Fund managers face redundancies as upheaval caused by the financial crisis reveals poor returns, low skills and overpriced products that are driving clients away.

Europe's fund management industry had managed to avoid the cyclical redundancies that haunt banking sector workers because customers felt they had little choice but to pay for expensive products promising investment returns and retirement nest eggs.

Now fewer clients means less income from fees which combined with rising operating costs and stiff competition is starting to hurt margins and make industry layoffs inevitable.

All the business heads I talk to are keeping a very close eye on costs and.. say they are ready to roll out contingency plans. And I think that means more aggressive cutting, Arthur Barrington-Ward, a specialist headhunter at Hutton Consulting, said.

The proposed sale of Deutsche Asset Management has highlighted the pressure felt by many fund firms owned by banks beset by their own problems.

Boutique managers running less than 2 billion euros (1.7 billion pounds) in assets are also facing a battle for survival, the experts said, as funds under 300 million euros in size are now broadly seen as unprofitable and inefficient to run.

As a result, firms of all sizes are looking at their product lines with the aim of pooling funds -- moves that will likely spell redundancy for the managers running those products.

If you get a big fund that people feel has critical mass, you can market it more aggressively and it's a lot more likely to keep growing and survive a volatile market than a 30-40 million pound fund, Barrington-Ward said.

The cost of business has become increasingly expensive in recent years as property, technology and compliance expense has risen faster than the volume of net new client assets, and top executives have been forced to rein in spending to keep margins intact and shareholders on side.

With those expenses trimmed to the bone, staffing -- the biggest fixed cost for fund firms -- is next to be chopped.

For the last year...wealth managers have...steered clear of layoffs because there's continued hope the sales guys are going to pull the industry around, said Sebastian Dovey, co-founder of wealth management strategic think-tank Scorpio Partnership.

Managers are prioritising distribution (of their funds) but there's only so much you can trim. We reckon at the top 15-20 institutions, there's probably not much more they can cut.

Aviva Investors, the asset management unit of the British insurer, said it was currently conducting a business review.

As with many others in our industry, we have looked at our business to ensure that we are set up to face what is clearly going to be a prolonged period of economic uncertainty, a spokeswoman for Aviva said.

PATCHY RETURNS, POOR SKILLS

Punishing market conditions in recent years have resulted in patchy returns and have also exposed those fund managers with low skills and expensive products that do not compare well to low-cost, low-risk trackers accessible to all.

As a result asset managers are struggling to maintain the confidence of investors, many of whom have started to pull their cash out. This has slashed the fee revenues which provide the lion's share of fund manager wages.

The combined assets of the investment fund market in Europe fell by 5.4 percent in Q3 2011 to 7,667 billion euros compared with 8,142 billion at December 31 2010, the latest data from the European Fund and Asset Management Association (EFAMA) shows.

The biggest open question is why are industry net new assets flat when the proven asset growth numbers are increasing? Managers need to find out where these people are investing and why they are not using their services, Dovey added.

Insiders said the sector was facing 'a moment of truth' in which it needed to prove its value to clients who have become increasingly tempted to save the fees and invest by themselves.

There are some managers who have fantastic performance and great products which grow very quickly but...most of those fund firms saddled with hundreds of similar and often underperforming funds, will come under attack, Alan Miller, CIO of independent investment house SCM Private.

Unless we see a massive extended bull run, (these firms) are going to be in permanent decline, he said.

INDUSTRY REVAMP

Europe will not be able to avoid some rationalisation of its fund management industry in 2012 and beyond, said Jean-Baptiste de Franssu, former president of industry body EFAMA.

Whether that comes via sales or some kind of joint venture with another similar group, funds know they have to take action to raise operating margins, he said.

De Franssu resigned from his role as CEO at Invesco Europe last spring to set up his own company advising on likely mergers in what he described as a bloated asset management sector.

He predicted the creation of many more ventures like Amundi, the product of the merger of the fund units of French banks Credit Agricole and Societe Generale .

2011 was a rough year and nothing tells us today that things are going to get easier in 2012, he said.

Even those staff who hold onto their jobs in 2012 will need to become much more sensitive to the changing needs of clients to keep their earning potential high and stay in employment.

Managers now need to be as comfortable shorting stocks as picking long-term winners as demand for absolute return ramps up. They may also need to feel comfortable articulating strategy to clients using tools like Twitter, often on a daily basis.

Active managers should spend more time demonstrating what a fund is good at and what additional value they can deliver than defending their price points, because if they can do that people will pay the fees, said Ben Phillips, a partner at global management consultant Casey Quirk.

In Phillips' view, the new demands on funds mean they must reinvent themselves, or die. Managers must be able to justify the higher fees charged for sophisticated products and provide more value than low-cost tracking funds. Simply cutting costs won't work.

That's not so much a slippery slope, it is more a death spiral, he said.

(Editing by Sophie Walker)