Hedge Fund vs. Mutual Fund

Hedge funds are investment partnerships where a few accredited investors pool their money into an investment portfolio comprised of relatively risky assets.

Mutual funds are a broader, more accessible, and more affordable form of investment fund with a diverse selection of actively and passively managed investments.

Scenario	Hedge Fund	Mutual Fund
Objective	Hedge funds aim to generate high returns for their investors by using various investment strategies, often with higher risk profiles.	Mutual funds aim to provide investors with a diversified and professionally managed portfolio of stocks, bonds, or other assets, typically with a lower risk profile.
Regulation	Hedge funds are less regulated than mutual funds and often cater to accredited or high-net-worth investors.	Mutual funds are heavily regulated and open to a wide range of investors, including retail investors.
Investor Eligibility	Hedge funds often require investors to meet minimum income or net worth requirements, limiting access to accredited investors.	Mutual funds are accessible to a broad range of investors, including retail investors with varying investment amounts.
Liquidity	Hedge funds typically have less liquidity, with lock-up periods during which investors cannot withdraw their funds.	Mutual funds offer daily liquidity, allowing investors to buy or sell shares on any business day.
Transparency	Hedge funds often provide limited transparency into their investment strategies and holdings, keeping their methods proprietary.	Mutual funds are required to disclose their portfolio holdings regularly, providing transparency to investors.
Fees	Hedge funds charge higher fees, typically a management fee (usually 1-2%) and a performance fee (often 20% of profits).	Mutual funds charge lower fees, primarily consisting of an annual expense ratio, which can vary but is generally lower than hedge fund fees.
Investment Strategies	Hedge funds employ a wide range of investment strategies, including long-short, arbitrage, derivatives, and alternative investments.	Mutual funds primarily invest in traditional asset classes such as stocks, bonds, and cash equivalents, following specific investment objectives.
Risk Profile	Hedge funds often have a higher risk profile due to their use of leverage, derivatives, and alternative investments.	Mutual funds tend to have a more conservative risk profile, focusing on long-term capital preservation and moderate returns.
Performance	Hedge funds aim for higher returns but come with greater volatility and risk. Performance can vary widely among hedge funds.	Mutual funds seek more stable, benchmark-aligned returns, aiming to track or outperform market indices within their asset class.
Tax Efficiency	Hedge funds may have tax advantages like the ability to defer taxes on gains through strategies like tax-efficient trading.	Mutual funds distribute taxable capital gains to shareholders, potentially resulting in tax consequences for investors.
Lock-Up Periods	Hedge funds often have lock-up periods, during which investors cannot withdraw their capital. These periods vary by fund.	Mutual funds typically do not have lock-up periods, providing investors with daily liquidity.
Diversification	Hedge funds may offer limited diversification, depending on their specific strategy and holdings.	Mutual funds provide investors with diversification across a range of asset classes and securities.
Exit Strategy	Hedge fund investors may exit through periodic redemption windows, typically at the end of specified periods, with potential penalties for early withdrawal.	Mutual fund investors can exit at any time with daily liquidity, and redemption typically incurs no penalties.
Access to Strategies	Hedge funds may offer access to strategies and assets that are not readily available in traditional markets, such as private equity or distressed debt.	Mutual funds provide access to standard asset classes and investment strategies commonly available in public markets.

Table of Contents

Understanding hedge funds

In short, hedge funds are a private and riskier type of investment fund where only accredited investors are allowed to participate.

Some of the main characteristics of a hedge fund include:

Aggressive and diverse investment strategies designed to maximize returns. These include stocks, derivatives, short positions, commodities, and other alternative assets.
Minimal regulation. Most are structured as general partnerships and are not subject to intense scrutiny from the Securities and Exchange Commission (SEC).
Strict eligibility criteria. Hedge funds are only open to accredited investors who meet certain criteria related to income, net worth, asset size, or professional experience. Thus, most hedge fund investors tend to be wealthy individuals, pensions, foundations, insurance companies, or university endowments.
Limited windows to invest or withdraw capital. Some funds will even suspend withdrawals during market downturns to avoid a portfolio-wide sell-off.
Fees which normally comprise both a management fee (around 2%) and a performance fee which can be anywhere between 10 and 30%.

Understanding mutual funds

Mutual funds are similar to hedge funds in that they pool investor funds to purchase securities. Unlike hedge funds, however, mutual funds invest in lower-risk, lower-return stocks and bonds.

Some of the main characteristics of a mutual fund include:

An investor cohort comprised of individuals, companies, and organizations. Some prefer the lower risk of a mutual fund, while others use them because of the difficulty in acquiring a basket of securities themselves.
Lower minimum investment requirements. The price of entry to some mutual funds can be as little as $250, but an amount closer to $3,000 is more typical.
One-dimensional trading strategies. Most mutual funds do not dabble in derivatives or other alternative investments, which makes them more appealing to the average retail investor. Each strategy takes a long-term view to profit realization.
Lower fees but more regulation. Mutual funds experience comparatively higher regulation than hedge funds which means managers are limited in the types of fees they can charge. Indeed, most mutual fund management fees are around 1-2%.

Key differences between hedge funds and mutual funds

As we have learned, there are quite a few differences between hedge funds and mutual funds. In fact, one of the only similarities is the way in which funds are pooled before they are invested.

Hedge funds are riskier, private, short-term investments that are only accessible to accredited investors. Mutual funds are less risky, longer-term investments that are open to retail investors and other interested entities. Risk is reduced since mutual funds invest in stocks, bonds, and other securities that tend to be less volatile.

The fee structure of a hedge fund may be considered exorbitant to some since the manager collects a management fee irrespective of how the fund performs. But it is worth keeping in mind that many hedge fund managers have also invested their own money and, as a result, have a vested interest in ensuring the fund performs well.

Top Hedge Funds:

Bridgewater Associates: Founded by Ray Dalio, it’s one of the world’s largest hedge funds.
Renaissance Technologies: Known for its Medallion Fund, which has achieved remarkable returns.
Man Group: The world’s largest publicly traded hedge fund.
Two Sigma: Known for its systematic and quantitative investment strategies.
BlackRock: While primarily known as an asset manager, it also operates hedge funds.
Elliott Management: A multi-strategy fund known for its activist strategies.
AQR Capital Management: Focuses on quantitative strategies.

Top Mutual Funds:

Vanguard 500 Index Fund (VFIAX): One of the largest mutual funds, it tracks the S&P 500 index.
Vanguard Total Stock Market Index Fund (VTSAX): Provides exposure to the entire U.S. stock market.
Fidelity Contrafund (FCNTX): A large-cap growth fund with a long history of strong performance.
T. Rowe Price Growth Stock Fund (PRGFX): Focuses on large-cap growth stocks.
American Funds Growth Fund of America (AGTHX): A diversified growth fund.
PIMCO Total Return Fund (PTTRX): One of the most prominent bond mutual funds.
Dodge & Cox Stock Fund (DODGX): A fund with a focus on value investing.

Key takeaways:

Hedge funds are investment partnerships that tend to invest pooled funds in a wide range of relatively risky financial products. Mutual funds are more accessible investment funds with a diverse selection of actively and passively managed options.
Hedge funds are characterized by aggressive investment strategies, higher fees, less regulation, and stringent eligibility criteria. There may also be limits on how capital can be accessed – particularly during market downturns.
Mutual funds tend to be comprised of retail investors and other interested entities who prefer a lower-risk, long-term investment approach. Some mutual funds will allow investors to join for an outlay of just $250.

Key highlights:

Hedge Funds:

Definition: Private and riskier type of investment fund open only to accredited investors.
Investment Strategies: Aggressive, diverse, and designed to maximize returns; can include stocks, derivatives, commodities, etc.
Regulation: Minimal; not under intense scrutiny from the SEC.
Eligibility: Strict criteria related to income, net worth, asset size, or professional experience.
Investment & Withdrawal: Limited windows; some suspend withdrawals during market downturns.
Fees: Combination of management fee (~2%) and performance fee (10-30%).

Mutual Funds:

Definition: Broader, more accessible investment funds pooling investor money for securities; lower-risk, lower-return stocks and bonds.
Investor Base: Individuals, companies, and organizations; open to retail investors.
Minimum Investment: Low, sometimes as little as $250, but typically around $3,000.
Trading Strategies: One-dimensional, long-term; usually avoid derivatives or other alternative investments.
Regulation & Fees: Higher regulation, hence limited fee types; management fees around 1-2%.

Key Differences:

Accessibility: Hedge funds are private and for accredited investors; mutual funds are public and more accessible.
Risk: Hedge funds are riskier, investing in a wider range of financial products; mutual funds are less risky, focusing on stocks, bonds, etc.
Investment Duration: Hedge funds often have short-term strategies; mutual funds lean towards longer-term.
Fee Structure: Hedge funds charge both management and performance fees; mutual funds usually charge management fees only.