Nov. 3 (Bloomberg) -- Vanguard Group Inc., the largest U.S. manager of stock and bond mutual funds, is gaining market share in exchange-traded funds, a business its founder John Bogle has criticized for encouraging speculation.

Vanguard, the third-largest sponsor of ETFs, captured more than 30 percent of the money flowing into the business this year by charging an average fee of 15 cents for every $100 in assets, compared with 54 cents for the industry, according to Morningstar Inc. The Valley Forge, Pennsylvania-based firm’s ETF sales trailed only Barclays Global Investors, based on data through the third quarter.

“If the price is low enough, investors will vote with their wallets,” Scott Burns, director of ETF analysis at Chicago-based Morningstar, said in a telephone interview.

Vanguard started selling ETFs in 2001, later than its larger rivals. The firm is competing for customers who want to capture the returns of markets or industries, rather than individual stocks. ETFs caught on more than a decade ago with institutional investors such as hedge funds, and are gaining popularity with brokers and advisers who manage money for individuals.

“Interest among those groups is phenomenal,” said Martha Papariello, principal with Vanguard Financial Advisor Services.

Vanguard has $77 billion in ETFs, after inflows of $17.8 billion this year. The firm’s share of the market rose to 11 percent from 8.5 percent as of Dec. 31, according to Boston- based State Street Corp., which sells the funds and tracks the business.

Industry Growth

IShares, owned by London-based Barclays Plc, is the market leader with $346 billion. It attracted $25 billion in 2009 Morningstar data show. State Street, second in ETF assets with $163 billion, had outflows of $25.8 billion.

ETFs typically mimic indexes, while trading throughout the day like stocks. U.S. ETF assets increased 30 percent this year to $695 billion, according to State Street. Mutual-fund assets grew 13 percent to $10.8 trillion, according to the Investment Company Institute, a Washington-based trade group.

State Street created the first fund in 1993. Barclays, which entered the business in 1996, agreed in June to sell the Barclays Global Investors unit to New York-based Blackrock Inc. for $14.2 billion.

Vanguard got into the business in this decade as brokers moved away from a model in which they were paid commissions for selling products to one in which they charge a flat fee for managing money, said John Woerth, a Vanguard spokesman. There was no incentive under the old model for advisers to use Vanguard products “because we don’t pay for distribution,” he said.

Vanguard Funds

Vanguard is best known for its index mutual funds. Its first, the Vanguard 500 Index Fund, was started by Bogle in 1976.

Bogle said that because so few portfolio managers beat market benchmarks over time, investors are better off buying index funds and paying lower fees. The Vanguard 500 Index Fund charges 18 cents for each $100 of assets. The average fee for an actively managed mutual fund is $1.25, according to Morningstar.

“We follow Bogle’s philosophy: costs are paramount,” said Richard Ferri, a financial adviser in Troy, Michigan, with $300 million of client money invested in Vanguard ETFs.

Criticism From Bogle

Bogle, 80, criticized ETFs in a 2008 interview with Bloomberg Television, saying they encourage short-term trading. In a presentation this June hosted by the Web site IndexUniverse.com, he said ETFs are “great for institutional speculators,” and questioned their value for individual investors.

Bogle was unavailable for comment, his assistant said. Bogle stepped down as Vanguard’s chief executive officer in 1996.

Ferri said he prefers ETFs to index mutual funds because they are cheaper to own. Vanguard’s Total Stock Market ETF charges 9 cents for $100 in assets, half the 18 cents for the comparable index fund, Bloomberg data show.

The Vanguard Emerging Markets ETF charges 27 cents per $100, compared with 72 cents for iShares MSCI Emerging Markets Index, data from the two firms show. Vanguard’s ETF attracted more than twice as much money in September as the IShares product, according to Morningstar.

Vanguard’s Total Bond Market ETF has taken in more than three times as much this year as the rival iShares Barclays Aggregate Bond Fund, Morningstar data show. The Vanguard ETF has a lower fee, according to numbers provided by the companies.

Smaller Investors

Matthew Hougan, editor of IndexUniverse.com, in Bar Harbor, Maine, said Vanguard has probably done best among cost-conscious smaller investors who buy and hold their ETFs.

The cost of holding an ETF isn’t “the end-all and be- all,” Hougan wrote in an e-mail. Bigger investors are more focused on transaction expenses and the ease with which an ETF can be bought and sold, he said. Barclays has had an edge in those areas because its funds have more assets and greater daily trading volume, he said.

Vanguard’s Papariello said about 20 percent of her firm’s ETF sales were to institutional investors. Brokers, planners and bank trust departments account for most of the sales, she said.

The ETF gains haven’t cut into the firm’s mutual fund sales, according to Papariello. Vanguard’s stock and bond funds attracted $74.2 billion in the first nine months of the year, the most among mutual fund companies, Morningstar data show. Vanguard has $1 trillion in stock and bond funds.

To contact the reporter on this story: Charles Stein in Boston at cstein4@bloomberg.net.

Last Updated: November 3, 2009 00:01 EST