How are hedge funds different from mutual funds? We explain

Pranati Deva
Updated: 15 Dec 2021, 04:55 PM IST
TL;DR.

Mutual funds and hedge funds are two very varied forms of investment opportunities available and attract very different kinds of investors. Let’s see how they differ

Both mutual funds and hedge funds are pooled funds from different sources that invest in various financial instruments.

Both mutual funds and hedge funds are pooled funds from different sources that invest in various financial instruments.

There are so many tools for investment making it increasingly confusing for investors to choose the right one. One of the most commonly chosen investment tools is mutual funds while one with a more niche clientele is hedge funds.

Both mutual funds and hedge funds are pooled funds from different sources that invest in various financial instruments, however, their clientele varies a lot. While hedge funds are generally chosen by high net worth individuals and foreign investors, mutual funds are a favored choice for the general public.

Mutual funds

Mutual funds are pooled funds that can be generally invested in equities and bonds. It is controlled and managed by a fund manager. These are low-cost investments with a minimum investment limit of as low as 500 or 1000 per month, thus making it very popular among investors. These are low-risk investments as compared to direct trading and offer a wide range of options for an investor to choose from. There are equity funds, bond funds, balanced funds, sector funds, multicap funds, etc. It provides great solace to investors who are unsure of direct trading and are even popular among experienced investors.

These funds are highly regulated by the market regulator Sebi and the fees for mutual funds are also capped.

Hedge Funds

Hedge funds are also pooled funds but they are often set up as limited liability companies or limited partnerships. These are more common with high net worth individuals since the minimum investment in hedge funds is pretty high. It is a very aggressive form of investment suited only for high-risk investors. Unlike mutual funds, these are open only to a limited number of investors and are not subject to the same regulations. The portfolio it offers caters specifically to the investor investing in these.

Let's look at some similarities they both have

1) They both are pooled funds from various investors that are invested in securities like bonds and equity.

2) They both offer great diversification opportunities for investors.

3) Both mutual funds and hedge funds are managed and controlled by fund managers.

Now let's take a look at the differences:

1) The biggest difference between the two is that mutual funds require a low minimum investment, while hedge funds have a very high initial investment. Due to this mutual funds are more accessible to common investors as compared to hedge funds. Only specific investors like banks, insurance firms, FPIs, HNIs invest in hedge funds.

2) While mutual funds are regulated by Sebi, hedge funds do not have very stringent regulations. Mutual funds have very well laid out guidelines. They have clear restrictions when it comes to allocation to derivatives. Hedge funds have no such restriction. They can run a long fund or a short fund and are also allowed to invest in derivatives, structured products, real estate, etc.

3) Mutual funds are more transparent than hedge funds. A mutual fund has to display its net asset value (NAV) every day while the same is not true for hedge funds. Mutual funds have to publish their performance reports, balance sheets, etc regularly while hedge funds only provide those reports to the investors, not the public. You do not have to be invested in a mutual fund to access its data but you have to be an investor in hedge funds for that.

4) While both mutual funds and hedge funds are managed by fund managers, there is a vast difference in the fees charged. The expenses for hedge funds are much higher than mutual funds. This is because hedge fund managers take on a more aggressive approach. A mutual fund can charge a fixed percentage of the AUM as a fee while hedge funds can also charge a performance fee on top of the basic management fees.

5) Another major difference is that hedge fund managers have to invest in their hedge funds while the same is not true for mutual fund managers. This is so that they are more cautious about their approach since their money is also at stake.

6) Mutual fund returns are generally evaluated in comparison with the markets of an index but the same is not true for hedge funds. For hedge funds, the absolute returns are taken into account.

If you want an accessible investment option with low risk and stable returns, mutual funds are the way to go but if you are a high net worth individual and prefer aggressive investment, then hedge funds are for you.

First Published: 15 Dec 2021, 04:55 PM IST
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