Investment advisors to the mutual fund industry may be in for a period of slimmer profits because of the fund skimming scandals. The conclusion was drawn by a quartet of FitchRatings' analysts covering the banking industry in a white paper published on December 3. The white paper is titled Under the Microscope: Increased Scrutiny of Fund Managers. The papers authors are Eileen Fahey, Leslie Bright, David Spring and Lamindy Brandon-Joseph. The industry may face a period of increased consolidation because of the scandals, the analysts wrote in the paper. However, they believe that the fund industry will ultimately emerge from the scandals and regulatory fallout in tact. They do predict that fund advisors will be forced to improve systems and controls so that "known misdeeds occur less frequently." The authors point out that the fund industry has been "long immune to normal pricing pressures" as investors typically judge funds by performance rather than expenses. That means that higher cost funds have prospered equally with lower cost funds. That may change, though, if regulators force boards to more closely watch fund expenses and advisory agreements. If fees do come under closer scrutiny, larger funds may benefit as they can operate with lower expenses. Fund advisors must also face a number of underlying management issues raised by the scandals, according to the paper. These include:

existing weak oversight by mutual fund directors.

a breakdown of operational risk systems at the advisor.

a incentive system that leads mid-level managers to value asset gathering over the long-term reputation of the fund firm.

the failure of firms to maintain a fiduciary culture that puts the shareholder's interest at the fore. Not all of the conclusions are gloomy, though. The authors do believe that funds will have a significant role to play with investors in the future. "Investors are unlikely to flee mutual funds, because alternative investment classes do not have the advantages of diversification and low, direct transaction costs," the authors wrote. To the extent that investors do turn elsewhere other industry products such as exchange-traded funds and closed-end mutual funds are the likely beneficiaries.  

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