Finally, insiders launched candid criticism at the mutual fund industry last week, to help it respond sensibly to the economic meltdown and reposition itself to regain investor trust.

Foremost among this advice is giving portfolio managers back the power to pick stocks and run with their investment ideas, instead of being so tightly tethered to an investment class and market capitalization. Further, fund managers should step away from their style boxes and take a look at bigger economic trends. The signs were all there, beginning with the 2007 demise of Bear Stearns' credit derivatives-laden hedge funds. Anyone could have foreseen the accelerating problems of the credit and capital markets, mutual fund managers among them. Had more of them moved into cash or safe investments, they would have avoided the across-the-board losses in 2008.

Bob Rodriguez, manager of the FPA Capital Fund, minced no words when he said that the industry's performance last year simply "stunk." Rather than sticking with mutual funds' traditional investment discipline of being fully invested and tracking a benchmark, Rodriguez said, fund managers should have wakened up to the magnitude and "extraordinary risk" of the financial crisis and taken a different tack.

"Whether in stocks or bonds, it seems as though the same old strategies were followed: be fully invested and don't diverge from your benchmark too far," he said. "If active managers maintain this course, I fear the long-term outlook for their funds, as well as their employment, will be at high risk."

Likewise, SwanDog Strategic Marketing issued a whitepaper last week, "How to Save the Mutual Fund Before It's Too Late."

The most important thing fund companies can do, wrote SwanDog Managing Principal Dave Swanson, is give back portfolio managers their stock picking powers. Following that, he calls upon fund companies to revisit risk management and make this a critical part of every customer communication.

Fund companies need to make a case for active management by demonstrating greater accountability through performance fees tied directly to results, he added.

(c) 2009 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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