YYY May Be Pricey

In more liquid waters, active mutual fund managers have posted the best relative performance with short-term duration funds. In the past 10 years through mid-June, some 28.15 percent of all such managed funds were beating their respective index fund rival. Although hardly anything to brag about, short-term bond fund managers nearly doubled the outperformance of the next-best group, intermediate-term bond funds.

It's not surprising then that the two active bond ETFs introduced have been short term in focus. YYY has portfolio characteristics landing it somewhere between a money market fund and a short-term bond fund. In some circles, it's being categorized as an ultra-short bond ETF.

The most YYY's weighted average maturity will extend to is one year. But its average should, over time, be closer to 180 days. The ETF, which follows no benchmark, has been publishing its top 10 holdings at the end of each business day on its Web site, and the full list of the underlying components is available from a variety of services in real time as well. And whereas a typical retail money market fund or enhanced cash mutual fund's expense ratio is around 0.65 percent, YYY's annual fee is expected to wind up at 0.35 percent, says Bear Stearns.

However, index-based ETFs are known for having lower expenses than mutual funds. For example, the iShares Lehman 1-3 Year Treasury Bond (NYSEArca: SHY) has an 0.15 percent annual expense ratio. The Vanguard Short-Term Bond ETF (AMEX: BSV) has an 0.11 percent expense ratio.

So from the start, YYY opened with a higher-costing fee structure than its passive ETF competition. Besides SHY and BSV, at least four other indexed short-term bond ETFs are available, the most expensive charging 0.20 percent per year.

"There's no reason to think that actively managed bond ETFs will be any more immune to cost pressures than open-end mutual funds," said Ptak. "If a manager hopes to add alpha, he's going to have to figure out a way to keep his cost structures low."

Vanguard To Enter Field

An interesting development might be the coming launch of a new ETF share class of the actively managed Vanguard Treasury Inflation Protected Securities Fund (VIPSX). VIPSX, of course, is an extremely low-turnover portfolio. That's generally the case with Vanguard's entire bond lineup. And the indexing pioneer has a history of coming out with second-share class versions as ETFs with even lower expenses than their mutual funds. In the case of VIPSX, that's 0.20 percent—exactly how much the passive iShares Lehman TIPS Bond ETF (NYSEArca: TIP) charges.

So how does Vanguard expect its active management plan to succeed? Although unwilling to discuss the ETF version of VIPSX until after it comes out, the company is able to provide some insight based on a tried-and-true strategy implemented fairly consistently throughout all of its actively managed bond mutual funds.

"We feel that our managers can add value across all asset classes when we break it down by several different factors," said Bob Auwaerter, head of fixed income portfolio management at Vanguard.

The first one is by managing a fund's overall duration. "There we're adjusting the interest-rate sensitivity of portfolios," he said. "An example of that is when we shortened durations in our funds from the periods when [ex-Fed Chairman Alan] Greenspan first started raising rates in 2003, to the day he retired. That was based on the belief that he'd taken rates down really low on the concern over deflation."

But Auwaerter added that: "We only shortened our funds as much as we could take them according to their specific guidelines."

Another way a bond fund manager at Vanguard is allowed to add value is by yield-curve positioning. The third way is to overweight and underweight sectors. One more way, of course, is through security selection which differs from the underlying benchmark. "But we only do this in a risk-controlled manner," Auwaerter said. "We're not going to bet the farm on a conviction. I may add to a position, but there are definite limits. I can't just keep adding to positions in the belief that I'm right and everyone else is wrong."

Each Vanguard manager has a predetermined, narrow set of bands he's allowed to shift using any of these four methodologies. "At the end of the day, I can't adjust durations on a long-term Treasury fund, for example, so that it's not acting like a long-term Treasury portfolio," Auwaerter explained.

That's certainly going to be a challenge for active ETFs. In a less-disciplined environment, will they allow managers to drastically alter a fund's makeup to appease short-term interests?

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