Hedge funds and mutual funds may appear identical at first look, but they are, in fact, quite distinct entities. Mutual funds and hedge funds contain portfolios built from pooled funds to achieve returns via diversification. This pooling of funds means that a manager—or group of managers—uses investment capital from numerous investors to invest in securities that serve a specific plan.
Hedge funds are aimed towards high-net-worth individuals. These funds need accredited investors to satisfy specific criteria. Institutional fund managers offer several mutual fund solutions for retail and institutional clients.
Mutual Funds
Mutual funds are typically managed to trade securities according to a predetermined plan. Despite the fact that strategy complexity varies, most mutual funds do not rely extensively on alternative investments or derivatives. By restricting the usage of these high-risk assets, they become more accessible to the general people. Mutual funds are a collection of funds from diverse sources invested in various financial instruments such as equities and bonds. These funds often have a modest initial investment limit and a low-risk profile. Their returns are not highly aggressive due to their low-risk character.
According to InvestmentNews, the three largest mutual fund asset managers as of March 7, 2021, were:
- Vanguard has $3.4 trillion in mutual fund assets.
- Fidelity has $1.9 trillion in mutual fund assets.
- American Funds has $1.6 trillion in mutual fund assets.
Hedge Funds
Hedge funds and mutual funds have the exact fundamental pooled fund structure. Typically, they are recognised for adopting higher-risk positions to maximise investor profits. On the other hand, Hedge funds are exclusively available on a private basis. As a result, they may employ options, leverage, short-selling, and others.
Hedge funds are pooled funds, but their investors are a select set of high-stakes investors from the upper crust of society who are ready to assume significant risks in exchange for higher profits. Hedge funds, on average, are managed far more aggressively than their mutual fund equivalents. Hedge funds are only available to high-net-worth people and organisations such as banks and insurance firms.
According to “BusinessInsider.com,” the top three hedge fund managers as of May 2018 were:
- Bridgewater Associates
- AQR Capital Management
- Renaissance Technologies
Difference
The redemption terms of hedge funds and mutual funds are a significant distinction. On any given business day, mutual fund investors can redeem their units for that day’s NAV (net asset value). On the other hand, Hedge funds are notorious for their lack of liquidity. Some allow redemptions weekly or monthly, while others only allow redemptions once a quarter or once a year. Many hedge funds require a lock-up period during which you cannot withdraw any funds.
Hedge funds are often riskier than mutual funds. While hedge funds’ investing techniques differ, they all strive to make a profit regardless of whether the market is rising or falling. Hedge fund managers can achieve this aim by employing high-risk strategies such as short selling equities and taking speculative holdings in derivative instruments. On the other hand, mutual funds are unable to assume such heavily leveraged positions, which makes them less hazardous and limits their potential rewards.
- Hedge funds and mutual funds are professionally organised and have management fees taken from the investment. On the other hand, hedge funds have substantially greater expenses than mutual funds. This is because hedge fund management is more sophisticated, necessitating a more aggressive and shrewd approach.
- The goal of hedge funds, on the other hand, is to achieve solid and consistent returns independent of market conditions. In a bullish market, mutual funds provide exceptional returns, but in an adverse market, they provide below-average returns. The disadvantage is that hedge funds will continue to produce steady but mediocre results even in a favourable market where mutual funds are outperforming.
- Mutual fund managers aren’t personally invested in the success of the funds they manage. On the other hand, Hedge fund managers are forced to spend a significant amount of their own money in hedge funds so that they can be more careful and make the best judgments since their own money is on the line.
- Annual reports and balance sheets, and quarterly asset performance must be made public regularly by mutual funds. On the other hand, Hedge funds are highly confidential, and their performance reports are only available to the investors.
- The quantity of capital invested, the period in which earnings should be invested, and the overall investment plan are all rigorously controlled in mutual funds. There are no such restrictions that apply to hedge funds. This is one of the reasons why there are so many restrictions on who may invest in hedge funds in the first place.
- Indexes are one of the most practical tools for assessing the performance of various market sectors and segments. Because hedge fund performance data isn’t readily available, comparing hedge fund indexes to the S&P 500 might help comprehend the performance parameters of comparing hedge funds to traditional mutual funds.
- Fees also have a significant role in performance comparisons. Operational fees for mutual funds have been reported to range from around 0.05 per cent to as much as 5% or more. Hedge funds generally charge a “two-and-twenty fee,” which combines a 2% management fee plus a 20% performance fee.
Hedge funds and mutual funds have very similar structures. They aggregate money from investors and invest it in a variety of assets under the supervision of a specialist. Aside from those fundamental parallels, there are significant variances in aims, expenses, and even who can invest. Hedge funds can provide consistent returns that outperform inflation while reducing market risk. However, most people will discover that mutual funds are a better fit for them.
When it comes to accessibility for the average person who wants to invest in their own portion of the market, mutual funds are the way to go. It is one of the most popular financings due to its cheap minimum investment amount and convenience of usage. On the other hand, a hedge fund may be better ideal for you if your objective is to beat inflation and you are a high net worth individual or organisation ready to take additional risks by putting forth a sizeable initial investment amount.
