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Distinguishing Mutual Funds from Hedge Funds

Some people tend to confuse hedge funds with mutual funds due to their similarity as pooled vehicles. You may find many distinct differences between the two upon closer inspection. We will identify these common differences in this article.

Hedge Funds

Investors do not register hedge funds, and their buyers are specifically defined. Only sophisticated investors are readily welcomed. Hedge funds typically have at most 500 investors.

Managers and investors find more freedom in hedge funds because of lesser constraints. They have the options to use derivatives and leverage, for example. The paperwork involved in hedge funds generally rely on a private placement memorandum for offerings.

Hedge funds are not as liquid as mutual funds. They often come with a lockup provision. Many investors expect managers to invest their own capital, exposing it to risk. Hedge funds cannot freely advertise.

When it comes to returns, hedge funds target absolute returns. This means that it intends to generate positive returns no matter the performance in the market.

Mutual Funds

Unlike hedge funds, mutual funds are registered in the SEC. Mutual funds can have an unlimited amount of investors, unlike hedge funds who can have 100 to 500 at most. They are also able to advertise at liberty.

Mutual funds do not place expectations on the manager to invest their own capital. A mutual fund allows withdrawal at any time, making it more liquid than hedge funds. Managers monitor and handle them based on index benchmarks. Managers base decisions on variances derived from the said benchmark.

As opposed to a hedge fund, mutual funds are less flexible. The market has the tendency to accuse managers of ‘style drift’ when they readily change strategies.  Entities offer mutual funds through a prospectus as far as paperwork is concerned.

Conclusion

At a glance, mutual funds and hedge funds may virtually seem the same. But at a closer look, we find that they have many variances in flexibility, investment, regulation, and many other variables.

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