Hedge funds and Mutual funds are two known reserved investment vehicles, wherein funds are collected from a number of investors who are willing to pool their money together to a fund manager, which thereof is invested in various types of securities.
A mutualfund is an investment, where investors try to make an investment in a diversified portfolio to lower the risk factor and increase the returns generated at a lower cost. Whereas, a hedge fund is private investments that are not registered, also uses a wide range of strategies and techniques and thereby invest money into securities with multiple risks.
The major difference between these two funds lies between the returns. A hedge fund provides certain returns and mutual funds are expected to provide relative returns. However, a thorough difference between these two is discussed below:
What is a Hedge Fund?
A hedge fund is a portfolio of investments, wherein advanced investment and risk management strategies are undertaken to improve the chances of higher returns. In a hedge fund, only a few approved investors pool their money, which is collected by a fund manager, who thereby use that money to invest in various kinds of assets. An amount of fee that is based on the profit accumulated on the assets of funds, is charged by the fund manager to perform the services like management of funds.
A hedge fund is considered as an investment partnership where only a few wealthy investors invest in the fund. In a hedge fund, the minimum amount for the first investment in the fund is set high and thus only a few investors invest. The fund does not face any rigid rules or regulations. Also, the risk affiliated with these funds is comparatively higher which forces the fund manager to opt for aggressive strategies such as selling short, trading option, investment in discounted securities and more. However, the financial instruments that hold less risk and better returns are equipped by these funds.
What is a Mutual Fund?
A mutual fund is an investment vehicle that constitutes a pool of money collected from various investors in order to invest in securities such as stocks, bonds, money market instruments, and other assets. This helps in increasing the buying power of investors and eventually leading to diversified portfolios. Investors are able to buy a number of securities at a much lower price than investing in individual securities.
Fund manager collects the investors’ money and is a portfolio expert. A fund manager usually manages and controls the fund, for which a small amount of fee is charged, as per the value of assets of funds.
The investors investing in mutual funds usually seek ownership rights in the assets, the portion of ownership is based on the funds contributed by each investor. The return on investments varies according to the performance of mutual funds, such as if the value of funds rises, the returns will also increase. Whereas, if the value of the funds faces a downfall, so will the returns on the investments. The proportion of the capital of unit holder decides the net income and capital appreciation and the amount they will be distributed in.
Key Differences between Hedge Fund and Mutual Fund
The difference between a hedge fund and a mutual fund can be understood well on the following basis:
- A portfolio investment wherein only a few highly approved investors pool their money in order to buy assets is termed as a hedge fund. Whereas, a mutual fund is an investment vehicle wherein the funds are gathered by many investors who pool their money together and thereof securities are ought through the collection of money.
- Hedge funds provide definite returns, whereas, mutual fund generate relative returns that vary according to the investment made in the securities.
- Hedge funds are employed with advanced investment and risk management strategies and thus managed vigorously in order to generate better returns, on the contrary, mutual funds do not facilitate aggressive techniques for higher returns.
- A few investors invest in a hedge fund, thus a limited number of owners. On the other hand, mutual funds facilitate numerous or thousands of owners that is a huge number of investors can invest in mutual funds.
- The type of investors in case of hedge funds are highly accredited with high net worth. Whereas, small and retail investors usually invest in mutual funds.
- Strict regulations are not imposed on hedge funds and hence lightly operated. On the contrary, mutual funds are constituted with strict regulations by the Securities Exchange Board of India (SEBI).
The management fees in hedge funds are entirely based on the performance of assets as contrary to mutual funds, where
- management fees are computed on the percentage of assets of the funds.
- A considerable portion of ownership is held by the fund manager in hedge funds. On the other hand, the fund manager does not hold any ownership rights in mutual funds.
- In hedge funds, information is accessible to investors only and no disclosure is made to the public. In contrast, in case of mutual funds, reports get published annually and disclosure of performance of assets is made twice a year.
The difference can be studied in brief through the following table:
|Meaning||A portfolio of investments pooled by the money of wealthy investors in order to buy assets is known as a Hedge fund.||A mutual fund is an investment vehicle that constitutes a pool of money collected from various investors in order to purchase securities such as stocks bonds etc. at a lower rate.|
|Management||Aggressively managed.||Less aggressively managed when compared to hedge funds.|
|Investor type||Pension fund, endowment fund, and high net worth individuals.||Retail investors|
|Regulation||Less regulation||Strictly regulated by SEBI|
|Fees||Based on Performance||Based on the percentage amount of assets managed|
|Ownership of fund manager||Substantial||Not-substantial|
|Transparency||Only Investors get access to information||Access to annual reports and semi-annual reports of the performance of assets|
Hedge funds and mutual funds, both have their own benefits and downsides but selection between these two depends on the capital held. Investors should make choice between these two funds based on their financial resources and requirements. Investors with a large amount of money should opt for hedge funds whereas mutual funds can be selected if resources are less and are willing to generate higher returns.