Overview for mutual funds vs hedge funds
Mutual funds vs hedge funds is a concept which explains the dissimilarities between the two terms. However, we must know in brief how these funds work in the market. Therefore, the two terminologies are explained below.
A hedge fund in prime brokerage accounting refers to the pool/vehicle of investment structure by a registered investment advisor or a money manager designed to receive a return. The structure briefly recognizes a limited liability company or limited partnership. They are complex and are heavily diversified.
It holds both short and long stocks because of which the risk management reduces. As a result, investors make money despite market fluctuations. The funds however serve rich investors due to the fees charged and higher risks involved as compared to other investments.
Also, a hedge fund is not necessary to get registered with SEBI (Securities and Exchange Board of India), with our market regulators or disclose NAVs during the day end. Whereas, the other mutual funds follow the regulatory requirements.
How does a hedge fund work?
Hedge funds(under prime brokerage accounting) invest in debt, bonds, real estate, currencies, convertible securities, derivatives (futures and options) equities because of which they use different types of trading techniques. There are different hedge funds(for mutual funds vs hedge funds) relying on the kind of strategies used to manage them and on the securities they invest in.
For example, to trade with debt and equities, the trading technique can be to operate in the stock market or purchase directly in a private placement from the company.
However, in the case of derivatives with futures, there lies an obligation to purchase or sell an underlying stock at a predetermined rate. Whereas, with options, the scenario remains the same just without an obligation. As a result, securities investment of such kind diversifies trading methods.
Types of Hedge Funds
There are 4 types of hedge funds (for mutual funds vs hedge funds) :
Fund of funds
These are majorly the mutual funds that invest in another hedge fund rather than individual securities. It briefly explains that one fund invests further in other types of funds containing various underlying assets rather than directly going for stocks or other securities.
Offshore hedge fund
Preferably established in a low taxation country, an offshore hedge fund is formulated outside our own country.
Domestic hedge fund
As the name suggests, these types of hedge funds are only open for investors that are subject to the taxation of the origin’s country.
These types of hedge funds are individual funds where the entire investment is made by investors where the fund manager will divert the funds from the standalone itself. Also, they are easy to report but do not get tax benefits.
Different Strategies of investing Hedge Fund
A hedge fund (for mutual funds vs hedge funds) can also be differentiated by the strategies adopted by its fund managers to maintain funds which sometimes makes it higher on the risk management rack.
Market neutral funds often seek to minimize market risks. Moreover, it includes long and short equity funds, convertible bonds and fixed-income arbitrage.
It refers to the situation where investment is done to take advantage of corporate events price movements. For example, distressed asset funds and merger arbitrage funds
The word defines purchasing security from security market trading at a low price and selling it in a higher price market for some profit. However, exchanging very high correlated securities( asset class or multiple ones) simultaneously when markets move sideways for some profits is known as relative value arbitrage.
By literal meaning, short selling refers to the selling of security without actually buying it but with a notion to purchase it at a predetermined future price and date. The investor expects the share price to drop on the future date and book profits.
These funds also advantage from the global market trends. Hedge funds under prime brokerage accounting note the global macros and the way it impacts equities, interest rates, currencies and commodities.
Note: The fees include both profit sharing ( varying from 10-15%) and management fees which is generally less than 2%. The minimum amount to invest in a hedge fund(for mutual funds vs hedge funds) is 1 crore per investor while the entire fund has to be at least a corpus of 20 crores.
What are Mutual funds?
A mutual fund(for mutual funds vs hedge funds) is termed as an investment vehicle formed when a fund house or an Asset Management Company (AMC) pools money or investments from different institutional investors and individuals with common objectives. A finance professional generally known as a fund manager handles the pooled investments.
They serve as an excellent option for investment concerning individuals to get exposure to an expert managed portfolio. Moreover, the portfolio can diversify if the mutual funds(for mutual funds vs hedge funds) are invested as an asset allocation covering a variety of instruments. Each investor experiences losses or profits directly proportional to the amount invested by them.
Here, the main idea of the fund manager lies to provide optimum returns to the clients or investors by investing in securities that go apt with the fund’s objectives.
Benefits and Risks
Mutual funds (for mutual funds vs hedge funds) offer professional potential diversification and investment management. As a result, there are 3 ways to earn money which are as follows:
Increased NAV(net asset value)
If the MV(market value) of a fund’s portfolio increases after deducting its expenses, therefore, there will also be an increase in the value of the fund and its shares.
Capital gains distributions
There is a possibility that there is an increase in the price of the securities in a fund. When a security is sold by a fund that has increased in price, there is a capital gain. At last, the fund distributes the capital gains to the investors subtracting any capital losses.
A fund (for mutual funds vs hedge funds) can also earn incomes from interest on bonds or dividends on stock. Following the same, a fund pays all the shareholders their income minus the expenses.
Risks: There is a risk present in all kinds of funds. However, in the case of mutual funds(for mutual funds vs hedge funds), one may lose a few or all money invested because security may fall in value. Due to the dynamic market conditions, interest payments and dividends may also vary.
Generally, it is thought that a fund’s past performance predicts future returns but it is not as important. The past performance can explain to the investor the stableness or volatile nature of a fund over some time. The higher the volatility of the fund, the higher is the investment risk.
Types of Mutual Funds
After knowing what mutual funds(for mutual funds vs hedge funds) are, there is a brief on the types of mutual funds and the benefits provided by them. They can be classified on the following characteristics based on:
- Asset class
- Investment goals
- Specialized mutual funds
Based on Structure
Here, the differentiation is basically on the flexibility to sell and purchase the individual mutual fund units.
- Closed-ended funds: In this type(for mutual funds vs hedge funds), the unit capital is predefined which is to be invested which explains that the company cannot sell more than the pre-agreed number of units.
- Open-ended funds: They do not have a specific constraint like a specific period or units which can be traded. It provides investors with the convenience and exit when required at prevailing NAV.
- Interval funds: They have both the traits of closed as well as open-ended funds. These funds are open for redemption or purchase during specific intervals while closed the rest of the time.
Based on Risk
- High risk: These funds are ideal for ones (aggressive investors) who wish to take high risks and are looking to build their wealth.
- Medium risk: They are ready for medium risk amounts (or moderate investors) which builds wealth over a longer period comparatively.
- Low risk: They do not take the risk with their money and low returns. They make investments at places like the debt market with long term ideology.
Based on Asset Class
- Equity funds: These are the high-risk funds with higher returns with an investment in equity shares or stocks of the company.
- Debt funds: They require an investment in debt instruments like government bonds, company debentures etc. Debt funds provide fixed returns and are considered to be safe investments.
- Hybrid or Balanced funds: These funds(for mutual funds vs hedge funds) invest in a mix of asset classes. The risk and returns are balanced where sometimes the proportion of equity is high while in others debt is more.
- Money market funds: These funds invest in a liquid instrument like commercial paper, treasury bills etc. Safe investments with moderate returns and risks in terms of credit risk, interest risk and reinvestment risk.
Based on Investment goals
- Income funds: Money gets invested in fixed income instruments such as debentures, bonds etc with the objective of regular income and capital protection to the investors.
- Growth funds: Here, money is invested in stocks of equity for capital appreciation. The investors who think of the long term timeline and are ready to take the risk, growth funds become ideal ones.
- Tax saving funds: They(for mutual funds vs hedge funds) invest primarily in equity shares that qualify for deductions under Income Tax Act.
- Liquid funds: With the motive of short term investments, the money is invested like in T-bills, CP’s etc for liquidity. They determine low risk with moderate or average returns.
- Fixed maturity funds: Here, the assets are enrolled in money market instruments or debt where the maturity date is either the same as that of the fund or before it.
- Capital protection funds: These investments are split between equity markets and fixed income instruments which ensures the protection of principal invested.
- Pension funds: pension funds are chosen when the investor has a long term goal in mind. They provide regular returns to investors majorly when he is ready to retire.
Based on Speciality
- Index funds
- Sector funds
- Emerging market funds
- Fund of funds
- Global funds
- International funds
- Commodity focussed stock funds
- Real estate funds
- Inverse/ Leveraged funds
- Market neutral funds
- Guilt funds
- Asset allocation funds
- Guilt funds
- Exchange-traded funds
Mutual funds vs hedge funds
Talking about mutual funds vs hedge funds, we first take into account a brief of their similarities. Both mutual funds and hedge funds are built from pooled funds and are managed portfolios. They target achieving returns through diversification. The pooling of funds explains that a manager of a group of managers uses investment from multiple clients to invest in securities available in the market that fulfil their objectives or strategy.
Mutual funds are offered by institutional fund managers with different options available for institutional and retail investors whereas hedge funds target high-net-worth investors. They require that the investors meet accredited characteristics.
Discussing mutual funds vs hedge funds or the dissimilarities are mentioned below. However, the major difference can be that mutual funds are high accessible whereas hedge funds are not.
Mutual funds can be easily used by the general public since the minimum amount can start from Rs. 500 as well which is way too high in the case of hedge funds. Also, there are specific groups only that are allowed to invest in hedge funds. Therefore, the discussion is explained in detail for mutual funds vs hedge funds.
Table for mutual funds vs hedge funds
|Basis||Mutual funds||Hedge funds|
|Definition||Mutual funds pool from the investors their savings to prepare a group of securities at attractive costs.||Hedge funds are accounted as a portfolio of investments where investors pool their money to buy assets.|
|Investors||Limited disposable income of retail investors||Firms and individuals with high-risk appetite and net worth.|
|Management style||Line with objectives and less aggressive||Highly aggressive|
|Performance fees||Charged as a percentage and based on assets managed||Depends on performance|
|Transparency||Regular disclosure on the performance of assets and annual reports.||Information is disclosed to the investors only.|
|Regulation||Exchange regulates the mutual funds(like SEBI in India)||Limited regulation|
|Fund manager||No compulsory involvement||The required investment of personal money|
Explanations for Mutual funds vs Hedge funds
The main idea of mutual funds is to offer returns over the risk-free rate of return, by the market. However, hedge funds provide maximum possible returns from the investment made by the clients that count as the key point in mutual funds vs hedge funds.
Secondly in mutual funds vs hedge funds, a mutual fund is a vehicle in which funds gathers from various investors hold by the fund manager for buying basket securities from the stock market. While in hedge funds only a few investors contribute to buying the assets and are termed as a portfolio of investments.
Thirdly, in mutual funds vs hedge funds, the investors for mutual funds are retail clients or common man who diversify their limited disposable income in them with a motive of growing their funds. While hedge funds include individuals with a huge appetite for risk with a desire for high returns in a short span.
Forth for mutual funds vs hedge funds, those serving the mutual funds do not hold a substantial interest for the working of the fund. Whereas the ones serving hedge funds should compulsorily have a large share in the corresponding fund. This is usually done to generate a level playing on the field and prevent any detrimental decisions to the overall interest of the fund.
Fifth coming up for mutual funds vs hedge funds, mutual funds need strict regulation by the SEBI or Securities Exchange Board of India of the corresponding country which is not in the case of hedge funds.
Sixth in mutual funds vs hedge funds, the mutual funds need to completely publish their annual reports or balance sheet yearly along with a quarterly performance of assets. The disclosures also have to be made public in addition to a statement being sent to all investors. Although the hedge funds have to disclose only to established investors without any public step to be followed.
Fees paid for the management for mutual funds lies on the percentage of asset managed while for hedge funds it depends on the performance of assets.
Talking for mutual funds vs hedge funds, the mutual funds start with a minimum amount of Rs 500 while hedge funds need $10 million for each investor.
Next for mutual funds vs hedge funds, the mutual funds can be redeemed easily (open-ended funds) since the invested amount is less. Whereas hedge funds have a long lock-in period like three years because of which redemption becomes difficult. The redemption is made in blocks with a condition saying 100% amount cannot be redeemed.
For mutual funds vs hedge funds, the mutual funds have a secondary market that allows customers to sell their units to customers and liquidate without the need of actually paying back the fund. While hedge funds there is no active secondary market since the units are exclusive.
Lastly in mutual funds vs hedge funds, mutual funds manager have to stick to the strategy that agrees upon at initiation while hedge funds allow making changes since they are aggressive.