As mutual fund assets continue to decline and investors seek lower cost alternatives, fund companies are struggling to make management fees stretch even farther.

Indeed, in addition to cutting staff, already lean firms are considering automating or outsourcing various functions, merging smaller funds and eliminating some funds altogether.

As a result, advisors may have to find new mutual funds since some existing ones in which they have their clients invested are likely to be eliminated.

The problem for the funds is that they can't raise fees to cover rising costs because new funds put expense caps in place with the expectation that their fund will be small for a short period of time, says Paul Ellenbogen, director of board consulting services at Morningstar Associates. But those caps are staying put; even as assets flounder.

So even though investors have become keener on low-cost funds, they aren't seeing the fees fall. "No one is really happy," Ellenbogen says.

"Not so long ago, funds were launched with high initial fixed costs under the belief that market gains would continue to push forward," says Ellenbogen. "Those high, initial fixed costs have become a ball and chain, and expense caps have become a liability for advisors."

And in today's tough environment, those caps have created an especially difficult situation. "All fund groups have suffered substantial losses of assets under management, which has been reflected quickly in earnings," says Burt Greenwald, president of the Philadelphia-based consulting firm B.J. Greenwald & Associates. "Funds will obviously look at expenses as one area where they can exercise control. This is particularly true in publicly owned companies."

The majority of fees are asset-based, says Keith Brown, president of the Boston-based Beacon Consulting Group. Fixed costs are steady even when assets are declining, meaning that funds' operating costs are trending upward, he says.

Performance fees can also have a bizarre effect in down markets, Ellenbogen says. When a fund outperforms its benchmark, its fees typically go up, but investors get irritated when their fund loses 35% and their fees go up because the S&P 500 fell by 37%.

"It's pretty bad when almost half of funds aren't at the critical point for profitability," which Ellenbogen says is $100 million. "This is a big problem for at least half of all mutual funds."

One way funds try to lower costs is by reducing headcount. "There have been an awful lot of layoffs. People are such a big cost," Ellenbogen says.

Even the largest, most cost-effective funds are being forced to cut people, he says, noting that mutual fund titan American Funds recently announced it was shedding an additional 500 employees. But layoffs aren't always the most practical way to lower costs in this industry. "You won't hear firms saying, 'Now that we've laid off 25% of our staff, we're going to start lowering our advisory fees,'" Ellenbogen says. "Fund fees tend to be very sticky on the way down."

Still, Greenwald notes that the industry's initial staffing cutbacks last fall were followed by two to three more waves, along with hiring and salary freezes.

Until there is evidence of a real turnaround, there is very little that companies can do to influence inflows or the appreciation of markets, Greenwald says.

"Asset values have declined, yet advisors' primary expenses-people and technology-remain largely fixed, likely cutting into their profit margins," says Edward O'Brien, senior vice president of institutional wealth services at Fidelity Investments. "As a result, enhancing profitability through greater efficiencies has become critical. In times like these, with margins under substantial pressure, advisors need all the time they can get to work on profitably growing their practices."

Besides slashing staff members, firms can consider other cost-cutting alternatives, such as automating manual processes, putting more information on the Internet rather than through print-outs and mailings, and outsourcing work to low-cost, third-party administrators.

"In the current economic environment, mutual and collective fund companies face a greater need to reduce fund expenses while retaining customer business and satisfaction," says Pat Centanni, executive vice president and head of global product management at State Street Corp.

Fund companies also will seek concessions from their vendors and service providers, adds Brown, but whether they will get them remains to be seen.

Funds can replace manual or partially automated systems and outsource other administrative processes that are paperwork- intensive in order to provide more functionality, greater scale and better accuracy, Centanni says.