Private Equity vs Hedge Fund: Know the Key Difference

Hedge funds and private equity are both alternative investment funds (AIFs) regulated by the Securities and Exchange Board of India (SEBI) under the Alternative Investment Funds Regulations, 2012. They are high-risk investments that invest in marketable securities and private companies.

Though they target mainly high-net-worth individuals (HNIs) and institutional investors, these investment vehicles vary based on investment structure, strategy, risk, fees, and taxation.

Let us cover hedge fund vs private equity in detail. 

What are Hedge Funds?

Hedge funds are alternative investments that pool money from investors with similar objectives and invest in shares, private equities, debt, real estate, currencies, commodities, etc. But hedge funds aim to offer a higher return at a much higher risk. These funds fall under AIF Category III. 

The minimum investment in a hedge fund per investor is ₹1 crore. Thus, it is suitable for high-net-worth individuals, institutional investors, banks, insurance companies, pension funds and endowments.

The hedge fund expense ratio consists of management and performance-based fees. The management fee is usually around 2%, and the performance fee is between 10% and 20%.

Capital gains on hedge funds are taxable at the fund level. In other words, the individual investor does not have any tax liability. However, the fund deducts taxes from the investors’ profit, automatically reducing the investors’ returns.

What are Private Equity Funds?

Private equity is a type of alternative investment fund that falls under the AIF Category II. They primarily invest in unlisted companies. Private equity funds also participate in buyouts of public companies that result in the delisting of the company. Private equity firms usually provide initial investments for new companies, including seed capital, venture capital, and angel investments. Hence, private equity firms get ownership in the companies.

Private equity funds are closed-ended alternative investment funds that do not accept investments after the initial period expires. These funds’ investment horizon is usually around seven to ten years as they invest in early-stage companies. Private equity investments are less riskier than hedge funds, as they invest in unlisted companies. Also, these funds have a lock-in period of 5-7 years. 

The expense ratio of a private equity fund is based on a hurdle rate. The fund will charge an incentive-based fee only after the hurdle rate is crossed. If the fund fails to achieve returns higher than the hurdle rate, the private equity fund will not charge any incentive-based fee. Private equity falls under Category II AIFs, and the capital gains are taxable based on the investor’s income tax slab rate.

Hedge Fund Vs Private Equity: Key Differences

The following table summarises the key differences between private equity vs hedge fund:

Basis of Difference	Private Equity	Hedge Fund
Category (SEBI)	Category II AIF	Category III AIF
Horizon	Focuses on investing in companies that have the potential to offer substantial profits over the long term, between seven years to ten years.	They invest in funds that aim to generate good ROI in the short term.
Capital Investment	When a private equity fund manager calls for it	Can make a lumpsum investment anytime
Target Companies	Unlisted startups, early-stage or distressed firms	Publicly traded, liquid financial instruments
Legal Structure	They are close-ended funds that have restrictions on transferability for a certain time period	They are open-ended actively managed funds that have no restrictions on transferability
Fee Structure	Management Fees – 2%Performance Fees – 20% once the hurdle rate is crossed.	Follows 2/20 ruleManagement Fees – 1% to 2%Performance Fee – 20%
Risk	Less risky than hedge funds	Riskier than private equity
Level of Investor Participation	Active	Passive
Liquidity	Illiquid; lock-in of 5–7 years	Offers better liquidity with monthly or quarterly withdrawals

Conclusion 

Hedge funds and private equity are aimed at experienced investors but serve different investment goals. A hedge fund aims to profit from short-term market swings, offering the potential for high returns but with higher risk and greater volatility. 

Private equity, on the other hand, invests in businesses to help them grow over time. It requires patience and a willingness to tie up capital for years. 

Knowing how these two options vary can help you select the right path based on your risk tolerance, need for liquidity, and long-term financial goals. 

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