Difference between Hedge Funds and Mutual Funds

Difference between Hedge Funds and Mutual Funds

Although both hedge funds and mutual funds pool money from different investors and invest such funds according to their own strategies in the financial market to make profits, however, their investor profiles, risks involved and tactics to generate returns are different from each other.

In this article, we will understand primarily the difference between hedge funds and mutual funds. But before we go ahead, let me explain first, what exactly hedge funds and mutual funds in brief so that their differences can be understood easily.

Both hedge and mutual funds are investment vehicles facilitating various investors to invest their funds and make profits through the diversified portfolio in the capital market without taking more risks because such funds are managed by the most experienced, skilled and professional fund managers.

Hedge Funds and Mutual Funds:

Hedge funds refer to a private investment vehicle that pools money from accredited investors or firms with high net worth known as limited partners. Hedge funds are managed by professional fund managers to provide maximum returns to their clients as quickly as possible. The hedge funds are invested in derivatives, short selling and leverage to achieve their objectives in a short time; however, these strategies are very risky.

Hedge funds can be utilised anywhere, anytime, even in a declining market, such as stock futures, commodity futures, options, currency or index to accomplish their goal. Hedge funds charge performance fees ranging from 20 to 30% as well as expense ratio for the services they provide to their limited partners.

Mutual funds, on the other hand, refers to such investment vehicle which pools money from retail/ common investors at minimum subscriptions and utilities such funds in the financial securities by the professional and experienced fund managers to gain returns. The financial securities could be stocks, bonds, debentures or commodities. However, mutual funds are not managed so aggressively as hedge funds are and due to this, mutual funds are safer than the hedge funds.

Hedge Funds vs Mutual Funds (Comparison Table):

BASIS OF COMPARISONHEDGE FUNDSMUTUAL FUNDS
MeaningHedge funds are private investment vehicle pool money from high net worth investors invest further in capital market to make returns.Mutual funds are also investment vehicle collect funds from retail investors and further invest such funds in financial securities to make returns.
Investors' ProfileHigh Net Worth Individuals/ FirmsCommon/ Retail Investors
Investment RisksHighLow
Regulatory ProvisionsSEBI (ALTERNATIVE INVESTMENT FUNDS) REGULATIONS, 2012.Securities and Exchange Board of India (Mutual Funds) Regulations 1996.
LiquidityHigh, depending on strategies adopted.Comparatively low depends on types of mutual funds.
FeesCharge a Management fee (1 to 2%) and Performance fee (10 to 30%).Charges only Expense Ratio upto 2%

Difference between Hedge Funds and Mutual Funds:

The main difference between hedge funds and mutual funds is based on their investment strategies, their investors’ profile, risks and liquidity. Now let us understand each aspect in short.

1) Investors’ Profile:

The main difference between hedge funds and mutual fund is their investor’s profiles. Hedge funds are open for accredited investors or firms not for retail investors. As the minimum amount is to be invested in hedge funds is Rs 1 crore, hence the individuals with high net worth can only invest in hedge funds, that’s why hedge funds sometimes also known as rich men’s mutual funds.

Mutual funds, on the other hand, is open for retail investors who can start investing with minimum amount as Rs 500/-. Thus mutual fund pools money from common investors.

Thus investors profiles of hedge funds are high net worth individuals or firms whereas investors profile of mutual funds are retail investors.

2) Investment Risks:

The hedge funds are managed aggressively in derivatives, short selling and also fund managers don’t hesitate to carry huge leverage, contrary, mutual funds have little leverage and managed carefully by its fund managers. Therefore, hedge funds are riskier than mutual funds.

3) Regulatory Provisions:

Hedge funds are regulated in the United States of America by the Securities and Exchange Commission (SEC), however, it is regulated in India under SEBI (ALTERNATIVE INVESTMENT FUNDS) REGULATIONS, 2012.

On the other hand, mutual funds are strictly regulated in India under the Securities and Exchange Board of India (Mutual Funds) Regulations 1996.

4) Liquidity (or locked up):

Since the hedge funds utilise various tactics to make returns, hence it requires different time intervals to apply different strategies. Thus locked up of investors’ money depends on the strategy of funds from day to years.

However, in mutual funds, investors’ money locked up for years depends on the types of mutual funds.

5) Fees:

Hedge funds companies typically charge a management fee as well as performance fee generally varies from 1 to 2% and 10 to 30% as per the performance of funds respectively. In the case of hedge funds, the fund managers also invest their own money in the game so that they don’t lose their interest over the performance of funds.

Mutual funds, on the other hand, charge only a management fee (expense ratio) typically up to 2% which is strictly regulated under the SEBI regulations.

Conclusion:

Hope you have understood the critical difference between hedge funds and mutual funds. In a nutshell, we can conclude this lesson in this way, hedge funds and mutual funds are conceptually similar but the major difference is types of investors who participate in such funds. The hedge funds are for the high net worth investors and mutual funds are for common investors.

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References: Hedge funds vs Mutual funds (source)

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