But not all ETFs offer bargain basement expense ratios. As the product offerings have become increasingly specialized and targeted in recent years, average fees have been on the rise. This trend isn’t necessarily attributable to issuer greed (the low end of the expense ratio range has expanded as well), but rather to increasing complexity and granularity of exposure available through ETFs. Replicating the S&P 500 is a relatively simple task, but tracking the performance of more complex strategies or far-flung markets often incurs additional costs. There are now a handful of ETFs that have seen expense ratios climb above the 1% mark, venturing into mutual fund territory. Below, we highlight five ETFs that charge an expense ratio of at least 1.0%.

5. Market Vectors Gulf States Index ETF (MES): Expense Ratio = 1.0%

This ETF tracks the Dow Jones GCC Titans 40 Index, a modified cap-weighted index that tracks the performance of equity markets in the Gulf States. With major allocations to Kuwait (41%), the UAE (27%), and Qatar (22%), this fund offers exposure to a basket of securities most investors would have difficulty accessing otherwise.

4. IndexIQ Hedge Macro Tracker ETF (MCRO): Expense Ratio = 1.10%*

MCRO is designed to replicate the performance of the IQ Hedge Macro Index, a benchmark that replicates the risk-adjusted return characteristics of a combination of hedge funds pursuing a macro strategy and hedge funds pursuing an emerging markets strategy.

Like other hedge fund replication ETFs from IndexIQ, MCRO is an “ETF of ETFs,” meaning that its underlying holdings are not stocks and bonds but rather other ETFs. While this strategy is an efficient way to pursue complex strategies that include exposure to multiple asset classes, it also has the potential to increase expenses by creating multiple levels of costs. MCRO charges an expense ratio of 75 basis points, but the acquired fund fees and expenses from MCRO’s underlying holdings add another 35 basis points, resulting in an effective expense ratio of 1.10%. A big reason for MCRO’s sizeable acquired funds expense is the 20% allocation to EEM, which charges 72 basis points.

3. S&P GSCI Enhanced Commodity Total Return ETN (GSC): Expense Ratio = 1.25%

Exchange-traded commodity products tend to be on the expensive side, but this product from Goldman Sachs is expensive even for natural resource exposure. GSC is linked to the S&P GSCI Enhanced Commodity Total Return Strategy Index, a benchmark that serves as a composite of commodity sector returns representing an unleveraged, long-only investment in a diversified basket of commodity futures. This ETN charges 1.25% in expenses, significantly higher than other diversified commodity products. DJCI, for example, charges an expense ratio of just 0.50%.

2. Dent Tactical ETF (DENT): Expense Ratio = 1.56%

This ETF from AdvisorShares is one of the early entrants in the active ETF race. DENT doesn’t track the performance of any benchmark, rather it seeks to deliver long-term growth of capital by identifying, through proprietary economic and demographic analysis, the overall trend of the U.S. and global economies and how consumer spending patterns may change.

Similar to MCRO, DENT is an ETF of ETFs, currently maintaining ten approximately equal positions in sector-specific and broad-based funds from various ETF issuers. DENT charges a management fee of 95 basis points, but 44 basis points in additional fees and another 17 in acquired fund expenses brings the total cost to 1.56%.

1. PowerShares CEF Income Composite Portfolio (PCEF): Expense Ratio = 1.81%*

This ETF is based on the S-Network Composite Closed-End Fund Index, which tracks the performance of closed-end funds that invest in investment grade fixed income securities and high yield fixed income securities, as well as those that utilize an equity option writing strategy. PCEF charges an expense ratio of just 50 basis points, but acquired fund fees and expenses of 1.31% results in an “all-in” expense ratio of 1.81%.

This expense ratio hasn’t deterred many investors; PCEF has accumulated nearly $40 million in assets less than a month after its launch.

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Disclosure: No positions at time of writing.

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A look beyond the handful of mega-tickers that account for the majority of assets often reveals some interesting trends. Buried in the February release (in line number 699 to be exact) were some interesting stats that may signal an exciting new era for actively-managed ETFs. One of the handful of active ETFs available to U.S. investors saw assets surge last month, and has been enjoying a jump in trading volumes ever since. The PowerShares Active AlphaQ Fund (PQY) saw cash inflows of $14 million in February, increasing total assets under management by more than 400% from the previous month.

Inside PQY

PQY was launched in April 2008, one of the “first generation” of active ETFs introduced by PowerShares (along with PQZ, PMA, PLK, and PSR, this ETF makes portfolio decisions based on proprietary quantitative models, but doesn’t allow manager discretion in selecting individual stocks). For nearly two years, PQY has struggled to gain traction, a symptom afflicting other active ETFs as well (at the end of January, the five active PowerShares ETFs had just $30 million in assets).

PQY’s methodology is a standard quantitative approach; the fund rates U.S.-traded stocks of companies with market capitalizations of $400 million or more on a weekly basis. The fund’s sub-adviser then generates a “master stock list” that ranks these stocks, segmented by market cap, based on its proprietary stock-ranking methodology. Stocks are selected based on factors such as strong earnings growth, low valuations and positive money flow. From a universe defined as the 100 largest Nasdaq-listed securities, fund managers select and purchase approximately 50 stocks.

PQY’s performance hasn’t been overly impressive. The fund’s fact sheet describes PQY as an “actively-managed ETF that seeks to outperform the benchmark NASDAQ-100 Index.” Since May 2008, PQY’s cumulative return has lagged QQQQ, a passively-managed ETF linked to the NASDAQ-100, by about 800 basis points. Since the calendar turned to 2010, however, PQY has been on a tear, outpacing QQQQ by about 120 basis points.

Of PQY’s 50 holdings, about 38 are also found in QQQQ, although the individual weightings often vary significantly. GOOG, for example, accounts for about 4.7% of QQQQ but just 1.7% of PQY. Apple, which is QQQQ’s largest holding at nearly 16% of assets, isn’t included in PQY. This absence makes PQY’s 2010 performance even more impressive, as AAPL is up nearly 6% on the year.

Momentum Building?

PQY’s success has seemingly continued into March; according to the fund web site assets are now just south of $21 million. Daily trading volumes now regularly top 10,000; prior to February the median daily volume since inception was just 800 shares.

But any declaration of an active asset boom may be premature; of the nine other equity ETFs tagged as “active” in our ETF screener, only PQY saw cash inflows in February. Active ETFs have been hailed as a gamechanger in the investing arena, but momentum has been slow to materialize. In addition to the five ETFs offered by PowerShares, Grail Advisors maintains a line of actively-managed stock and bond ETFs.

Last year, bond fund giant PIMCO launched its first actively-managed funds, and has subsequently added two more (PIMCO also offers five bond index funds). PIMCO’s entrance into the space gave active bond ETFs a boost (MINT now has more than $170 million in assets), but investors have so far been hesitant to make the switch to active equity funds. Among the obstacles these funds face are limited track records, lingering concerns about the impact of ETF disclosure requirements, and relatively lofty expense ratios.

PQY’s recent surge doesn’t mean that active ETFs have arrived or that a bursting of the floodgates is imminent. But it does clearly show that there investors out there who believe a marriage of active management and the ETF structure can be very valuable. Coming months will tell whether the momentum is sustainable.

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Disclaimer: No positions at time of writing.

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• PIMCO 0-3 Year Banking Sector Corporate Bond Index Fund: This ETF would be based on an index consisting of investment grade corporate debt securities issued by banking institutions with remaining maturities less than three years. Vanguard currently offers an ETF focusing on short-term corporate bonds (VCSH), but funds targeting debt issues from a specific sector would be an industry first.

• PIMCO 1-5 Year High Yield Corporate Bond Index Fund: This proposed fund would seek to track an index comprised of below investment grade corporate debt (based on the average rating from S&P Moody’s, and Fitch) with at least one year and less than five years remaining until maturity. This fund would also represent a new level of granularity in the fixed income space; holdings of existing junk bond ETFs are spread across the maturity spectrum.

• PIMCO Emerging Markets Aggregate U.S.$ Denominated Bond Index Fund: This ETF would be linked to the BofA Merrill Lynch US Emerging Markets Sovereign & Credit Plus Index, a benchmark comprised of U.S. dollar denominated emerging market and crossover sovereign, quasi-government and corporate debt securities with at least one year remaining term to final maturity. Currently, the iShares JP Morgan Emerging Markets Bond Fund (EMB) and PowerShares Emerging Markets Sovereign Debt Portfolio (PCY) offer exposure to debt issued by governments of the developing world.

• PIMCO High Yield Corporate Bond Index Fund: This fund would track an index consisting of corporate debt securities rated below investment grade (again, based on the average rating of the “big three” ratings agencies) with at least one year remaining until maturity. A high yield bond fund from PIMCO would compete with existing products from State Street (JNK), iShares (HYG), and PowerShares (PHB).

• PIMCO Investment Grade Corporate Bond Index Fund: PIMCO also filed for approval on an ETF that would be linked to the BofA Merrill Lynch U.S. Corporate Index. This benchmark consists of debt securities with an investment grade rating and an investment grade rated country of risk. The iBoxx Investment Grade Corporate Bond Fund (LQD) is currently the most dominant fund in this space, maintaining more than $12 billion in assets.

• PIMCO Build America Bond Strategy Fund: Finally, PIMCO filed for an actively-managed fund focusing on taxable municipal debt securities issued under the Build America Bond program, which was was created as part of the American Recovery and Reinvestment Act of 2009. Under this program, the federal government essentially subsidizes 35% of the interest payments made by municipalities on taxable bonds. For example, if debt was issued with a 10% interest rate, Washington would cover 3.5% of that, thereby reducing financing costs for cash-strapped state and local governments. The Build America Bond program has been somewhat controversial, but very popular with investors (and for good reason as Matt Hougan recently pointed out). PowerShares launched it Build America Bond Portfolio in November, and assets have already grown to more than $180 million in assets.

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Disclosure: No positions at time of writing.

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“Legg Mason’s plan to get into the rapidly expanding ETF industry comes on the heels of a year that saw several fund industry giants toss their hats into the ETF ring,” writes John Gabriel for Morningstar. “After dragging their feet for several years, many fund companies are now embracing the opportunity to capture a slice of one of the most popular and fastest-growing segments of the asset-management industry.” Legg joins T. Rowe Price, PIMCO, and Goldman Sachs as major players in the financial services industry gearing up for a run at actively-managed funds.

Slow Start, Huge Potential

The first actively-managed ETF was launched in March 2008 by a most unlikely issuer: Bear Stearns debuted the Current Yield ETF (YYY) just before collapsing. JP Morgan kept YYY around for a while, but ultimately pulled the plug. The next pioneer PowerShares, which launched four active ETFs in April 2008 and another in November of that year. In May of 2009, Grail Advisors entered a new frontier of the actively-managed ETF space by launching the American Beacon Large Cap Value ETF (GVT). Unlike the PowerShares active products, which rely primarily on quantitative analysis, GVT allows manager discretion in the selection of its underlying holdings, making it the first true active ETF in the eyes of many investors. Grail has since expanded its product line to seven funds, including two bond and five equity ETFs.

When Grail launched GVT, many industry analysts (ETF Database included) anticipated an opening of the floodgates. But the surge in active ETFs is yet to materialize, as the active ETF space remains a relatively small community. In addition to the funds from PowerShares and Grail, AdvisorShares offers the Dent Tactical ETF (DENT) and PIMCO has launched three active bond funds (MINT, SMMU, and MUNI). WisdomTree also maintains a line of actively-managed currency products. In total, only about 3% of the ETFs in the ETF screener are active, and these funds account for a much smaller percentage of total ETF assets.

Despite the relatively slow start, there are plenty of reasons to believe that actively-managed ETFs will see a surge in use in coming years. It’s important to remember that the first passively-managed ETF was launched in 1993, and the industry didn’t enter its “golden age” until more than a decade later. Mutual funds aren’t going to give up ground to ETFs without a fight. But the attractive aspects of passive ETFs–lower costs and potential for enhanced tax efficiency–are still very applicable and achievable in an active setting. Moreover, the “disclosure dilemma” that many advisors worried would be an insurmountable obstacle has been proven to be a non-issue, a fact that should increase the comfort level of advisors when using active ETF products.

The entrance of firms like T. Rowe and Legg into the space would likely provide a nice boost, just as PIMCO’s foray into the space did for active bond ETFs. But the real gamechanger may come from an issuer already very active in the space: Grail is reportedly near a deal to convert an established mutual fund to an actively-managed ETF. If such an arrangement proves to be successful, the active ETF space could potentially skip through the growing pains endured by other areas of the ETF market, and assets could surge overnight.

Stay tuned – the corner of the ETF industry could become very active very quickly.

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Disclosure: No positions at time of writing.

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SMMU is benchmarked against the Barclays Capital 1-3 Year Municipal Bond Index, and will compete most directly against the iShares S&P Short-Term National Muni Bond Index Fund (SUB), the SPDR Barclays Short Term Municipal Bond ETF (SHM), and Market Vectors Short Municipal Index ETF (SMB).

PIMCO’s current active bond ETF offering include the Enhanced Short Maturity Strategy Fund (MINT) and Intermediate Municipal Bond Strategy Fund (MUNI), which were launched in November and December of last year, respectively. The market’s reaction to actively-managed ETFs has been largely disappointing, as most funds have failed to gather more than $10 million in assets. But PIMCO’s bond funds have been an exception – at the end of 2009 MINT and MUNI had assets under management of $45 million and $36 million, respectively. By comparison, the five actively-managed ETFs from PowerShares had accumulated just under $30 million at the end of the year, while Grail Advisors, which launched GVT amidst great pomp and circumstance last year, has only $15 million in five funds (Grail launched two more active bond ETFs last month, bringing the total number of funds to seven).

Behind PIMCO’s Actively-Managed Success

The reasons for PIMCO’s success in the actively-managed ETF arena are threefold. The first relates to the efficiency of bond markets. Countless studies have proven that efficient market theory holds in equity markets, and that active management adds no value to stock portfolios (and may actually destroy value). But bond markets are another matter. Because many fixed income investments are thinly-traded, many investors believe that active management offers greater potential for excess returns.

Moreover, many fixed income ETFs are effectively active because the fixed income indexes on which they are based simply aren’t built for the replication strategy utilized by ETFs. The Barclays Capital U.S. Aggregate Bond Index, which underlies AGG, has more than 8,000 components. But AGG has fewer than 300 holdings, using a sampling technique to construct a portfolio with similar credit quality, yield, and duration as the benchmark. Sounds like active management to me.

The second reason is an issue of costs. The expense ratios charged by PIMCO’s three bond funds (0.35%)  more closely resemble those of traditional actively-managed bond ETFs than most active products that have hit the market. The Dent Tactical ETF (DENT) holds the honor for the highest ETF expense ratio at a whopping 1.57%, higher than many mutual funds and almost 20 times the costs of Schwab’s low-cost funds at the other end of the spectrum. GVT charges 0.79%, while PowerShares active equity funds charge as much as 0.75%. PIMCO’s bond ETFs are more expensive than their passively-indexed competitors (BND, for example, charges just 14 basis points), but the gap is significantly smaller than in equity markets.

But the cost efficiencies are just one of the attractions. While cheap, PIMCO’s ETFs aren’t any more attractive from a cost perspective than other actively-managed bond ETFs. The new funds from Grail both charge 0.35% as well, and PowerShares’ PLK charges just 0.30%. The third and perhaps most important reason for PIMCO’s success in the bond ETF arena is the company’s long and impressive track record in bond management. PIMCO is the largest bond fund manager in the world, and has a reputation for consistently delivering solid returns to investors. Co-founder Bill Gross is widely regarded as the world’s most prominent bond investor, and his market commentaries are devoured by investors.

The PIMCO brand carries some weight with investors, as evidenced by the mostly successful entrance into the ETF arena.

More In The Pipeline

PIMCO has filed for two more active bond ETFs that should make it to market in coming months, including the Government Limited Maturity Strategy (GOVY) and Prime Limited Maturity Strategy (PPRM). Both of these funds, along with SMMU, were among the Seven Most Anticipated New ETFs of 2010. PIMCO also offers five passively-indexed bond funds, all of which invest primarily in U.S. Treasuries.

The ETF industry expanded at a near record pace in January, with almost two dozen new funds launching in the first month of 2010 (see the complete list). More than 120 new products hit the market in 2009, and expansion this year is expected to exceed that total.

Disclosure: No positions at time of writing.

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T. Rowe Price is the latest in a now long line of mutual fund giants to jump over to the ETF industry. Vanguard was one of the earliest entrants into the space, and has become one of the most successful ETF issuers. The firm founded by Jack Bogle saw cash inflows of almost $5.5 billion in November, the most of any ETF issuer for the month. PIMCO and Charles Schwab have also made successful transitions into the ETF space: PIMCO now has nine fixed income ETFs (including two actively-managed funds) that have collected nearly $500 million in aggregate assets, while Schwab’s four low-cost funds have racked up more than $150 million in just over a month of trading. And just this week, Old Mutual made its entrance to the ETF industry, launching the first “zero cost, zero fee” ETF.

T. Rowe’s filing indicated that the firm plans to “utilize active investment management strategies.” It goes on to state that the objective of the initial ETF will be “to achieve positive total returns with an emphasis on income…by applying a proprietary sector and security selection methodology.” The methodologies used in these active funds would include over/underweighting sectors and subsectors and adjusting average maturities and durations in fixed income funds.

Actively Managed ETFs: Too Early To Tell

Many in the ETF industry have been predicting the rise of actively-managed ETFs as the “next big thing.” But so far, these products have been slow to gain traction among investors. Despite some impressive results (PSR has outperformed its benchmark by a wide margin), the five actively-managed ETFs launched by PowerShares in 2008 have only about $30 million in assets. Actively-managed ETFs from Grail (GVT) and Dent (DENT) have also been slow to bring in cash.

Many in the industry see the a tough battle ahead of actively-managed ETFs, due to a number of factors. “The problem…is that actively managed mutual funds are sold on either commission-based sales loads or on track record,” writes Matt Hougan. “ETFs have neither.”

But others think that these “structural impediments” are relatively easy to overcome. “Big-Active is already…relying on track record, brand and fingers-crossed wholesaling to the financial adviser community, without the quid pro quo of 1980s-era commissions and trips to Hawaii,” writes Hougan’s colleague Dave Nadig. “There’s really nothing in the way of them extending the model into the ETF world.”

The jury is out on still actively-managed ETFs, and T.Rowe seems to be gearing up to make a big push into the space. Stay tuned to see how this one turns out and sign up for our free ETF newsletter to stay up to date on all developments in the ETF industry).

Disclosure: No positions at time of writing.

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The new PIMCO ETF will be managed by Jerome Schneider, deputy head of the company’s money market desk. “Investors are holding a lot of cash, and are compelled to look for something beyond the near-zero yields that money market funds offer,” said Schneider. “MINT aims to maximize investors’ current income by accessing PIMCO’s discipline, risk management and market expertise within a highly liquid and transparent ETF.” MINT will be managed in the mold of  countless other PIMCO bond funds, relying on both a top-down analysis of financial, political, and social trends as well as a bottom-up credit analysis.

With the federal funds rate close to zero (and expected to remain there for the foreseeable future), holding cash in money market strategies has yielded less than enhanced cash investment strategies, opening the door for a fund to both preserve capital and attempt to deliver more attractive returns on cash investments. According to its fact sheet, MINT will be benchmarked to the Citigroup 3-Month Treasury Bill Index, an unmanaged index representing monthly return equivalents of yield averages of the last 3 month Treasury Bill issues.

Growing Space

MINT is the first actively-managed bond ETF from PIMCO, but it hits the market more than 18 months after PowerShares broke ground in the space with its Active Low Duration Fund (PLK). PLK is benchmarked against the Barclays Capital 1-3 Year U.S. Treasury Index, meaning that these two funds likely won’t compete directly.

WindomTree’s U.S. Short-Term Government Income Fund (USY) is another actively-managed bond ETF investing in very short term, high quality debt securities. USY is benchmarked against the Merrill Lynch 0-1 Year Treasury Index, and at the end of the third quarter had an average of 178 days to maturity. MINT will be just slightly more expensive than both PLK (30 basis points) and USY (25 basis points).

Existing actively-managed bond ETFs have been slow to gain traction, holding less than $25 million in aggregate assets as of October. But PIMCO’s arrival could give all of these funds greater visibility among investors, particularly if they continue to achieve success relative to their respective benchmarks.

To stay up to date on all the developments in the actively-managed ETF space, sign up for our free ETF newsletter.

Disclosure: No positions at time of writing.

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Blurring The Lines

DENT isn’t the first actively-managed ETF – PowerShares introduced four active funds in April 2008 and Grail followed suit in May of this year – but it is unique in several ways. The PowerShares and Grail active funds focus primarily of selecting individual stocks (and bonds and REITs, in the case of PLK and PSR, respectively), while DENT is an “ETF of ETFs,” investing in other exchange-traded funds across various asset classes to execute a tactical strategy.

DENT’s current allocation shows that its managers are not too bullish on the prospects for U.S. equity markets, at least not relative to the rest of the world. DENT’s only U.S. equity exposure is to the technology sector and the Dow Jones Industrial Average. The fund’s holdings as of November 10 included:

Slow Start

Unlike most (but not all) U.S.-listed ETFs, DENT has the flexibility to invest in a number of asset classes, including fixed income and domestic and international equities. Harry Dent, one of the fund’s two managers, is the developer of the Dent Method, an economic forecasting approach based on changes in demographic trends. In 1992, Dent published The Great Boom Ahead, accurately predicting the unexpected bull market of the 1990s. But Dent has had his share of misses as well: in 2006 he predicted the Dow hitting 40,000 by the end of the decade.

The goal of DENT is long term growth of capital, so it is perhaps unfair to evaluate the fund’s performance after only two months. But the ETF has gotten off to a slow start, trailing behind the broad-based iShares Russell 3000 Index Fund (IWV) as well as the iShares Aggregate Bond Fund (AGG) since its inception:

Disclosure: No positions at time of writing.

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Similar to traditional actively-managed bond funds, the proposed ETFs would allow portfolio managers unrestricted trading, but with the benefits of the exchange-traded structure. “Our stated goal has been to bring a full lineup of traditional, active fund managers and strategies to the ETF marketplace,” said William M. Thomas, CEO of Grail Advisors LLC, in a press release. “These new fixed-income ETFs, both very important additions to our actively-managed list.”

Invesco PowerShares launched the first actively-managed bond ETF, the PowerShares Active Low Duration Fund (PLK) in April 2008. PLK, which seeks to generate alpha over the Barclays Capital 1-3 Year U.S. Treasury Index, has year-to-date returns of 0.8%, while the passively-indexed iShares Barclays 1-3 Year Treasury Bond Fund (SHY) has lost about 0.8% on the year. Despite this stellar performance, the actively-managed bond ETF concept has been slow to catch on among investors. According to data from the National Stock Exchange, PLK had total assets of only about $6 million as of September 30.

Floodgates Opening?

Ever since PowerShares introduced its line of actively-managed ETFs in 2008, this “hybrid” product has been widely expected to gain significant traction among investors. Passively-indexed ETFs have attracted hundreds of billions of dollars in assets from investors disillusioned with expensive active management that fails to consistently generate excess returns. But for investors who believe in the return enhancement possibilities of active management, the ETF structure can still offer material benefits, including reduced expenses and increased tax efficiency.

Since PowerShares pioneered the actively-managed ETF in 2008, the space has been relatively slow to develop. But in recent weeks, it’s shown signs of life. Besides Grail’s four new ETFs, AdvisorShares made its entry into the ETF industry with the launch of the Dent Tactical ETF (DENT), a product that relies on a team of managers trends in U.S. and global economies through demographic analysis and anticipated changes in consumer spending patterns.

Several other issuers are expected to launch actively-managed ETFs in the coming months as the lines between traditional mutual funds and exchange-traded funds continues to blur. Pimco has filed for actively-managed municipal bond ETFs, while earlier this year iShares filed for approval on two actively-managed ETFs, including one bond and one equity fund. To stay up to date on all the developments in this exciting corner of the ETF industry, sign up for our free ETF newsletter.

Disclosure: No positions at time of writing.

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Most ETF assets are invested in passively-indexed funds that seek to match, not beat, the performance of well known domestic and international benchmarks across various asset classes. ETFs initially became popular among investors because they offered a stark contrast to traditional actively-managed mutual funds, eschewing costly searches for excess returns in favor inexpensive “index tracking.”

But in recent years, the lines between ETFs and mutual funds have been blurred. A handful of Chicagoland ETF issuers, Invesco PowerShares, Claymore, and First Trust, have developed dozens of exchange-traded products that track “intelligent” or “enhanced” indexes, benchmarks that implement quantitative analysis and screening methodologies to determine their holdings. The Claymore Raymond James SB-1 Equity ETF (RYJ), for example, tracks an index composed of stocks rated “strong buy 1″ by Raymond James & Associates.

In April 2008, PowerShares pioneered the actively-managed ETF space, introducing a line of four ETFs that don’t seek to replicate the performance of a specified index, but rather to outperform a benchmark. The performance of these ETFs is measured against indexes including the Nasdaq 100, S&P 500, and the Russell Top 200. PowerShares added a fifth actively-managed ETF (PSR) in late 2008 that invests in REITs. These actively-managed ETFs were initially bound by limitations on trading frequency and timing, but such restrictions have since been lifted.

GVT was the first ETF to allow its managers discretion in determining ETF holdings, freeing itself from compliance with rules-based methodologies (although quantitative analysis likely continues to be a major part of the stock selection process).

Threat To Mutual Funds?

Actively-managed ETFs remain relatively small in number and assets under management. Yet they pose a formidable challenge to mutual funds that have dominated the investment landscape for decades. “While ETFs already have claimed a substantial chunk of index-tracking assets, their foray into active management strikes at the more profitable core of the mutual-fund business,” writes Eleanor Laise.

The new Grail ETFs will have an expense ratio of 0.89%, well above the fees for both traditional passively-indexed ETFs (which can go as low as 0.09%) and funds that use quantitative analysis to determine holdings. But most actively-managed ETFs are still far cheaper than comparable mutual funds, which can charge expenses well above 1%.

Disclosure: No positions at time of writing.

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