Mutual Fund vs Hedge Fund Top 7 Differences You Must Know

Each individual or organisation desires their money to grow at a rapid pace for which they have to make investments. A variety of investments exists, some offer larger return but may have to bear larger risks and vice-versa. In this regard, we will go through the investment options pertaining to Mutual Funds and Hedge funds with the key differences between them.

Both Mutual funds andhedge funds are an investment vehicle which will pool in money from various investorswith the objective of multiplying them in a quick time and proportionate level of risk depending on the appetite of the investors. Both these funds are managed by a professional fund manager.

Let us understand each of the options in details with the differences between Hedge funds and Mutual Funds

Below infographics compares the Hedge funds vs Mutual Funds.

Now that we know the top level differences between Mutual Fund and Hedge Fund, let us look at each one in detail.

A mutual fund is an investment vehicle which will pool money from multiple investors for purchasing securities. These funds are generally risk-averse in nature and focus on regular increase in the investment made in the stock market. They are regulated by the exchanges and hence it is mandatory for them to issue a prospectus which will clearly state out the objectives of the fund and the strategies to be implemented by them. Accordingly, they have to abide by the same which in turn shall infuse confidence in the investors.

Retail investors who have limited savings for investment purpose in turn become inclined towards this area of investment. Such funds offer limited returns but in turn more security in the principal investment which has been made. The funds are managed by a professional fund manager who has to manage the funds within the limits of the prospectus and maximise the returns within the ambits of the law. It is not mandatory for the fund manager to include their personal investment. Some of the other important advantages of mutual funds are:

Increased diversification towards many securities which in turn reduces concentration risk

Transparency and Easy comparison through annual reports and periodical disclosures on the performance

Ability for investment participation in areas largely available to large investors e.g. Investment in foreign markets which may not be directly accessible to individual investors.

Open ended mutual funds can offer liquidity on a daily basis as the shares of the funds can be sold at a price equal to the NAV of the fund.

Despite some many advantages, there are some drawbacks which one should take note of:

Opportunity for customising the fund is relatively less

As the fund has to adhere to the objectives of the fund, if an opportunity for gains is outside the purview, it cannot be pursued.

There are 3 primary structures of mutual funds:

Most of the mutual funds are open ended which permits investors to buy and sell the units at any point of time at the NAV (Net Asset Value). This NAV of the entire fund is computed based on the price of the securities owned by the fund. Such a benefit offers cushion to the investors for enhancing their returns during bullish markets or relevant liquidation during choppy market conditions.

These funds issue shares to thepublic only once during the IPO (Initial Public Offering).The shares are listed on the stock exchange and shares can be sold only to another investor in the market and not to the fund. The price which investors can garner for their investment may differ from the NAV and could either be at a Premium or at a Discount of the NAV.

These trusts issue shares only once upon their creation with the overall portfolio also remaining unchanged. They generally have a restricted life span whereby the investors can redeem shares directly from the fund at any point of time or can choose to wait till the termination of the trust. Such funds do not have the services of a professional fund manager.

Also, have a look at the following articles for deeper understanding

A hedge fund is an Investment pool which is responsible for Private collection of funds with the use of Diverse and Aggressive Strategies for the purpose of earning Regular and above normal returns for their investors. The investors are less in number but occupy a very healthy base. Investors are generally from the affluent sections possessing a very large risk appetite for absorbing losses which can hamper the entire capital investment. As an entry criterion, the Offering Memorandum of a hedge fund states the minimum investment required to be made by prospective investors and in most of the cases, this amount is not less than $10 million.

The fund is continuously managed by a Hedge Fund Manager who is completely responsible for the regular functioning and decisions of investment which will have an impact on the performance of the fund. Hedge funds with Assets under Management (AUM) exceeding $100 million are mandated to be registered with the U.S. Securities and Exchange Commission. Additionally, hedge funds are not required to make periodic reports under the Securities Exchange Act of 1934.

Let us study some of the important benefits of these funds:

Hedge funds seek to protect the Profits and the Capital amount from declining markets by using various hedging strategies. They can take advantage of falling market prices:

Utilising tactics such as Short Selling whereby they shall sell the securities with a promise to buy them back at a later date

Adjust to the trading strategies according to the existing market conditions.

Extracting the benefits of wider asset allocation and diversification

Hence, for e.g. if a portfolio includes shares of a Media company and Cement sector and if the government offers some benefits to the Media sector but imposes additional charge on the Cement sector, then in such cases the benefits can outshine the possible declines in the cement sector.

Generally, Managers do not have any restrictions in their choice of investment strategies and possess the ability to invest in any asset class or instrument. The role of the fund manager is to maximize the capital as much as possible and not beat a particular level of benchmark and be content. Their individual funds are also involved which should act as a booster in this case.

The ability to make profits in volatile market conditions equips them to generate returns that have little correlation to traditional investments. Hence, it is not essential that if the market is falling down, the portfolio has to be making a loss and vice-versa.

One of the unique and mandatory criteria is that the fund manager must be one of the large investors in the fund which will make them cautious while considering relevant investment decisions.

Perhaps, one of the most popular structure, this involves the funds to be invested by the investors into the feeder, which will then consolidate to the master fund. It is from this master fund, the fund manager will further invest in purchasing of various assets. This is done to gain tax benefits as the feeder will allow investment from around the globe. Structurally, it is easier to manage and report to the investors as well.

These are individual funds whereby all the investments are made by the investors and the fund manager will divert the funds from these standalone funds itself. Generally, such funds do not get tax benefits but are relatively easier to report.

This is an investment strategy whereby one fund will further invest in other types of funds containing different underlying assets instead of direct investments in stocks and other types of securities.

Additionally, you may have a look at these following articles for in-depth understanding.

Mutual Fund vs Hedge Fund   Key Differences

A mutual fund is an investment vehicle whereby the funds are consolidated from several investors managed by a professional fund manager for purchasing a basket securities from the stock market. On the other hand, hedge funds are a portfolio of investments whereby only a few established investors are permitted to contribute for purchasing of assets.

The objective of mutual funds is to offer returns in excess of therisk free rate of returnwhich is being offered by the market whereas hedge funds aim to offer maximum possible returns from the investment made.

The investors of mutual funds are retail investors (common man) who divert their limited disposable income in these funds with the hope of growing their money whereas those making investments in hedge funds are generally HNIs or established individuals with a large appetite of risk. These investors make very large investments and desire very high returns in a quick time.

Though both types of funds are managed by a professional fund manager, a mutual fund manager does not hold a substantial interest in the working of the fund. Hedge fund managers have a mandate to hold a large share in the respective fund to generate a level-playing field on the part of the manager and prevent any decisions that can be detrimental to the overall interest of the fund.

Mutual funds are tightly regulated by the Securities exchange board of the respective country which is not essential in the case of Hedge funds.

In terms of transparency, mutual funds have to completely adhere in the form of yearly publishing of annual reports/balance sheet in addition to quarterly performance of assets. These disclosures have to be made public with the statement being sent to all the investors stating the overall performance. Hedge funds offer the information only to the investors without any public disclosure of information.

The Management fees for mutual funds depend on the percentage of assets managed whereas for hedge funds, the fees are based on the performance of the assets.

Numerically, mutual funds have a large number of investors with each having a limited investment [as low as Rs.500 ($8.33)] whereas hedge funds have a small number of very large investments by each investor [minimum $10 million investment].

The redemption of mutual fund is relatively easier (open ended funds) to execute since the amount of funds is relatively less and whereas in hedge funds, the lock in period is a long time (generally 3 years) due to which redemption is not possible. Subsequently, redemptions are made in blocks and 100% amount cannot be redeemed.

Basis for Comparison  Mutual Fund vs Hedge Fund

These funds pool in savings from investors to prepare a basket of securities from the market at attractive costs.

A portfolio of investments whereby few established investors pool money to purchase assets.

Retail investors with limited disposable income

High Net worth individuals and firms with high risk appetite

Based on the assets managed and charged as a Percentage

Regulated by the Exchange (e.g. SEBI in India)

Annual reports and regular disclosure on performance of assets

Both Mutual funds and Hedge funds are known investment vehicles whose objective is to enhance the principal amount given by outsiders with the aim of growing money. It is the pace and strategies adopted by these funds which makes the difference in garnering the returns.

Mutual funds are targeted towards the retail investors who are risk averse but will prefer their money growing at a constant pace over a long period of time whereas hedge funds believe in extracting the maximum possible benefit from the very large investments made by established investors. These investors want to make maximum possible gains and accordingly are ready to absorb equivalent risk.

Though the regulation and disclosures for both these structures differ, it all depends on the investment objective of the investor and the amount of risk they are ready to absorb. The investor will accordingly have to structure their decision making.

This was the comparison between Hedge Funds and Mutual funds. Please go through the following posts for detailed learnings

Filed Under:Asset Management in FinanceMutual Funds Basics

worked as JPMorgan Equity Analyst, ex-CLSA India Analyst ; edu qualification – engg (IIT Delhi), MBA (IIML); This is my personal blog that aims to help students and professionals become awesome in Financial Analysis. Here, I share secrets about the best ways to analyze Stocks, buzzing IPOs, M&As, Private Equity, Startups, Valuations and Entrepreneurship.

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