BOSTON - As Peter Drotch prepares to retire as director of PricewaterhouseCoopers' investment management industry group, he is predicting tough times ahead for the fund industry.

The major challenge Drotch sees for the industry is a squeezing of profit margins.

Drotch, who helped build the investment management practice of PricewaterhouseCoopers of New York into a business serving 3,000 mutual funds with $2.8 billion in assets under management, will retire at the end of September. These clients represent 60 percent of the industry, said Drotch, who recently talked about his career at his downtown Boston office.

Drotch, 58, joined the firm in 1964 as an accountant, following graduation from the University of Connecticut. In 1975, he was named partner, at age 33, making him the youngest partner ever named.

In 1977, he was named interim head of the investment management division, which had just been created. Drotch viewed this as a temporary assignment and looked forward to returning to the firm's general practice. Gradually, however, the practice grew on him - particularly as the fund industry took off.

Going forward, however, Drotch foresees challenging times ahead. In part, mutual fund industry profits may be further squeezed by Congress' and the public's increasing attention to fees, which may push them lower, he said. Doing so is not necessarily economically feasible in spite of perceived growing economies of scale, he added.

"While the cost of technology has been coming down and improving productivity immensely, the demands on that technology for more sophisticated services for investors - and for having to process far more complicated products than we have ever seen - is actually making those systems more expensive," Drotch said.

The industry is not doing a good job of explaining this business reality to Congress, the General Accounting Office or to the public, Drotch said.

As operating and technology costs continue to grow, fund companies are also likely to outsource back-office and technological functions, Drotch said.

"The outsourcing option is being chosen by larger and larger organizations, " Drotch said. "Last year, Federated and PIMCO, two huge organizations, outsourced their fund accounting. Five years ago, they probably would never have done that. But they are today. It's a matter of affordability."

The rapid pace of mergers and acquisitions will also have a negative impact on the industry, Drotch said. While these acquisitions are being made to accelerate growth, many of the companies doing the acquiring have not sufficiently factored in the enormous multiples they are paying for these asset management firms, Drotch said.

Companies acquiring other asset managers for high prices will eventually realize that they will need exceptional asset growth to justify those prices, Drotch said.

"Firms have not factored in this pressure to grow," Drotch said.

Anxious to make acquisitions, fund companies do not seem to be using any fixed standards to judge whether the prices they are paying are warranted, Drotch said.

"They decide they want to make an acquisition because it's part of their overall strategy, and then they back in with creative multiples," sometimes basing them on the target firm's assets under management, other times on the firm's asset flow, and still other times on fee flows, Drotch said.

This oversight as to how much they are paying and what kind of asset growth they will need to justify these prices is ultimately going to result in a rash of mutual fund mergers and closings, Drotch said.

Drotch also believes that the current debate that the SEC has initiated on the fund and accounting industries over independent auditors "might very well become contentious."

The SEC could hurt accounting firms' businesses if it completely prohibits their consulting divisions from working with fund companies, Drotch said. Fund companies have increasingly looked to PricewaterhouseCoopers and other big accounting firms to help them with operational, regulatory, strategic and international decisions, he said.

It is these additional services that make PricewaterhouseCoopers valuable, Drotch said.

It is also this broad depth of expertise that has made working in investment management at PricewaterhouseCoopers so interesting for Drotch and it is why he remained at the firm for so long.

"The depth of our industry expertise is clearly unmatched," Drotch said. "To have worked with people of this caliber has made it worth all the nearly-four-decades while," he said.

Although Drotch is proud of the growth of the investment management practice, he wants more than anything to be remembered for his work relationships, he said.

"I want to be remembered for my friends, the people who I have worked with," said Drotch. "For challenging people - helping them grow. And, for heading the industry group with the lowest turnover at PricewaterhouseCoopers and the highest percentage of women partners." Of 125 partners in the group, 25 are women, he said.

"Sure, you can look at the phenomenal growth of our business and assume I drove it with aggressive budgets and business plans," Drotch said.

"When I confess how little time I actually paid to the numbers, it will stun a lot of people. I have never focused on the performance reports of the business. I've always focused on the performance reports of the people and trying to make their lives better. The business always followed naturally."

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