Hedge funds and mutual funds are both types of investment vehicles that pool money from investors to buy securities like stocks, bonds, or other assets.
Regulation and Structure
Mutual Funds
- Heavily regulated by the SEC (Securities and Exchange Commission) in the U.S. and similar bodies elsewhere.
- Must register, disclose their holdings quarterly, and adhere to strict investment guidelines.
- Available to the general public, with shares priced at the end of each trading day based on the net asset value (NAV).
Hedge Funds
- Face less regulation; they have more flexibility in their investment strategies but still must comply with securities laws.
- Can employ strategies that are often off-limits to mutual funds, like short selling, leverage, and derivatives.
- Typically only available to accredited investors or those with a high net worth, due to the higher risk and complexity involved.
Investment Strategies
Mutual Funds
- Usually follow a long-only investment strategy, meaning they buy securities with the expectation that they will increase in value over time.
- Focus on diversification, risk management, and long-term growth or income.
Hedge Funds
- Can use a wide array of strategies including:
- Long/short equity: Buying stocks expected to appreciate and short-selling those expected to decline.
- Market neutral: Aiming for gains independent of market movements.
- Global macro: Betting on macroeconomic trends.
- Arbitrage: Exploiting price differences between markets or securities.
- Aim to achieve absolute returns, often irrespective of the broader market’s performance.
Fees
Mutual Funds
- Typically charge a management fee, and sometimes a small load or front-end fee. The fee structure is usually straightforward.
- Common fee structure: 1% management fee.
Hedge Funds
- Operate under the “2 and 20” fee structure:
- 2% of assets under management (AUM) as a management fee, plus
- 20% of any profits as a performance fee, which incentivizes outperformance.
- Fees can be negotiable or vary based on the fund’s strategy or size.
Liquidity and Redemption
Mutual Funds
- Offer daily liquidity; investors can buy or sell shares at the end-of-day NAV.
Hedge Funds
- Often have lock-up periods where investors cannot withdraw their money. After this, there might be quarterly or semi-annual redemption opportunities.
- Some hedge funds use gates or side pockets to manage liquidity during stressful market conditions.
Performance and Risk
Mutual Funds
- Generally aim for steady, long-term growth with risk managed through diversification.
- Performance is benchmarked against market indices like the S&P 500 or a bond index.
Hedge Funds
- Aim for high returns regardless of market conditions, often with higher risk due to leverage and complex strategies.
- Performance is less about beating a benchmark and more about achieving positive returns in all market environments.
Transparency
Mutual Funds
- High transparency regarding holdings and strategy due to regulatory requirements.
Hedge Funds
- Less transparency; some investors might receive detailed reports, but the general public has less insight into what the fund holds and how it operates.