ETFs Get Active

Waldron says that First Trust wants to capitalize on active management strategies to generate even better returns. The company is working with index providers that create strategy-based indices.

The company has eight ETFs on the market and expects to have 15 or more ETFs by the end of the year. "Anything going forward will be a next-generation ETF," Waldron says.

Other ETFs that use fundamentals to pick stocks include the family of funds from WisdomTree Investments that weight indices based on total cash dividends companies pay or their dividend yield. WisdomTree launched its first set of ETFs in June; last week the company filed to launch 10 more funds based on international sectors.

ETF giant PowerShares has a set of ETFs that are based on "intelligent indexes" that use 10 factors to determine whether a company fits into an index at any one time: projected and actual earnings, sales growth, cash-flow growth, book growth, P/E ratio, price-to-sales, price-to-cash flow, price-to-book and dividend yield. Stocks are then chosen based on fundamentals, valuations, timeliness and risk.

Management on the Horizon

Waldron believes that investors will take a wait-and-see approach to the new nearly managed indices to see if they do indeed generate alpha. In the meantime, Baker says there providers working to come up with an actively managed ETF that suits both investors and portfolio managers.

But disclosure issues have held up the process. The Securities & Exchange Commission requires an ETF to publish the net asset value of its holdings every 15 seconds so that the market can accurately track the NAV with relative accuracy throughout the trading day.

"The problem with an actively managed ETF is a concern that if you publish the NAV every 15 seconds, when the manager is changing a portfolio, smart people out there will be able to look at the NAV and see how it is changing and be able to reverse engineer what the manager is doing," says George Simon, an attorney with law firm Foley & Lardner. Simon represents firms in the securities industry and was formerly the associate director of the SEC's Market Regulation division.