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.
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.
- 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.
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