Dec. 5 (Bloomberg) -- The money-management industry's most- famous critic, John C. Bogle, has a new target in his sights.

It's the fast-growing business of exchange-traded funds, which he lately has been lambasting as a ``U-turn for the worse'' in the evolutionary progress of index funds.

Bogle, the founder and retired chairman of the Vanguard Group, started the first index mutual fund 30 years ago. That fund, the Vanguard 500 Index Fund, today remains the largest of all index mutuals with assets of $116 billion.

All index mutual funds together hold about $900 billion, Bogle said in an Oct. 26 speech to the CFA Society of San Francisco. Of that total, he said, exchange-traded funds now account for a dazzling 38 percent, up from just 9 percent at the end of the 1990s.

``Classic indexing has been overwhelmed by what I call indexing nouveau, represented by the ETF,'' Bogle said in that speech. His complaint is that ETFs, which unlike standard mutual funds trade continuously on stock exchanges, have been marketed as vehicles for trading and short-term speculation rather than long-term investing.

Also, he says, the newest ETFs have focused more and more on narrow segments of the markets rather than the stock and bond markets as a whole.

Specialized

``The flow into style, sector and foreign funds has overwhelmed the flow into the broad stock market index component,'' Bogle said. ``We've moved a long, long way from classic indexing.''

Partisans of exchange-traded funds dispute that view, saying ETFs do a good job of simultaneously accommodating both long-term investors and professionals who use them for hedging, trading and other short-term purposes.

That argument gives no promise of being settled any time soon. What interests me most is Bogle's acknowledgment that the indexing movement, whose ``triumph'' he frequently proclaims, isn't looking quite so triumphant these past few years.

Nobody I know disputes the basic argument for indexing, which says that a passive, low-cost portfolio designed to track the performance of a market will always tend to beat the results of the average active investor, who must bear the considerable costs of trading and research.

Small Slice

Yet with more than three decades of history behind it, indexing has taken, by Bogle's own estimate, no more than a 7 percent share of assets in stock and bond mutual funds.

These days many sophisticated investors, who by rights should make up indexing's prime constituency, instead are flocking to the ultimate in active management, hedge funds. Defying the powerful argument for low-cost investing, hedge funds generally charge even higher fees than the typical actively managed mutual fund.

The notion is stirring that the principle of indexing can be applied to hedge funds. Harry Kat, a professor at London's Cass Business School, says low-cost ``synthetic'' hedge funds would have outperformed 82 percent of managed funds over a 15-year period he studied.

As the $1.3 trillion hedge-fund industry keeps growing, it stands to reason that market-beating results will become harder and harder to achieve. ``In most cases, managers aren't good enough to make up for the massive fees that they charge,'' Kat said in an interview with Bloomberg News.

Just Saying No

Well then, where's the stampede into synthetic hedge funds? Shows no signs of happening any time soon. Something in human nature stubbornly resists the idea of passive investing.

Bogle speaks of this as ``the willingness -- nay eagerness - - of investors to favor complexity over simplicity and action over inaction, continuing to believe against all odds that they can beat the market.''

There's more to this than Wall Street marketing to the emotions of unsophisticated individuals. The little people aren't the ones buying hedge funds, after all.

No, what we see is institutions and wealthy players looking at the big numbers posted by hedge fund stars and Ivy League endowment funds and saying, ``I want that too.''

Whether this is good or bad for the investors concerned, it serves the markets well. It increases their efficiency as mechanisms for directing capital to the places in the economy where it can do the most good. How important is this? It's the very reason for the markets' existence.

So if the ``triumph'' of indexing has proved slow in coming -- indeed, if it looks as though it may never come -- that need be no cause for dismay. Bogle's Vanguard Group has always offered a full line of actively managed stock, bond and money funds, along with its index funds (which, we must not neglect to note, includes a full line of ETFs, 18 at last count).

The choice of active or passive funds, conventional or exchange-traded, is wide open for each investor, big and small. May it ever be so.

(Chet Currier is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Chet Currier in Los Angeles at ccurrier@bloomberg.net

Last Updated: December 5, 2006 00:03 EST