Mutual fund and Hedge fund are two things we hear about all the time and except for a few basic details, we don’t know much about them at the same time, and we don’t know how they differ.
In this blog, we will discuss about the differences between Hedge fund vs Mutual Fund. If you’re an investor in the financial market, it’s probably best that you know how these two entities differentiate and make up your mind towards investment.
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Hedge Fund vs Mutual Fund are two different types of Investment and there is a big difference between these two.
Difference between Mutual Fund and Hedge Fund:
Both Mutual fund and Hedge fund are considered institutional investments.
What that means, is these guys are the big money of the market. They mainly drive the market up or down.
Average-day regular traders or investors are considered retail investors, whereas institutional investors usually have a lot more money to invest.
There are a lot more sophisticated methods in their investment pattern, and people often use that as a selling point when they’re trying to buy or sell securities.
I will be a lot calmer and sleep better at night when I know that institutional investors have their money in the same assets that I invest in.
So both hedge funds and mutual funds directly invest in financial assets aiming for growth and performance.
Both are run by a team with a hierarchy, starting from the top guys, which are the fund managers, and eventually trickling down to senior associates, junior associates, analysts, et cetera.
The structure of both hedge funds and mutual funds is that they pull capital from investors, meaning they take your money and they invest it for them.
Although it sounds like a nice idea, they’re not doing this out of the goodness of their hearts. They’re doing it to make a profit and take a cut of those profits as a fee for their services.
There are a lot more differences and similarities in regulations and stock holding disclosures.
Mutual funds are highly regulated entities. The reason they are much more regulated and restricted is because they invest a lot of the public’s money.
If you go to any one of your banks and you have a decent amount of money, you’ll probably get a recommendation to invest your money with a mutual fund, it’s usually one of the funds they offer.
Whereas hedge funds have a lot fewer investors and don’t generally hold the public’s money.
Hedge funds are often very strict on who they get to invest with them. They usually accept the concept of what’s called a sophisticated investor.
Now, a sophisticated investor doesn’t have to be sophisticated at all. A sophisticated investor just means you have a personal income of $200K a year, or you and your spouse have a dual income of $300K a year along with the fact that they are more strict in who they have invested in them.
They’re a lot more discreet on their investment strategy and philosophy as well. If you want to find information about a mutual fund, their information is often very public.
They tell you about their philosophy with some time. They’ll tell you exactly what they’re invested in, where they’ve made the money, etcetera.
Many people hold their money with a hedge fund and have no idea whatsoever as to where their money is at any given point in time.
Hedge funds do not disclose their positions until many ways down the road. They do this because it is sensitive information and the advantage for them is to act first and find opportunities.
The investment strategies of Hedge fund vs Mutual fund differ a lot.
Investment strategies are always acting first and finding opportunities, that’s where number 2 comes into the picture.
Hedge funds are exceptionally more sophisticated in their investment strategies. This means they engage in all different types of investment strategies.
Most are very advanced and their investment strategies. These include short selling, buying distressed securities, buying mezzanine debt, using options and derivatives, synthetic assets, micro craft, super volatile stocks. These are just to name a few.
They also take up very concentrated positions, meaning they do not hesitate to allocate high portions of the funds capital to one specific position.
Mutual funds, on the other hand, are often long equity funds.
What this means is they buy stocks simply with the aim of them going up. They’re very regulated and they don’t engage much in selling shorts and all the other various types of these sophisticated investments because these usually tend to be very risky and much more volatile.
The payoff is much more rewarding as well. Keep in mind, the standard rule and this may vary from country to country and region to region is that mutual funds cannot invest more than 5% of the total funds capital to any one specific position.
So let’s say, for example, you have a mutual fund worth $100,000. That means you cannot invest more than $5,000 into any one stock.
Now, this can kind of be a bad situation. Imagine you found the opportunity of a lifetime in the stock market. You know, with a great amount of certainty that the stock is worth more than what is selling at the current market price.
If you are a Mutual Fund manager, you’d only be able to invest 5% of the fund capital and therefore your return might not even be that great.
However, if you’re a hedge fund, you can invest astronomically more amount of your funds capital and you probably will because you’re looking for that raw and high level of profit that’s associated with.
Mutual funds are very much not in that category and because mutual funds strategy is often just a long equity fund, they are benchmarked much more heavily toward market indexes.
The reason for this is because the quantity of investors they have in their funds is so astronomically high, we’re talking about millions of people.
In many cases, they have to kind of beat a specific index that they are paired against. So for example, if a mutual fund is invested in North American stocks, they’re probably going to be benchmarked against the S&P 500 or Nasdaq 100, If you want to know more about these please read our article on “Nasdaq 100 vs S&P 500”.
This investment in mutual funds makes sense because the investments that they’re making are within these indexes.
Beating the market is a huge plague on mutual funds because if they can’t beat the market. There’s no reason for an investor to give their money and pay the expense ratios associated with investing in them.
The investor has a much larger incentive to just buy the index fund and buy the so-called market. You buy an ETF or a broad market index fund whose performance is made to reflect the market.
Hedge funds don’t invest in that way, they’re not benchmarked against the S&P 500, or any other big index.
Hedge funds are not looking at their performance on a year-to-year basis. They engage in such highly sophisticated strategies, sometimes when they find an opportunity.
The payoff is not going to be the next day, it could take years to unravel.
So those are just some key and distinct differences and similarities between hedge funds and mutual funds.
Hope you liked this article on “Hedge Fund vs Mutual Fund”. Please read our other article on “ETF vs Mutual Funds vs Index Fund” difference.