Hedge Fund vs Mutual Fund

6 Mins

Mutual Funds are a common investment option that offers secure returns and helps you manage risks. Hedge funds are slowly gaining popularity in India but are not as widely accepted as mutual funds. Like mutual funds, Hedge Funds also pool investments from various investors and implement highly complex strategies to ‘hedge’ risks. Here is a comparison of Hedge Funds Vs Mutual Funds for your better understanding before investing in them.

What is a Hedge Fund?

Hedge mutual funds are set up as private investment limited partnerships. They are classified as a type of mutual fund and invest in securities.

Securities and Exchange Board of India (SEBI) defines them as follows “Hedge funds, including fund of funds, are unregistered private investment partnerships, funds or pools. They may invest and trade in many different markets, strategies, and instruments (including securities, non-securities, and derivatives). Hedge funds are not subject to the same regulatory requirements as mutual funds.” Hedge funds in India must not be necessarily registered with SEBI. They are also not bound to disclose their NAVs at the end of the day. Unlike other mutual funds, they are not required to follow the regulatory requirements of SEBI.

Who Should Invest in a Hedge Fund?

Hedge funds are privately managed mutual funds that are handled by experts. They are costlier than mutual funds making them affordable only for the financially well-off. In addition to owning surplus funds, an investor must also be an aggressive risk-seeker. Fund managers buy and sell assets at high speed as they try to keep up with the market movements.

Hedge Funds involve a higher risk owing to their structural complexity. Hence, they demand a higher expense ratio (fee to the fund manager) than regular mutual funds. It may range from 15% to 20% of your returns. It is not recommended for first-time depositors and is only fruitful for investors with considerable experience in the field. The success of a fund depends largely upon its fund manager. Therefore, invest in hedge funds only if you have full faith in your fund manager.

What is a Mutual Fund?

Mutual Fund is a trust for collecting money from investors. It invests them in different asset classes according to the investor’s investment objective. The investors share a common financial goal and mutual funds help to achieve them. Mutual funds can also be defined as a financial intermediary. They are set up with an objective to professionally manage the investors’ money.

Mutual fund investors can enjoy economies of scale by pooling their money. They can purchase stocks or bonds at much lower trading costs in comparison to direct investing in capital markets. Investors also get additional advantages such as diversification, stock, and bond selection by experts, lower costs, the convenience of investment, and flexibility.

The mutual fund allots units to each investor in accordance with the quantum of money invested. Each unit represents the proportionate ownership of an investor into the assets of a scheme. An investor’s liability in case of loss to the fund is limited to the extent of the amount invested.

Who Should Invest in Mutual Funds?

Investors with clear investment objectives should invest in mutual funds. You should have a moderate to high-risk appetite as all mutual fund investments are subject to market risks. Selecting the right mutual fund is also crucial as it should be in line with your requirements. You should also take into consideration the credibility of your fund manager before investing. This may also influence the expense ratio of your investment.

Mutual funds are ideal investment instruments for investors looking to diversify their portfolios while keeping risk under control. They are also recommended for investors who do not want direct exposure in equities markets.

Hedge Fund vs Mutual Fund: Key Differences

The basic structure of Hedge Funds is similar to that of Mutual Funds. They also identify as a pooled investment vehicle. A pool of investors collects money and a fund manager uses it to invest in other assets. But still, there are a few variations in this relatively new variety of funds.

The following table highlights the key differences between hedge funds and mutual funds.

Basis of Difference	Hedge Fund	Mutual Fund
Regulatory requirements	SEBI registration not required, and no disclosure of NAVs	Disclosure of NAVs is necessary at the end of the day
Investor category	HNIs, banks, commercial firms	Anyone
Underlying securities	Equities, money market instruments, currencies, real estate, derivatives, convertible securities	Equities, money market instruments, cash
Risk	Very High Risk	Comparatively lower
Minimum ticket size	INR 1 crore	Not uniform but as low as Rs. 500 in some funds
Minimum corpus	INR 20 crores	Not Defined
Investment strategy	Short selling permitted	Mutual funds cannot do short selling
Fees	Performance-based	Percentage based. Depends on the assets managed.
Transparency	Disclosure only to investors	Publishes reports and disclosure from time to time
Liquidity	Low	High
Fractional Units/ Shares	No	Yes

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Hedge Fund Vs Mutual Fund: Which is Better?

Mutual funds and hedge funds are investment options that suit a different set of investors. Hedge funds are high ticket investment options. Thus, not every individual can opt for hedge funds. Hedge funds are popular amongst high net worth individuals, institutions and corporations. On the other hand, mutual funds are suitable for all types of investors. You can start investing with as little as INR 500. Mutual funds allow you to invest either through lumpsum or SIP route. These are long term investment options that have the potential to generate significant growth.

Thus, depending on your financial position, investment objective, risk tolerance levels and investment tenure, you can pick the suitable option between a hedge fund and a mutual fund.

Frequently Asked Questions

What are the types of Hedge Funds?

Hedge funds can be classified depending on the securities they invest in and the kind of strategies for managing them.
Following are the different types of hedge funds:
Domestic hedge funds: A Domestic hedge fund is open to investors only from the origin country. They must be subject to the country’s taxation.
Offshore hedge funds: Offshore funds are established outside of the origin country. They may preferably be based in a low taxation country.
Fund of funds: Fund of funds are mutual funds that invest in other hedge mutual funds instead of individual underlying securities.

How does Hedge Fund work?

Hedge funds pool money from big investors like high-net-worth individuals (HNIs), endowments, commercial firms, banks, and pension funds. These funds fall under the Alternative Investment Funds (AIF) -category III. The pooled money is used to invest in securities, they may be listed in national and international markets. These securities can invest in equities, bonds, currencies, real estate, convertible securities, and futures and options.