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It's just not that easy to make money by managing money anymore.

The mutual fund industry is -- or, rather, should be -- in the throes of an overhaul, according to a new study commissioned by Big Four accounting firm KPMG. On a global scale, 40% of asset managers expect to report a loss in 2003. But the path to profitability is clear, the survey's author contends -- although few firms have embarked on that journey.

The main problem facing the fund industry is strong leadership, says Amin Rajan, the study's lead author and chief executive of the research consultancy firm Create.

"Many asset managers have business models that work only in the bull market," Rajan says. "When fees are tied to funds under management, for instance, it's an arithmetic certainty that profits will decrease in a bear market. Firms need a variable cost structure in which costs decrease in a bear market."

Striving toward that new type of business model will have a direct impact on fund investors. It's no surprise that cutting costs is the first line of defense against shrinking profits -- some 80% of firms have already begun that process. But fund firms need to go far beyond that to thrive, Rajan says.

Chief among the goals should be to narrow the product range, and re-evaluate manager performance and pay. "Only about 20% of fund firms have begun the second step of narrowing the product range," Rajan says. "For the vast majority of companies, this model remains aspirational."

John Capone, a partner in KPMG's investment-management group, notes, "The cost-cutting model is a quick fix, and it's over now. These firms need to know what customers demand, and adjust to changes in the marketplace. And they're not doing a good job of responding."

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Expect fund firms to introduce new products that are in line with their focus, but with added specificity, Capone and Rajan say. In other words, Vanguard's new line of

sector index funds is a good example of such a strategy, while, say, bond shop Pimco would not be advised to launch an array of technology stock funds.

"It's critical that they deliver what they promise and become that trusted brand," Capone says. "Investors are holding firms more accountable."

Timid leadership, though, hurts the fund industry, the study notes. One of the major factors preventing a turnaround in the fund business is the near-total unwillingness of chief executives to address the issue of manager compensation, Rajan says.

"In other troubled industries, such as automakers, executives attacked every item of cost," he says. "But in investment companies, manager pay is still a sacred cow."

And let's not forget that manager pay comes from a willingness on the part of investors to reward "star" managers, particularly during the bull market. Management expenses didn't seem like such a big deal when investors were earning returns in the high double digits, but now those pay contracts are taking a bigger bite -- both at the individual investor level as well as the firmwide level.

"That's the biggest problem facing firms now," Rajan says. "Manager compensation."

In conducting its survey, KPMG studied 185 investment-management firms in 20 countries, and sat down with chief executives and chief investment officers from 60 firms for face-to-face interviews.