Hedge funds and mutual funds are often misunderstood to be the same as both require pooling of funds from the investors. Fund managers manage both types of funds, and investors need to pay a fee in return. However, there are various points on which the mutual funds differ from the hedge funds. To better understand the two, we must know the differences between Mutual Fund vs Hedge Fund. Before we detail the differences, let us see what each of these terms means.
What is Mutual Fund?
A mutual fund is a financial investment product for retail investors. These funds are heavily regulated and are operated by professional fund managers. In mutual funds, small savings of the public are pooled and then invested. It allows small investors to own stocks of high-value companies.
- What is Mutual Fund?
- What is Hedge Fund?
- Mutual Fund vs Hedge Fund – Similarities
- Mutual Fund vs Hedge Fund – Differences
- Final Words
What is Hedge Fund?
A hedge fund is also a pooled investment or an alternative investment technique wherein fund managers use many different techniques to earn active returns. The investors in hedge funds are accredited investors, high net worth individuals (HNIs), insurance firms, pension funds, and more.
Mutual Fund vs Hedge Fund – Similarities
Both mutual funds and hedge funds work on the principle of pooled investments. The savings are pooled and are then invested in various financial instruments to earn returns. Fund managers apply various long- and short-term strategies to earn returns on the funds.
Managed by Fund Managers
Be it a mutual fund or hedge fund; professional fund managers oversee both types of instruments. However, hedge fund portfolio managers more actively change and deploy strategies to earn quick returns on investment.
The goal of both (mutual and hedge funds) is to maximize the return by diversifying investment. Therefore, a mutual fund manager or a hedge fund manager selects the different type of investment products, such as equities, bonds, and so on, to maximize investors return.
Mutual Fund vs Hedge Fund – Differences
Following are the differences between mutual funds vs hedge funds:
In a mutual fund, investors pool money to invest in a basket of securities. Under a hedge fund, a few high-net-worth investors come together to buy assets.
Who can Invest?
Anyone can invest in mutual funds, but they need to be of legal age. In hedge funds, however, not everyone can invest. Since hedge funds are risky, retail investors don’t have the risk appetite and understanding to invest in such funds. Thus only high net worth individuals (HNIs) or accredited investors can invest in the hedge funds.
Compared to hedge funds, mutual funds face more regulations as they use public money. While mutual funds across the globe need to register with the regulatory authority, with hedge funds, there are no such requirements. Further, unlike mutual funds, hedge funds do not need to make periodic statements and file the same with the regulatory authority.
Since mutual funds face more regulations than hedge funds, they have certain restrictions on the assets they can invest in. Mutual funds don’t invest in something open to wild speculations, such as derivatives. On the other hand, Hedge funds are under no obligation to disclose or restrict the assets in which they are investing. The whole investible universe is accessible to the hedge funds, and they can actively change their strategies. Hedge funds do not require approval from the investors in order to select the strategy.
Since the mutual fund is open to all individual investors, the minimum investment is small, say a few hundred dollars or even less. Because of this, one mutual fund could have millions of investors. Hedge funds are basically private companies and are open to high net worth investors. Thus, the minimum investment amount is big. Usually, a hedge fund may not have more than 500 investors.
Mutual funds need to value their portfolio daily on the basis market price of the securities. This daily pricing helps both new investors and also existing investors who want to liquidate their investments. There is no such requirement for hedge funds. Thus, it makes it difficult for hedge fund investors to value their investment at a given time.
Mutual fund managers are less aggressive and invest in line with the pre-defined objective of the fund. Hedge fund managers, however, pursue an aggressive management style to maximize the returns.
Contribution from Fund Manager
Usually, there is no contribution from the mutual fund manager. A hedge fund manager may have a personal investment in the fund.
Since hedge funds are open to a variety of strategies, they can deploy more efficient tax-saving strategies than mutual funds. One of the reasons why mutual funds do not take up such strategies is that most of the investors in mutual funds are not high net worth individuals and, therefore, do not fall in such brackets.
Talking of the income from mutual and hedge funds, in both cases, there is no tax on the income at the fund level. However, once the income is in the hands of investors, it is taxable as per their applicable tax rate.
Since mutual funds face heavy regulations, they are less risky than hedge funds.
Mutual funds trade in the secondary market, allowing customers to liquidate their investments and earn money. On the other hand, hedge funds are not available in the secondary market, and hence, an investor can’t sell them to other investors. For selling hedge funds, investors need to sell them back to the fund itself.
As mutual funds are bound by strict regulatory requirements, they need to disclose many information. For instance, they need to provide information on their working, sources of finances, services they use, and also the daily net asset value (NAV). On the other hand, Hedge funds do not face strict regulations, and disclosure requirements are comparatively lesser. They only need to prepare monthly or quarterly statements.
In mutual funds, investors can usually enter and exit at their will. However, investors in hedge funds have restrictions on exit or can exit only during a specific time.
The fee that a mutual fund manager gets is subjected to regulations. On the other hand, there is no such limit on the compensation or fee of the hedge fund manager. Further, there are regulations guiding the mutual funds structure for fees, compensation, and entry and exit loads. Also, mutual funds need to present their fee structure in a format that is easily understandable. On the other hand, Hedge funds can even charge front-end sales and performance fees as well.
As per the regulations, mutual funds face restrictions from leveraging or borrowing against the value of the securities in their portfolio. On the other hand, Hedge funds can leverage and borrow on the basis of security in their portfolio.
Both mutual and hedge funds are investment options available to an investor. The objective of both options is to magnify the return of the investors. However, their strategies and structure are what make them different. Which of the two you should invest in depends on your investment objective, the amount of savings you have, and your risk appetite.