Innovation is a constant in any industry, but sometimes in the fund business its mark is not always obvious.

Though exchange-traded funds are often spoken of as the driver of innovation in the fund industry, 2013 has also debuted original products in mutual fund wrappers. Specifically, from alternative asset managers such as hedge funds and private equity.

This year the number of ETF launches as well as closures is down from 2012. More careful consideration is being given to products before they launch," said Robert Goldsborough, fund analyst at Morningstar. "I think the number of launches going down is directly related to the maturity of the marketplace. That said I think there are a lot of interesting products still coming out if fewer in number," he added.

Goldsborough said some of the more innovative new ETF products are investing in European assets. He mentioned two double-leveraged products he found interesting: the Barclays ETN+ FI Enhanced Europe 50 ETN (FEEU) and Credit Suisse FI Enhanced Europe 50 ETN (FIEU).

The actively managed ETF arena is still in its nascent stages, he said. "The state of the actively managed ETF market is that we're still in the early innings. There's still a ways to go. There are some good existing products in several areas such as fixed-income and alternatives, but the market is hardly developed at all on the equity side. By that I mean, there are very few traditional stock managers handling actively managed ETFs."

Aside from product design there is the issue of active ETFs having compelling value propositions different from actively managed funds. "Certainly the bank loan ETFs do," said Goldsborough. He points to the SPDR Blackstone/GSO Senior Loan ETF (SRLN) and The First Trust Senior Loan Fund (FTSL) as examples.

Goldsborough said there are a few others that he sees as having attractive propositions such as Cambria Shareholder Yield ETF (SYLD), PIMCO Foreign Currency Strategy ETF (FORX), iShares Enhanced US Large-Cap (IELG) and iShares Enhanced US Small-Cap (IESM). "Those are some of the ones that we feel have the most compelling value propositions."

Conversely, Goldsborough said that the falling number of ETF closures could be a function of providers taking more time to nurture flagging products and also giving some a longer time horizon to achieve success. "I think there are fewer closures because providers are giving more time to products they think can gather assets or changing around the makeup of the products," he noted.

"There is a lot of innovation out there but, not a lot of volume behind it," said Bill Katz, a CitiGroup analyst covering asset managers, exchanges and brokers. "In a $3 trillion industry it is still on the margins," he stated.

Katz sees several areas where companies are becoming innovative. "I think there are some interesting products right now in emerging markets, some twists on private equity and some compelling fixed-income ETFs," he said. "Money markets are still to be determined. I think WisdomTree is the most innovative player in the ETF space right now."

The center of innovation has changed over the years according to Katz. "The progression of products has gone from asset allocation funds three or four years ago, to absolute return products and the growth of ETF movement to cheap beta," Katz said. "Now product innovation's wave is bringing alternatives to the common man," he added.

On the mutual fund front, some of the biggest news in the alternative space is hedge funds and private equity firms getting a slice of the '40 Act market.

"Firms such as Blackstone, Carlyle and KKR have had much success in turning alternatives into '40 Act funds," Katz said. "These products are catching on among investors."

One such fund is the Aurora Horizons Fund (AHFAX), launched by Natixis affiliate, Aurora Investment Management, in March of 2013, which is sub-advised by several other hedge fund managers.

According to Scott Schweighauser, president and portfolio manager at Aurora, the firm's parent, Natixis, had been asking for a product such as this and finally last August, the time was right.

"We have been in business for over 25 years. For a long time our parent company had been looking to take advantage of our expertise in hedge fund investing in a product designed for retail investors," he said. "Every year Natixis would come to us and say, 'How about now?' We would ping our managers and the response we would get back was it didn't fit their business strategy. Last August we pinged the managers on our approved list and we got a critical mass that said yes," he stated.

The product is beneficial for both parties, Schweighauser said. "This is a way for them to expand and diversify their business base and contemplate a world in which they themselves are looking to literally expand their horizons and expand their asset base. For us, we can tap into a vastly different type of investor as well as a huge pool of capital," he added.

Schweighauser points to conditions in the bond market as also bringing opportunity. "We are probably toward the tail end of a three-year bull market in bonds, so interest rates, if they go anywhere are going to go higher," he said. "That creates an issue for investors. What do they do with the bond portion of their portfolio? The flip side is higher interest rates are inherently good for hedge fund strategies," he added.

Making the fund scalable for hedge fund managers is an important component of launching these kinds of strategies, Schweighauser said. "It is important for mutual fund strategies to have good distribution. That is what Natixis brings to the table. For us to ignite the imagination of high-quality hedge fund managers, we need to be able to demonstrate our fund will be a very significant size. In a structure like this no one is getting paid an incentive fee, therefore for a hedge fund manager to say, 'This is worth my while,' we need to make it scalable for them. Having Natixis as the distribution arm is important. We think of them as the Ferrari in the garage we can now drive because we have a retail product. It's the marriage of two outstanding facets," he said.

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