Although both private equity and hedge fund refer to the investment vehicle which pools money from different high net worth investors and utilises such funds according to their own strategies to generate returns for their investors. Such high net worth investors are known as limited partners. In fact, both private equity and hedge fund have a similar category of investors, but there are some key difference between private equity and hedge fund if we consider their motive, strategies and methods of investment.
In this article, we will discuss primarily the difference between private equity and hedge fund as well as what exactly mean by these two terms. Now let us first understand the concept of private equity and hedge fund.
Private Equity vs Hedge Fund (Comparison Table):
|ASPECTS OF COMPARISON||PRIVATE EQUITY||HEDGE FUNDS|
|Meaning||Private equity refers to those private investment vehicles which invest their funds directly to private companies by purchasing 100% ownershipPrivate equity refers to those private investment vehicles which invest their funds directly to private companies by purchasing 100% ownership.||Hedge fund refers to such funds which make returns by investing in derivatives, short selling and sometimes leverage or borrowed funds.|
|Investment Time Horizon||LONG||SHORT|
|Risk of Investment||LESS||HIGH|
Private Equity and Hedge Fund:
Private equity refers to those private investment vehicles which invest their funds directly to private companies by purchasing 100% ownership in such companies and sometimes they acquire operational control of public limited companies as well by purchasing stocks of such companies through the stock exchange.
Private equity firms intend to stay longer with acquired companies and primarily focus on profits and exit by selling the company or issuing Initial Public Offering.
A hedge fund, on the other hand, is such funds which make returns by investing in derivatives, short selling and sometimes leverage or borrowed funds. That is why hedge fund is considered as a high-risk investment vehicle as compared to other funds.
The main objective of hedge funds is to provide higher returns to their limited partners as quickly as possible. Hence, the fund managers invest their investor’s money to highly liquid financial instruments and also exercise shot selling and leverage. Hedge funds charge a performance fee as well as expense ratio from their investors for services provided. Now let me explain the difference between private equity and hedge fund.
Difference between Private Equity and Hedge Fund:
Private equity funds and hedge funds can be distinguished based on the following three major aspects.
1) Investment Time Horizon:
Since private equity funds invest their funds in a private company and focus on profitability, potential growth and plan to sell off the company at a higher value which requires long term investment of funds. Therefore, private equity funds need long term capital from their investors (limited partners). Thus investing in private equity funds require longer time horizon usually minimum of 3 to 5 years or 7 to 10 years.
Hedge funds, on the other hand, focus on making maximum profit for their investors in a short time through highly liquid instruments. Such instruments could be anything such as stock futures, commodity futures and options, arbitrage or currency. Therefore, hedge funds don’t require long term investment such as private equity funds. Thus hedge fund doesn’t ask their investors to park funds for a longer duration.
2) Risk of Investment:
As private equity firms invest in matured companies for the long term, hence the risks of the investment in private equity funds are relatively less.
On the other hand, as we learned above, hedge funds focus on making quick profit through derivatives, short selling and even leverage (borrowed funds) which are the riskiest instruments of the capital market.
Thus we can conclude that hedge funds are riskier than private equity funds.
Liquidity is the most significant aspects when it comes to investment whether in private equity funds, hedge funds or any other funds.
As we know, the basic profit-making strategy of hedge funds are short selling, leverage and derivatives that generally require a short period of time, however, basic motive of private equity is to make sustainable profit and growth which require long term investment.
Thus we can say that private equity funds are less liquid (or promise investment for long term), on the other hand, hedge funds are more liquid that means the investors can get a higher return in less duration.
In fact, both private equity funds and hedge funds pool investors’ funds and invest such funds gathered according to their own strategies, objective and mechanisms to earn returns on their investors’ behalf. The major difference between private equity and hedge fund is associated with their ways and motive of investing. Hope you would have understood the difference between private equity and hedge fund in this lesson.
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References: Investopedia Private Equity vs Hedge Fund (source)