31, 2001, and the related statement of operations for the year then ended, the statements of changes in net assets for each of the two years in the period then ended, and the financial highlights for each of the five years in the period then ended. These financial statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of October 31, 2001, by correspondence with the custodian. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Morgan Stanley North American Government Income Trust as of October 31, 2001, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the five years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. Deloitte & Touche LLP New York, New York December 11, 2001 2001 Federal Tax Notice (unaudited) Of the Fund's ordinary income dividends paid during the fiscal year ended October 31, 2001, 3.08% was attributable to qualifying Federal obligations. Please consult your tax advisor to determine if any portion of the dividends you received is exempt from state income tax. 42 -----END PRIVACY-ENHANCED MESSAGE-----