For the past 18 years, it's been almost an article of faith that an exchange-traded fund would be the epitome of a passive investment.

Invest in the stocks that make up a particular market index. Rebalance the makeup of the portfolio when the index rebalances its own makeup.

That's changing, with the advent of actively managed exchange-traded funds, which aren't based on indices at all. And even passively managed ETFs, which don't rely on Standard & Poor's or Dow Jones or MSCI for their supply of indices.

"There still are rules," said Michael Riley, vice president and head of U.S. ETF Products for State Street Global Advisors. But "you have no index or benchmark per se that is licensed."

SSgA, of course, is the granddaddy of creators of exchange-traded funds. At the start of 1993, it launched Standard & Poor's Depositary Receipts, now known as the SPDR S&P 500. Each SPDR unit is valued at about 1/10 the value of the Standard & Poor's 500 Index. That index stood at 1,331.94 at close of trading July 26.

Getting that first ETF rolling was no easy task. State Street had to seek and be granted relief by the Securities and Exchange Commission from provisions of the Investment Company Act of 1940 that otherwise would have prohibited the formation of this form of investment fund.

Unlike mutual funds, individual investors do not sell or redeem their individual shares at the net asset value, or NAV, of what's in the fund. Instead, financial institutions purchase and redeem ETF shares in large blocks, varying in size from 25,000 to 200,000 shares, called "creation units." Individuals trade in secondary markets, in baskets of the underlying securities, generally through a broker.

Every creator of an exchange-traded fund has to first get relief from the SEC. And then, if you're creating a fund whose benchmark for performance is that of a particular index, you have to get the rights to replicate the index.

That means calling up Standard & Poor's, Dow Jones, MSCI, Russell Investments or other source of indexes and licensing the right to mimick it.

The mimickry might be achieved, Riley notes, by full replication or by sampling.

With full replication, the fund invests in a carefully weighted amount of every stock or asset that makes up the index. In sampling, the fund takes a subset, geared to still achieve the same performance as the full index.

The MSCI EAFE Index, for instance, includes thousands of stocks in 22 different equity indices in Europe, Australasia and the Far East. Fully replicating "that is capital intensive and quite a management undertaking," Riley said.

So the creator of an ETF based on the EAFE Index may just use 300 stocks, to mirror its performance. "There's no magic number," he said.

After all, in the case of an index fund, the performance of the index is what a portfolio manager has to match. The manager is trying to achieve "beta"-a market return for the investor in the fund.

But, nearly two decades later, fund creators want to go beyond beta to "alpha." That means trying to get above-market returns. Which in turn means actively managing what the fund holds and not directly tying the fund to an index.

There can be a link, but it's indirect. The promise may be that the fund will generate a return that is equal to 500 basis points-or 5%-more than the return produced by a particular blend of equities and fixed-income securities. Or 200 basis points better than the Standard & Poor's Index.

A manager doesn't have to rebalance the portfolio or follow the makeup of an index.

"You trade as you see fit to provide the alpha you're targeting," Riley said.

The objective becomes the benchmark, in this base. And if the manager fails to reach the objective, there's a measure of success to watch. Like the blend of stocks and bonds or the S&P 500.

"It's a barometer for shareholders. It's a barometer for the portfolio manager to be measured against," Riley said. "He needs some type of bogey."

In April, State Street filed a registration statement with the SEC, to create its first six actively-managed ETFs. Riley said he hopes they'll be out in the market with creation units by the end of the year.

Laurence D. Fink, chairman of State Street's chief rival in ETFs, also said in July that "BlackRock will be joining and building many active ETFs," even if it means losses in early stages of development.

But even passively managed funds don't have to call on an established developer of indices, such as MSCI or NYSE Euronext or Nasdaq OMX Group, to get benchmarks.

They can just create their own. Which is what IndexIQ, a Rye Brook, N.Y., fund manager with $700 million under management does.

"We're a little bit boring," said Adam Patti, its chief executive. "We actually talk to clients and try to figure out what they are looking for, what they are using and what the problems are with the products they currently have at their disposal."

This "ongoing process" of verbal market research led to the creation in July, for instance, of the IQ Emerging Markets Mid Cap ETF

This is IndexIQ's attempt to give institutional investors what Patti calls "diversification." That is to say, returns that do not correlate with the returns generated by U.S. stocks.

ETFs that base their holdings on large international stocks really end up betting on ... U.S. stocks, he said.

"The diversification really isn't there any more," he said. "The reason for that is when you buy an emerging market large-cap ETF, you get megacap multinationals" that are investing in the U.S. and Europe.

"They're exporters. They're plays on developed markets. When you looking under the hood, you get a developed market export play. You're not really getting emerging markets," he said.

To set up a mid-cap index, the fund follows clear rules. The bottom 15% of stocks in any given country's universe of stocks is ruled out, as small-cap stocks. The top 70% are ruled out, as large-cap.

And the result is holdings in 20 countries, in a wide range of industries. But they turned out to be heavier in consumer stocks, healthcare and industrials, Patti said, because of the focus on "mid cap" holdings. If large caps were included, there'd be heavier holdings in materials firms, energy companies and financial organizations.

IndexIQ has only 15 ETFs and one mutual fund. Its specialties are international funds and funds that replicate the strategies of hedge funds.

And they can be small. A Taiwan fund, for instance, has only $4.5 million in assets.

But that does not mean IndexIQ will deviate from the index it has created and the method of rebalancing that it has committed itself to.

"To us, active means a portfolio manager makes decision, " Patti said. "Nothing we do is active. Everything we do is index-based."

In active funds, "you have a portfolio manager who is picking stocks," he said. "We're not big believers in that."

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