understanding the basic differences between hedge funds and mutual funds
Understanding the Basic Differences Between Hedge Funds and Mutual Funds
While hedge funds provide maximum returns, mutual funds are less riskier of the two. This Buzzle article has enlisted some vital points for understanding the basic differences between hedge funds and mutual funds.
Quick Tip
According to a June 2013 report in Wall Street Journal, wealth managers were recommending hedged mutual funds. These are investment instruments which utilize the strategies of hedge funds, but incorporate the transparency and ease in tradeability of mutual funds.| Hedge funds | Mutual funds |
| About | |
| It is an aggressively managed investment portfolio, contributed to by few investors, and it undertakes complex investment strategies for generating higher returns. They are private offerings which are managed by hedge fund managers. | It is a collective investment scheme where money is collected from investors in order to buy securities. They are public offerings which are managed by mutual fund managers. |
| Rules for Investing | |
| According to the U.S. Government, only accredited investors who meet certain criteria are able to invest in hedge funds. | Anyone can invest in mutual funds, anytime. |
| Number of Investors | |
| Investors are limited to 100 or 500, depending on the funds collected. | There is no limit to the number of investors. |
| Regulated by U.S. Securities and Exchange Commission (SEC) | |
| No, they are not regulated by SEC. | Yes, they are tightly regulated by SEC. |
| Mitigating Losses | |
| Implement various hedging techniques for survival. | No other option but to exit positions and convert to cash. |
| Type of Return on Investment | |
| Irrespective of the market conditions, these aim at getting absolute returns. | The returns depend on the prevailing market conditions, and their relativity to the index benchmark. |
| Tools for Investment | |
| Include high-risk investment tools like leverage, short-selling, volatile derivatives, like options, futures, commodity trading, etc. | Include lower-risk investment options like stocks, commodities, real estate, money market instruments, and bonds. |
| Manager Fees | |
| As the nature of work is critical, they get a fixed amount of fees over and above their performance incentives. | Remuneration to mutual fund managers depends on the performance of the portfolio. |
| Liquidity | |
| They have absolute zero liquidity as they have lockup periods, and an investor is not allowed to withdraw or sell them for a certain period. | They have a higher liquidity as they can be easily sold and purchased according to the wish of the investor. |
| Performance in Bear Market | |
| Because of hedging, they perform relatively better. | Mutual funds may not be able to perform like hedge funds. |
| Disclosure of Asset Allocation | |
| Disclosure of asset allocation not required | Required to disclose asset allocation in every quarter and file periodic paperwork. |
| Marketing Efforts | |
| As there are few investors, marketing efforts are limited. | Mutual funds need to undertake aggressive marketing to gain investors. |
| Secrecy | |
| Not priced on a regular basis, and investors may keep a tab at the end of the month. | Performance is priced daily and is made known to the public. |
| Flexibility | |
| Change in strategy can be easily incorporated in hedge funds. Hence, they are flexible. | Strategy changes cannot be easily incorporated. If undertaken suddenly, they will be touted as 'style drift'. |
| Offered Through | |
| They are offered through private placement memorandum. | They are offered through prospectus. |
| Affordability | |
| Limited only to the rich and high-net worth investors. | Affordable for average investors who do not have too big sums to invest. |
| Risk and Returns | |
| They involve a greater risk, and therefore, generate higher returns. | They have lesser risk, and hence, yield lower returns. |
| Leveraging | |
| As they are aggressive in nature, they often resort to leveraging. | Mutual funds cannot leverage positions. |