By now, many investors are familiar with the index approach to exchange-traded funds, in which a single security seeks to capture the diversity of a broader swath of stocks. Most of these funds work by pegging their holdings to a particular index, but, a growing number are of ETFs are actively managed by an investing professional.

In about two years, the number of actively managed ETFs has grown rapidly from the five launched in spring of 2008. There were 25 active ETFs at the end of May, with a total of $2.37 billion in assets, according to Strategic Insight, an industry research firm. The largest was the PIMCO Enhanced Short Maturity Strategy Fund with $774 million in assets, most of which were added during the first five months of the year.

More actively managed ETFs are on the way. A June 17 filing with the Securities and Exchange Commission indicates BlackRock iShares is preparing to launch two new entrants, the iShares Active Equity Fund and iShares Active Fixed Income Fund. The equity fund will invest at least 80% of its assets in the largest 1,000 stocks trading on domestic exchanges and the fixed income fund which will rely on quantitative models will invest mainly in investment grade securities.

In March, JPMorgan Chase filed regulatory documents with the SEC to launch passively and actively managed ETFs. Some say the move signals a potential surge in these offerings as larger, well-known financial institutions seek a piece of the business.

Because they cost less to own and may provide better tax benefits, ETFs active and passively managed are often touted as the next big thing for individual investors, and even in this early stage of the industry's development, that's a reasonable concern for the mutual fund industry, says Patrick Watson, a portfolio manager with Capital Cities Asset Management in Austin, Texas.

Actively managed ETFs in particular could be poised for big growth, says David O'Leary, portfolio manager of the Invesco PowerShares Active Alpha Multi-Cap fund (PQZ) and the PowerShares Active Alpha Q fund (PQY). "If you look at first push into the ETF business, it went from zero to about $750 billion in index ETFs over 17 years," he says, adding that there could be between 50 to 100 actively managed funds within a year.

The industry is less certain about the audience for the products. The Financial Research Corporation, an industry research group, does not anticipate there will be a flood of actively managed ETFs hitting the market, says Amy Strong, a research analyst with the FRC. Many of the actively managed funds on the market are currency and fixed income funds and the firm says it anticipates most future launches will likely fall into those categories.
Regardless of how quickly the actively managed ETF universe expands, investors should be aware that these products are still new and pose some questions. Here are three to ask when sizing up actively managed ETFs:

1. What should investors look for when sizing up an active ETF manager?

Because the industry is so new, ETF managers don t have long track records in the industry. However, reviewing a fund manager s record at another investment vehicle like a mutual fund could be informative.

The same solid research that good mutual fund managers perform should translate into similarly solid results, says O'Leary, whose employer, AER Advisors of North Hampton, N.H., did institutional research before launching their ETFs and going into business with Invesco PowerShares. "The screening process [for stock picking within an ETF] really isn't any different [than stock picking in a mutual fund]," he says.

2. What about trading costs?

One key to tamping down trading costs on a fund is making sure there s enough investor interest to generate volume. One challenge right now is that longtime mutual fund investors haven't got much incentive to switch to actively managed ETFs, Watson says. "If I like a particular manager and he's run a mutual fund well for 10 years, and an ETF comes out and is managed by him, is there really any reason for me to buy this new ETF? It's an unproven structure and has different constraints than the mutual fund I already have," he says.

Still, investors have demonstrated an interest and dedication to these new investment vehicles, according to National Stock Exchange data. The first five PowerShares funds alone tripled their assets under management from 2008 to 2010, growing to $44.9 million.

"Getting to critical mass happens eventually," says Watson, who adds that ETFs can offer some tax benefits that mutual funds cannot. He also says that the trading commission costs of ETFs are dropping because online brokerage transaction fees are plunging. "Trading commissions, from an investor point of view, are on a downward slope, so if you're long-term oriented, that becomes negligible."

3. How active is active?

Because active ETF managers can trade throughout the day, there's more room to be flexible in a fund's holdings. Of course, that can be good or bad in a turbulent market.

Just as with mutual funds, the number of changes ETF managers make to their portfolios can vary. O'Leary said his Multi-Cap fund had about a 90% turnover its first year, and about 150% last year, a particularly turbulent period for stocks. Because fund managers are required to post their holdings continually, investors concerned with the minutiae of their funds can track changes in near real time, or at the very least, on a daily basis. "For people who are interested in what the manager is doing, you get much more transparency with an ETF," O'Leary says.

On the other hand, investors who would rather pay less attention to those changes could suddenly find themselves holding a portfolio quite different from the one they bought.

Correction: An earlier version of this article overstated the assets under management of the first fives PowerShares funds. They manage $44.9 million in assets, not $44.9 billion. Separately, the article supplied an incorrect location for the National Stock Exchange. It is headquartered in Jersey City, N.J., not Chicago.