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Fund manager Mario Gabelli rose to superstar status by seeing value where others didn't. But recent events have raised a few questions for his followers.

Last week Merrill Lynch analyst Cynthia Mayer lowered her rating on shares of

Gabelli Asset Management

(GBL) - Get GAMCO Investors, Inc. Class A Report

to neutral from buy, in part because of concerns about high fund fees and potential regulation of companies that manage both hedge funds and mutual funds.

Back in September, Gabelli publicly released a memo describing how its funds steer clear of late traders and market-timers. Nevertheless, the sins of the market-timing masses are splattering onto the well-behaved few. Mayer noted that "regulatory exposure is low, but at some point Gabelli's above-average equity fund fees could be pressured."

In other words,

Alliance Capital's

(AC) - Get Associated Capital Group, Inc. Class A Report

recent agreement with regulators to

cut its fees has shifted investor focus from fraud to fees. And that's not a good sign for premium providers like Gabelli.

How far above average are Gabelli's equity fund fees? Morningstar's average expense ratio for Gabelli's domestic stock funds is 1.95%, compared with the industry average of 1.50%. Gabelli's international stock funds are closer to the pack at 1.95%, compared with 1.86% for the rest of the industry.

"By and large his funds are expensive. Most funds fall in Lipper's bottom 40% of peer groups when it comes to cost," says Lipper Analyst Jeff Tjornehoj.

Still, being a higher-priced provider in a falling-price environment doesn't bother Chief Executive Mario Gabelli. "Consumers have a choice. They can buy a



TheStreet Recommends


or Gabelli fund," says Gabelli. "Just like they can buy the same Armani shirt in Neiman Marcus or Loehmanns. The shopper has the choice and knows the environment."

With a $37.5 million pay package in 2002, Gabelli can shop on the moon if he wants. And since his funds are tilted toward high-net-worth investors, most of his investors can probably afford the slightly higher fees.

However, investors might want to know what kind of performance they are receiving for those extra fees.

According to Lipper, Gabelli's equity funds have performed slightly below average, year to date, despite strong three-year and five-year records. On an asset-weighted basis, Gabelli's funds are up 24.5% vs. 25.6% for peers through November.

Mayer points out that Gabelli shareholders should care intensely about the equity fund fees and equity levels, because the firm's assets are about 85% equity.

Morningstar stock analyst Rachel Barnard, in a report on the stock, echoes Mayer's sentiment by saying the company's lack of diversification makes the stock "vulnerable to bear markets." She adds, "Gabelli is subject to the ebb and flow of the stock market. But the market has been kind to Gabelli in recent months, as higher equity prices have boosted assets under management."

Like Merrill's Mayer, Barnard sees Gabelli shares as being fairly valued at their current levels, with few near-term catalysts to push the stock higher.

Gabelli has been counting on growth from its hedge funds, which seek double-digit gains no matter the market conditions. Although hedge funds constitute only 2% to 3% of Gabelli's $21.2 billion assets under management (as of Dec. 31, 2002), they are free to generate large performance-based fees, even while pricing and regulatory pressure impinges on the two main businesses: separate accounts (50% of assets under management) and mutual funds (47% of assets under management).

In Mayer's downgrade of the company's stock, she notes that conflict-of-interest concerns have arisen over money managers' controlling both hedge funds and mutual funds. Since Gabelli has several money managers -- including Mario Gabelli himself -- pulling double duty, Mayer says, "Gabelli might have to either combine funds or add portfolio managers."

Many analysts, however, see this potential regulatory risk as manageable. "I don't think that having hedge funds and mutual funds in the house is a major problem," says Nataly Frankel, a financial services analyst at Sidoti & Co. "It's only 2% in terms of assets. They would find some way to separate it out."

As it searches for other growth engines, Gabelli sits on $13 per share of cash. Mayer doesn't mind the cash cushion, which she says can be used either for defensive or acquisitive purposes. But like other analysts, she remains "unclear when the company will use the cash, or how."

Last month, Gabelli offered analysts and investors a bit of clarity by giving some of that cash back in its first-ever dividend, a paltry but perhaps well-meaning 2 cents per share. It also successfully introduced a $1.5 billion closed-end fund in late November, the

Gabelli Dividend and Income Trust

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It would be safe to assume that investors buying Gabelli shares trust Mario Gabelli to invest that cash wisely. Like Warren Buffett, Mario Gabelli has legions of value-investing fans who trust him implicitly and don't mind paying the goodwill costs associated with having his name on the building, or, as Lipper's Tjornehoj calls it, the "Martha Stewart risk" from mixing his name with his


ticker symbol.

"If he's turning in the performance that people associate with his name, the shareholders won't scream for their money back," says Tjornehoj.