Mutual Fund vs Hedge Fund – All You Need To Know

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 mean.

What is Mutual Fund?

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 Hedge Fund?

Hedge fund is also a pooled investment or an alternative investment technique wherein fund managers use a lot of 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

Pooled Investments

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.

Diversification

The goal of both (mutual and hedge fund) 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 FUnds

Mutual Fund vs Hedge Fund – Differences

Following are the differences between mutual fund vs hedge fund:

Meaning

In a mutual fund, investors pool money to invest in a basket of securities. Under hedge fund, a few high net worth investors come together to buy assets.

Who can Invest?

Anyone can invest in mutual funds, but he or she needs 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.

Regulation

Compared to the hedge funds, mutual funds face more regulations as they use public’s money. While mutual funds across the globe need to register with the regulatory authority, with hedge funds, there is no such requirements. Further, hedge funds, unlike mutual funds, do not need to make periodic statements and file the same with the regulatory authority.

Investible Assets

Since mutual funds face more regulations than the hedge funds, they have certain restrictions on the assets they can invest in. Mutual funds don’t invest in something that is open to wild speculations such as derivatives. Hedge funds, on the other hand, are under no obligation to disclose or restrict the assets in which they are investing. The whole investible universe is accessible for the hedge funds and they can actively change their strategies. Hedge funds do not require approval from the investors in order to select the strategies.

Investment Amount

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 open to high net worth investors, thus, the minimum investment amount is big. Usually, a hedge fund may not have more than 500 investors.

Pricing

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 investment. There is no such requirement for the hedge funds. Thus, it makes it difficult for hedge fund investors to value their investment at a given time.

Management Style

Mutual fund managers are less aggressive and invest in-line with the pre-defined objective of the fund. Hedge fund managers, however, purse 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 personal investment in the fund.

Taxation

Since hedge funds are open to a variety of strategies, they can deploy more efficient tax saving strategies than the 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.

Risk Factor

Since mutual funds face heavy regulations, they are less risky than the hedge funds.

Secondary Markets

Mutual funds trade in the secondary market, allowing customers to liquidate their investment and earn money. Hedge funds, on the other hand, are not available in the secondary market and hence, an investor can’t sell it to other investors. For selling hedge funds, investors need to sell it back to fund itself.

Disclosure Requirements

As mutual funds are bound by strict regulatory requirements; they need to disclose a lot of 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). Hedge funds, on the other hand, do not face strict regulations, and disclosure requirements are comparatively lesser. They only need to prepare monthly or quarterly statements.

Exit Option

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.

Fees

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. Hedge funds, on the other hand, can even charge front-end sales and performance fee as well.

Leveraging

As per the regulations, the mutual funds face restrictions from leveraging or borrowing against the value of the securities in their portfolio. Hedge funds, on the other hand, can leverage and borrow on the basis of security in their portfolio.

Final Words

Both mutual and hedge funds are investment options available to an investor. The objective of both the option is to magnify the return of the investors. However, their strategies and structure is what makes 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. 1,2

1.
ICI – The Differences Between Mutual Funds and Hedge Funds . ici.org. December 2019. [Source]
2.
hedge fund and mutual fund. managementstudyguide. December 2019. [Source]
Last updated on : December 31st, 2019
What’s your view on this? Share it in comments below.

Leave a Reply