Hedge Funds vs Mutual Funds

Mutual funds are publicly available investment products, regulated and open to daily trading. In contrast, hedge funds are private investments, accessible exclusively to accredited investors.
Difference between hedge fund and mutual fund
3 mins read
20-August-2024

Mutual funds are investment instruments that collect money from investors to invest in a pool of diversified securities such as stocks, bonds, and other money market instruments. Hedge funds are private investment instruments that seek investments from accredited investors and employ a host of high-risk investment strategies to achieve high returns. Mutual funds are designed to offer long-term returns and diversification, and any investor with a valid investment account can invest in mutual funds. However, hedge funds restrict low investments and generally allow investors who invest a significant amount to invest their money in hedge funds. Hence, it is important to understand both investment instruments for a better investment approach.

If you are an investor, you can consider investing in mutual funds and hedge funds, but it is important to know the difference between them. This blog will help you understand hedge funds vs. mutual funds and which one you should choose between the two.

What are mutual funds?

Mutual funds in India have become a cornerstone for personal investment strategies, offering an accessible way to dive into the stock market. These mutual fund schemes pool money from various investors to invest in a diversified portfolio of stocks, bonds, or other securities. Governed by the Securities and Exchange Board of India (SEBI), mutual funds are transparent, requiring a prospectus that outlines their goals and methodologies. Whether you're drawn to the hands-off approach of index funds or the guided expertise of actively managed funds, the mutual fund arena offers a breadth of options to suit a range of risk tolerances and investment goals.

What are Hedge Funds?

Hedge funds operate in exclusivity and high stakes, attracting a niche group of affluent investors ready to embrace risk for the chance of significant returns. These private investment pools leverage a variety of strategies, including short selling, leverage, and derivatives, to outperform the market. In India, hedge funds are still a growing segment, overseen by SEBI under the category of Alternative Investment Funds (AIFs). The entry bar is set high, both in terms of minimum investment and the expected financial acumen of the investor, making hedge funds a playground for the seasoned and the bold.

Hedge fund and Mutual fund - Key differences in a comparison table

Mutual funds are publicly offered and regulated, allowing for daily trading. In contrast, hedge funds are privately available to accredited investors and employ higher-risk strategies to target higher returns. Take a look at the comparison table below to explore the key differences between hedge funds and mutual funds.

Aspect

Mutual funds

Hedge funds

Investor Base

Open to the public, ideal for individuals at various income levels.

Reserved for high-net-worth individuals and institutional investors.

Objective

Aim for steady growth, mirroring or slightly outperforming market indices.

Seek aggressive growth, employing high-risk strategies for potentially high returns.

Management and Ownership

Managed by professional fund managers without significant ownership stakes.

Fund managers often have personal investments in the fund, aligning their interests with investors.

Regulation

Strictly regulated by SEBI, ensuring transparency and investor protection.

Less regulated, with more flexibility in investment strategies but with higher risk.

Transparency

High, with mandatory disclosure of financial statements and performance reports.

Low, with disclosures primarily to investors, maintaining a veil of secrecy around strategies.

Fees

Lower fees, generally a percentage of assets under management.

Higher fees, including management fees and performance fees.

Liquidity

High, with the ability to buy or sell shares at net asset value daily.

Lower, with restrictions on withdrawals and potential lock-up periods.

Investment Strategy

Conservative, focusing on publicly traded securities for lower-risk, stable returns.

Aggressive, employing strategies like leverage and short selling for high-risk, high-return potentials.

 

Hedge fund vs. Mutual fund - Key differences summarised

Mutual funds and hedge funds are ideal investment instruments that can offer good returns to investors. However, they significantly differ on several factors that can impact your investment decision. Hence, it is vital to understand hedge funds vs. mutual funds. Here are the differences between the two:

Investment strategy

Hedge funds have investors with a high risk tolerance and a large investment amount. Hedge funds use an investment approach that includes a variety of advanced and sophisticated strategies, including leverage, short selling, derivatives (options, futures), and arbitrage. These strategies are designed to maximise returns and often involve higher risk. On the other hand, mutual funds follow a simple and traditional investment where the portfolio manager invests in a pool of securities such as stocks, bonds, and other market instruments to provide steady returns and lower risk through diversification. The strategies are generally more conservative compared to hedge funds, and safer investment instruments are preferred.

Investors

Hedge funds restrict investments and do not consider investments from every investor. Investors in hedge funds are generally accredited investors (high-net-worth individuals) and institutional investors (such as pension funds and endowment funds) due to their complex strategies and higher risk. They require a significantly large amount as the initial investment amount. On the other hand, mutual funds are designed to cater to every type of investor and are open to all. There are no specific qualification requirements for investing in mutual funds. They are accessible to the general public, including those new to investing. The minimum investment amount requirement is generally very low.

Investments

Hedge funds consider investments in a wide range of assets, which are more stretched than mutual funds. They may invest in securities such as equities, bonds, commodities, currencies, and real estate and can also include alternate investment instruments. The main goal is to invest in any investment instrument that can offer higher returns to investors, even if it is risky in nature. Conversely, mutual funds invest in a diversified yet limited pool of securities and mainly invest in equities and bonds. The investments are based on the type of mutual funds. For example, equity mutual funds mainly invest in equities.

Fees

Hedge funds mainly charge a management fee, which is a percentage of assets under management (AUM). This fee compensates the fund manager for overseeing the fund's operations and investments. They can also charge a performance fee, which is a percentage of the profits earned by the fund. The fee structure of hedge funds is generally higher than that of mutual funds. Mutual funds charge an expense ratio, which includes management fees (paid to the fund manager) and operational costs (administration and marketing). This fee is represented as a percentage of the fund's average AUM. Some mutual funds also charge entry loads (fees paid when buying units) or exit loads (fees paid when selling units).

Holding period

Hedge funds come with a predetermined lock-in period, restricting investors from redeeming their investments. Depending on the fund's structure, these periods can range from a few months to several years. The redemption terms after the lock-in period are also specific and affect the overall investments. Mutual funds also have a minimum holding period requirement, where investors are not allowed to redeem their investments. These holding periods can range from several months to years and define the taxation criteria for investors.

National regulation

Hedge funds are not registered or regulated by SEBI and are subject to very few regulations and compliance when compared to mutual funds. However, they are still required to comply with general investment and taxation laws set by the Indian government. On the other hand, mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI), which sets strict guidelines for transparency, reporting, and investor protection. The regulations and compliance are significantly higher than those of hedge funds, making them more transparent for investors.

Mutual Funds vs Hedge Funds - Which is better?

Mutual funds and hedge funds cater to different investor profiles and risk appetites. Mutual funds pool money from various investors to purchase a diversified portfolio of stocks, bonds, or other securities. They are typically managed by professional fund managers and offer liquidity and transparency, making them suitable for average investors. Hedge funds, on the other hand, employ more aggressive investment strategies, including leverage and derivatives, aiming for higher returns. They often require substantial minimum investments and are less regulated, posing higher risks. Choosing between them depends on one's financial goals, risk tolerance, and investment horizon. For conservative investors seeking stability and moderate growth, mutual funds are generally better. Conversely, hedge funds might be more appealing to those with higher risk tolerance and the capacity to absorb potential losses in pursuit of substantial gains.

Key takeaways

  1. Investor Accessibility: Mutual funds are accessible to the general public with varying income levels, while hedge funds are exclusive to high-net-worth individuals and institutional investors.
  2. Risk and Return: Mutual funds aim for steady growth and lower risk, whereas hedge funds pursue aggressive growth with higher risk through strategies like leverage and short selling.
  3. Regulation and Transparency: Mutual funds are highly regulated by SEBI, ensuring transparency and investor protection. Hedge funds, however, are less regulated, providing more flexibility but with increased risk and limited transparency.
  4. Fees and Costs: Mutual funds typically have lower fees, based on assets under management. In contrast, hedge funds charge higher fees, including performance fees, reflecting their complex strategies.
  5. Liquidity: Mutual funds offer high liquidity with daily trading options. Hedge funds often have restricted liquidity, with lock-up periods and limited withdrawal opportunities.

Choosing between them depends on individual financial goals, risk tolerance, and investment strategies.

Conclusion

Hedge funds vs mutual funds represent two contrasting paths within the investment universe. Mutual funds, with their broad accessibility and regulated environment, offer a safer route for individuals looking to grow their wealth over time. Hedge funds, while less accessible, provide a high-octane alternative for those willing to navigate the complexities and volatilities of aggressive investment strategies in search of rapid gains. Understanding the difference between hedge funds vs mutual funds is crucial for any investor aiming to make informed decisions that align with their financial objectives, risk tolerance, and investment horizon. Whether you lean towards the steady journey of mutual funds or the adventurous path of hedge funds, the key is to invest wisely and in accordance with your personal financial goals.

Essential tools for all mutual fund investors

Mutual Fund Calculator

Lumpsum Calculator

Systematic Investment Plan Calculator

Step Up SIP Calculator

Tata SIP Calculator

BOI SIP Calculator

Motilal Oswal Mutual Fund SIP Calculator

Kotak Bank SIP Calculator

Frequently asked questions

Are hedge funds better than mutual funds?

Whether hedge funds are better than mutual funds depends on the investor's goals and risk tolerance. Hedge funds offer higher potential returns but with increased risk and less transparency, making them suitable for wealthy, risk-tolerant investors. Mutual funds provide stable, regulated, and transparent investment options, ideal for average investors seeking moderate growth.

Is hedge fund legal in India?

Yes, hedge funds are legal in India. They are categorised under Alternative Investment Funds (AIFs) and are regulated by the Securities and Exchange Board of India (SEBI). Hedge funds in India must comply with SEBI's regulations to operate legally.

Why is it called a hedge fund?

Hedge funds are named for their strategy of "hedging" against market risks. They use various techniques, such as short selling and leverage, to offset potential losses. This approach aims to achieve positive returns regardless of market conditions, providing a "hedge" against adverse market movements.

Why would anyone use a hedge fund?

Investors use hedge funds to achieve higher returns and diversify their investment portfolios. Hedge funds have the flexibility to employ a range of strategies, including leveraging and short selling, which are not typically accessible to mutual funds. This can appeal to affluent individuals seeking aggressive growth opportunities.

Which is riskier, hedge fund or mutual fund?

Hedge funds are riskier than mutual funds due to their use of aggressive investment strategies, such as leverage, short selling, and derivatives. They are less regulated and have higher minimum investment requirements. Mutual funds, being highly regulated and diversified, offer lower risk and are more suitable for conservative investors.

Who can invest in hedge funds and mutual funds?

Mutual funds are open to a wide range of investors, including retail investors, with no specific qualifications required. Hedge funds, however, are generally accessible only to accredited or institutional investors who have a high net worth and want to invest a significant amount.

How do hedge funds and mutual funds charge fees?

Mutual funds charge fees through an expense ratio, including management and operational costs, and may also have entry or exit loads. Hedge funds generally charge a management fee based on assets under management (AUM) and a performance fee, which is a percentage of the profits earned.

What types of investments do hedge funds and mutual funds make?

Mutual funds generally invest in a diversified mix of securities, such as stocks, bonds, and other securities, based on their fund type and investment objectives. Hedge funds, on the other hand, may invest in a broader range of assets, including equities, fixed income, derivatives, currencies, and alternative investments.

How do hedge funds and mutual funds manage risk?

Mutual funds manage risk through diversification, spreading investments across various securities to reduce exposure to any single security. Hedge funds use various strategies, including hedging, leverage, and short selling, to mitigate risk and potentially enhance returns.

What is the holding period for investments in hedge funds and mutual funds?

Most hedge funds have a different lock-up period, ranging from a few months to several years, during which investors can not redeem their investments. Mutual funds also require investors to invest their money for a specific period, which can range from several months to several years.

How are hedge funds and mutual funds regulated?

Mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI) and are subject to extensive regulations. On the other hand, hedge funds are not required to be registered and regulated by SEBI and are subject to lower regulations than mutual funds.

Show More Show Less

Bajaj Finserv app for all your financial needs and goals

Trusted by 50 million+ customers in India, Bajaj Finserv App is a one-stop solution for all your financial needs and goals.

You can use the Bajaj Finserv App to:

  • Apply for loans online, such as Instant Personal Loan, Home Loan, Business Loan, Gold Loan, and more.
  • Explore and apply for co-branded credit cards online.
  • Invest in fixed deposits and mutual funds on the app.
  • Choose from multiple insurance for your health, motor and even pocket insurance, from various insurance providers.
  • Pay and manage your bills and recharges using the BBPS platform. Use Bajaj Pay and Bajaj Wallet for quick and simple money transfers and transactions.
  • Apply for Insta EMI Card and get a pre-approved limit on the app. Explore over 1 million products on the app that can be purchased from a partner store on Easy EMIs.
  • Shop from over 100+ brand partners that offer a diverse range of products and services.
  • Use specialised tools like EMI calculators, SIP Calculators
  • Check your credit score, download loan statements, and even get quick customer support—all on the app.

Download the Bajaj Finserv App today and experience the convenience of managing your finances on one app.

Do more with the Bajaj Finserv App!

UPI, Wallet, Loans, Investments, Cards, Shopping and more

Disclaimer

Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.