Mutual funds vs. hedge funds: What's the difference?

Mutual funds and hedge funds are both pooled investment vehicles that offer diversification and professional management. However, mutual funds are designed for a broad range of investors, while hedge funds are tailored for high-net-worth individuals seeking potentially higher returns. The choice between mutual funds and hedge funds depends on an individual's investment goals, risk tolerance, and financial situation.

• Table of contents

1. What are mutual funds?
2. What are hedge funds?
3. Difference between hedge funds and mutual funds
4. Is a hedge fund better than a mutual fund?

What are mutual funds?

Mutual funds have become a popular choice for personal investments as they offer an easy way to enter the stock market. These funds pool money from various investors to invest in a diverse mix of stocks, bonds, or other securities. Regulated by the Securities and Exchange Board of India (SEBI), mutual funds are transparent, requiring a prospectus that outlines their goals and strategies. Whether you prefer the passive approach of index funds or the active management of other funds, mutual funds offer options that may suit different risk levels and investment goals.

What are hedge funds?

Hedge funds cater to a select group of investors who are willing to take on higher risks for potentially better returns. These funds use different methods, like short selling, leverage, and derivatives, to earn relatively better returns. In India, hedge funds are still an emerging sector, regulated by SEBI under the Alternative Investment Funds (AIF) category. The entry requirements are high, both in terms of minimum investment and the expected financial knowledge of the investor, making hedge funds a domain for experienced investors.

Difference between hedge funds and mutual funds

Mutual funds and hedge funds both have some important structural and regulatory differences.

• Accessibility: Mutual funds are available to the public. Hedge funds are only accessible to accredited individuals and institutions. The Securities and Exchange Board of India has a few parameters on who can be an accredited individual. These include a certain minimum threshold for annual income and assets.
• Regulation: Mutual funds are heavily regulated by the SEBI and must provide detailed disclosures. Hedge funds have relatively lower levels of regulation and can set their own standards.
• Fees: Mutual funds typically charge lower management fees compared to the higher fees of hedge funds. Hedge funds may also charge performance fees.
• Investment strategies: Mutual funds generally pursue more conservative strategies. Hedge funds can employ riskier strategies like short-selling, leverage, and derivatives.
• Liquidity: Most mutual fund units can be easily bought and sold daily. Hedge funds have more restrictive redemption policies, like lock-in periods.
• Transparency: Mutual funds provide daily NAV and monthly/fortnightly holdings. Hedge funds have limited reporting requirements.
• Risk profile: Mutual funds can be low or high risk depending on the type of scheme. Hedge funds take on much higher risk in search of higher returns.

Read Also: What are credit risk mutual funds

Is a hedge fund better than a mutual fund?

Hedge funds offer the potential for higher returns but with more risk. Mutual funds also entail risk, but it may be lower than that of hedge funds.

For high-net-worth individuals who are eligible to invest in both hedge funds and mutual funds, the decision would depend on their investment goals and risk tolerance. Since hedge funds have higher risks, it is better for investors to understand those risks before investing.

Read Also: Understand the types of risk profile

Conclusion

Mutual funds and hedge funds both offer professional management of pooled investment capital. However, there are key differences between the two regarding regulation, accessibility, strategies, fees, transparency, and liquidity. Mutual funds cater to retail investors and the minimum investment amount is low. Hedge funds only cater to wealthy accredited investors seeking higher returns through more aggressive tactics.

FAQs:

What is common to both hedge funds and mutual funds?

Both hedge funds and mutual funds pool money and invest it according to a specific strategy. They are professionally managed investment vehicles that aim to generate returns for their investors. The key difference is that hedge funds can engage in more complex trading strategies like short-selling and leverage, while mutual funds are more strictly regulated.

What is the main difference between mutual fund management and hedge funds?

Mutual funds are open to all investors. Hedge funds can only be used by accredited investors meeting certain minimum income or net-worth requirements. The minimum ticket size is also much higher than mutual funds.

Mutual fund management invests in traditional assets like stocks and bonds, while hedge funds can also invest in unregistered securities and riskier securities. The mutual funds industry is tightly regulated, while hedge funds are not. The investment strategies used by mutual funds depend on the scheme category and have to adhere to certain guidelines. Hedge funds can freely use alternative strategies like short selling, hedging and leverage.

Also, hedge funds are lightly regulated with higher fees, while mutual funds operate under strict regulations with lower fees.

What is a hedge fund in simple words?

Hedge funds are private investment vehicles that use aggressive strategies to target high returns for wealthy accredited investors. They combine complex and unconventional investing techniques like short-selling, leverage, derivatives trading, and arbitrage.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.