Alittle-noticed boom has accompanied the rise of exchange-traded funds - a surge in indexes those ETFs track. There are now more than 1,000 ETFs in the U.S., with more created every month. But in the ETF market, new is what creates the buzz - there's not much demand for yet another ETF that tracks investing mainstays.

To create an index that can power a successful ETF, it seems the key is to identify a narrow area of the market that's not already covered. Big index companies like Dow Jones and S&P are always developing new benchmarks, but they also face competition from smaller operations, including S-Network Global Indexes, Accretive Asset Management, IndexIQ and 4asset-management. Sometimes the competition is a lone investor with an idea.

BIRTH OF AN INDEX

Consider Mike Keenan, a geologist by training who runs a California-based natural resources-oriented hedge fund. Keenan uses ETFs to take positions in his hedge fund. Several years ago, he noticed some gaps in the universe of portfolios available.

One area he wanted an ETF to cover was nuclear energy. Keenan approached several ETF companies but was rebuffed. In August 2007, Van Eck Global, a company Keenan had not pitched, brought Market Vectors Nuclear Energy ETF (NLR) public. Keenan phoned New York-based Van Eck to congratulate the company on the launch. He also mentioned that the world could use an ETF devoted to coal. Van Eck liked the idea and put Keenan in touch with S-Network. Market Vectors Coal ETF (KOL), launched in January 2008, now has more than $365 million in assets under management.

Joseph LaCorte, managing member of S-Network, says he gets lots of pitches for new indexes from individuals. Keenan's coal idea was worth developing, but many "are not ready for primetime."

Keenan's other idea for an index, also in partnership with S-Network, resulted in Market Vectors Gaming ETF (BJK). Although outside his area of expertise, the gaming index, an idea that Keenan says came to him in the shower, was also a narrowly focused industry slice.

Jim Wiandt, founder and CEO of IndexUniverse.com, a website devoted to index investing, says most narrowly focused ETFs are "telling stories" and seek to tap "some trend in the market that seems obvious and resonates with people." He cites ETFs tracking oil sands producers and smartphone companies as examples.

LASER FOCUS

The narrow focus can work for some portfolio managers. "I'm very tactical in nature," says Roy Blumberg, director of client portfolio management at the Philadelphia Group, a wealth management firm in King of Prussia, Pa.

Blumberg uses narrowly focused ETFs to do what he once did with individual stocks. Before the boom in custom index-based ETFs, he would have room in a portfolio for only a few names in a favored sector. Performance could suffer if he purchased the wrong companies in the right sector. But ETFs have changed the dynamic. "When you have a specific index, you can target extra weighting without the same stock-specific risk," Blumberg says.

LaCorte sees some of his indexes being used for strategic reasons, rather than just tactical. He notes that the company's Composite Closed-End Fund Index, available as the PowerShares CEF Income Composite Portfolio ETF (PCEF), has a good yield (reported at 9.02% as of early last month) and is the type of asset some investors might want to hold for the long term. He even sees alternative energy as a strategic play. "Sustainability is not going away," he says.

BACKLASH OVER EXPENSES

Many ETFs based on custom indexes with a narrow focus have hefty expense ratios compared with those charged on broad-based portfolios available from BlackRock's iShares, State Street's SPDRs, Schwab or Vanguard. That may make some advisors hesitate, even if they like the idea of using these ETFs. But Wiandt takes a slightly different view of costs. "The prices of very narrow ETFs match, often times, the prices of the broader traditional mutual funds," he notes.

And while narrowly focused ETFs can be popular, what's perceived as trendy doesn't sit well with some planners. "There are so many flavors out there now," says Donald Patrick, managing director of Integrated Financial Group in Atlanta. Patrick uses some alternative investment ETFs that are not highly correlated, but generally shuns those focusing on narrow slices of the market. "We're not trying to bet on sectors," he says.

Although being new will attract attention in indexing circles, that doesn't always translate into a winning ETF product. There have been some notable failures among custom index-based ETFs. A group of 15 funds called HealthShares, each focusing on a single medical category, launched in January 2007. By December of the following year, all had been shuttered. Evidently, the world wasn't ready to invest in stocks of companies selected by the disease they were targeting.