December 19, 2023

Mutual Funds vs Hedge Funds

Mutual Funds vs Hedge Funds

The primary distinction between hedge funds and mutual funds is their accessibility, as hedge funds are typically only open to accredited or high-net-worth investors, while mutual funds are available to the general public

This article covers: 

What Is Mutual Fund?

Mutual funds are a type of investment vehicle that pools the capital of multiple investors to purchase a diversified portfolio of securities, such as stocks, bonds, and other financial instruments. The pooled money is managed by a professional fund manager who is responsible for making investment decisions on behalf of the fund’s investors.

The basic structure of a mutual fund involves three key players:

  1. Fund sponsor- The fund sponsor is the entity that creates the mutual fund and is responsible for marketing and selling the fund’s shares to investors.
  2. Fund manager- The fund manager is the individual or team of professionals who manage the fund’s portfolio and make investment decisions on behalf of the investors
  3. Fund custodian- The fund custodian is the entity that holds the assets of the mutual fund, such as the securities, and ensures that they are safe and secure.

Hedge Fund Meaning

A hedge fund is a type of investment instrument that pools capital from a limited number of accredited investors to invest in a range of securities and other assets. Unlike mutual funds, hedge funds are typically only available to wealthy individuals and institutions due to regulatory restrictions that limit the number of investors and require a high minimum investment.

Hedge funds are managed by skilled fund managers who use a range of investment strategies to generate returns for investors. These strategies may include long and short positions, leverage, derivatives, and other complex financial instruments. Hedge funds can invest in a wide range of assets, including stocks, bonds, currencies, commodities, and real estate.

The term “hedge fund” comes from the idea of hedging, which involves taking positions in different assets to offset potential losses. The goal of a hedge fund is typically to generate higher returns than traditional investment vehicles while also protecting against downside risks.

Some common types of hedge funds in the market include:

  • Domestic hedge funds: Domestic Hedge Funds are only open to individuals who reside in a particular country and pay taxes in the same country. 
  • Offshore hedge funds: Offshore Hedge Funds invest only in multinational companies or other organizations and industries overseas, often in low taxation countries. These investment are popular among high-net-worth NRIs. 
  • Funds of funds: Fund of Funds is not precisely a hedge fund but invests in other hedge funds after considering their returns. This fund is suitable for small investors who cannot bear high risks. 

Hedge Funds In India

Here are some of the key players in the Indian hedge fund industry in 2024:

S No.Name of the Hedge Fund FirmAUM (in billions of USD) 
1Blackrock Advisors8.5
2Citadel LLC50
3Bridgewater Associates235.5
4AQR Capital Management145.5
5Man Group PLC151.4
6Renaissance Technologies121.8
7DE Shaw & Co LP128
8Tiger Global Management124.7
9Two Sigma Investments LP81.2
10Millennium Management341

Hedge funds are currently governed by the Securities and Exchange Board of India (SEBI) in India and are bound by a number of rules and limitations. Hedge fund investments are restricted to a select group of investors, including high-net-worth individuals and institutions.

Difference Between Hedge Fund And Mutual Fund

The key difference between a hedge fund and a mutual fund is that a hedge fund uses complex investment strategies to generate high returns for their investors, which can include leveraging their investments, short-selling securities, and using derivatives. On the other hand, mutual funds typically invest in a mix of stocks, bonds, and other securities, with the aim of achieving a balance between risk and returns based on their investors’ goals and risk tolerance. 

Investors Profile

  • Hedge funds are typically open only to accredited investors who meet specific net worth and income requirements. On the other hand, mutual funds are available to a wider range of investors, including retail investors who can invest with as little as a few hundred dollars.
  • Hedge funds require a significant minimum investment, often in the hundreds of thousands or even millions of dollars. Whereas mutual funds have lower minimum investment requirements and no income or net worth restrictions.

Charges

  • Hedge funds charge higher fees compared to mutual funds, typically a management fee of 1-2% of assets under management, plus a performance fee of around 15% of profits. Whereas mutual funds charge lower fees compared to hedge funds, typically a management fee of less than 1% of assets under management.
  • The performance fee is charged only if the fund performs above a certain benchmark, known as the hurdle rate. Mutual funds do not charge a performance fee, as their investment strategies are typically more conservative and do not involve as much risk-taking as hedge funds.

Holding Period

  • Hedge funds have a shorter holding period compared to mutual funds, often holding securities for a few weeks or months. Whereas mutual funds have a longer holding period compared to hedge funds, often holding securities for several years.
  • Hedge funds have a greater degree of flexibility in their investment strategies, allowing them to adjust their portfolio quickly in response to changing market conditions. Mutual funds have a more limited degree of flexibility in their investment strategies, as they aim to maintain a diversified portfolio of assets with a long-term outlook.

Regulations

  • Hedge funds are not regulated by the Securities and Exchange Board of India (SEBI) and are classified as alternative investment funds. Whereas mutual funds are regulated by the Securities and Exchange Board of India (SEBI).  
  • Hedge funds must only be sold to accredited investors such as HNI(High networth individuals), insurance companies, pension funds, etc. On the other hand, mutual funds can be sold to the general public.
  • Hedge funds operate under a limited partnership agreement. Whereas mutual funds operate under the guidelines of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996. These regulations define the legal structure of mutual funds, their registration requirements, and investment restrictions.
  • Hedge funds have fewer reporting requirements compared to mutual funds. On the other hand, mutual funds provide more detailed disclosure to investors, including annual and semi-annual reports and prospectuses.

Investors should carefully consider their investment objectives, risk tolerance, and investment experience before choosing between these two types of investment vehicles.

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Mutual Funds vs Hedge Funds- Quick Summary

  • Hedge funds are for accredited investors, while mutual funds are open to the normal public. 
  • Mutual funds pool money from multiple investors to invest in stocks, bonds, and other assets. 
  • Hedge funds are private investment funds that use aggressive investment strategies and are typically only available to accredited investors. 
  • Some of the key hedge funds available in India are Blackrock Advisors, Citadel LLC, etc.
  • The difference between hedge funds and mutual funds is that mutual funds are more accessible to retail investors and typically have lower fees than hedge funds. 
  • Mutual funds are regulated by national authorities to protect investors’ interests, while hedge funds have fewer regulatory restrictions.

Mutual Funds vs Hedge Funds- Frequently Asked Questions

1. Mutual funds vs hedge funds: Which is better?

A: Hedge funds offer more flexibility and potentially higher returns than mutual funds, but they also come with higher fees and risks. Mutual funds are typically more accessible and diversified.

2. Are hedge funds and mutual funds the same?

A: No, hedge funds and mutual funds are not the same. Hedge funds are typically only available to accredited investors, while mutual funds are available to a wider range of investors. 

3. Are mutual funds more liquid than hedge funds?

A: Yes, mutual funds are generally more liquid than hedge funds. This is because mutual funds can be bought and sold at any time during the trading day, while hedge funds typically have lock-up periods or redemption restrictions. 

4. Why is it called a hedge fund?

A: The term “hedge fund” originated from the practice of hedging, or mitigating risk, by using investment strategies such as short-selling and derivatives trading.

5. What is the biggest hedge fund in the world?

A: As of 2021, the biggest hedge fund in the world is Bridgewater Associates, which manages over $140 billion in assets under management. Bridgewater Associates was founded in 1975 by Ray Dalio and is known for its global macroeconomic investment strategy. 

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