Difference between Hedge Funds and Mutual Funds
Read this article to know the difference between the two types of mutual funds- Hedge Funds and Mutual Funds. Read about the type of investors of these funds, the risks involved in investing in Hedge and Mutual funds
Today many people are baffled by the term hedge funds and mutual funds. For those, who understand the intricacies of business, this may be appearing quite simple, but for an average Joe, the difference is pretty confusing. So, your first step should be to know how you are placed.
Objective of Mutual funds and Hedge funds scheme
Before jump starting further, let us know the objective of both the scheme.
Investment Objective- The primary objective of both the scheme is to provide the investor's maximum growth opportunity by pooling their funds in stocks (mutual funds) or derivatives(hedge funds) other growth oriented sectors of the economy.
Let's start with the terminology
Concept of Mutual Fund - Mutual Funds is a professionally managed fund that is ideal for the retail investors.
The performance report and portfolio analysis is mentioned in the document for your convenience. Remember, there is no guarantee that past performance will be sustained in the future. Returns below one year are absolute returns and above one year is Compound Annualized Growth Rate, calculated for dividend option. In some schemes it is presumed that dividends declared under the scheme are reinvested at the prevailing NAV.
Concept of Hedge Fund - While some people are of a notion that hedge fund is an instrument that allows you to invest in security that is publicly traded. It is a myth that needs to be debunked. Erstwhile, hedge fund permits you to invest in instruments like PIPE deals, futures, options, foreign exchange, etc. The term hedge fund signifies a fund that assists you to invest in various instruments available in the market through varied strategies.
Liquidity, risk and flexibility in Mutual funds and Hedge funds
The major bone of contention between hedge fund and mutual fund is described as below
Types of Investors- Retail investors park their funds in liquid/ ultra liquid schemes. Hedge funds are meant for sophisticated or elite investors.
Risk - The risk involved in mutual fund is less in comparison to hedge fund because a huge number of people park their funds in these professionally managed funds, but in latter case maximum of 100 to 500 investors can park their funds.
Paperwork- A mutual fund is offered through a prospectus; a hedge fund is offered through a private placement memorandum.
Liquidity - Mutual funds are considered as more liquid option in comparison to hedge funds. The hedge fund usually has lock in period, while in mutual fund you can withdraw the money according to your whims and wishes.
Absolute versus relative-Hedge funds primary objective is to produce absolute returns inspite of what markets perform. In mutual funds the performance is gauged by the index benchmark.
Self Investment - In hedge funds, it is expected that hedge fund manager will invest some of his own capital to maintain a trade off. If he does not self invest, it can be interpreted as red flag. In mutual funds it is not expected that mutual fund manager should invest in mutual funds to safeguard you against risk.
Flexibility - In hedge funds the hedge fund manager can sell short, use derivatives, in exchange. He can also make changes in the strategy accordingly; if he feels appropriate. In mutual fund, the mutual fund manager cannot be as flexible or he cannot make brash decisions. The managers tend to be cautious, as they are managing money of pool of people.
Performance of Mutual funds and Hedge funds
The performance depends upon- In Mutual funds the investment is stock, money market instruments, bonds, though there may be some exceptions. It is the reason why performance of mutual fund is subject to the market risk. In hedge funds you can invest in various instruments like derivative, real estate, art, website domains. So, the performance is not dependant upon the market conditions.
Rules and Regulation- There is no prohibition; if you are investing in mutual fund. Anyone can invest in it. The hedge funds have strict rules and regulations, so not anyone can invest in it.
Read Gold ETF or Gold Savings Fund, which gives you better returns?