Mutual Funds vs. Hedge Funds: A Comparative Analysis
Summary
Mutual funds (MFs) and hedge funds (HFs) may look similar but they are fundamentally different investment vehicles. MFs offer opportunities for steady growth while adhering to stringent regulatory oversight by financial authorities. They are dedicated to investing in publicly traded assets, particularly stocks and bonds. In contrast, HFs are exclusively for wealthy investors who seek higher returns through riskier strategies. They have more investment freedom, including unconventional assets such as life insurance policies or distant mining ventures. Understanding these distinctions is crucial for making informed investment choices.
MFs and HFs are often grouped together by those new to fund investment, but they are not the same. Despite some surface similarities, they are fundamentally distinct investment vehicles. MFs are publicly offered and regulated investment products that are accessible for daily trading. They are required to announce their net asset value (NAV) daily. This is determined by dividing the aggregate value of all cash and securities held in the fund's portfolio, minus any liabilities, by the total number of shares outstanding or currently held by its shareholders. MFs usually prioritise steady growth in the stock market. Not surprisingly, the asset management industry in India is booming. The total value of assets under management (AUM) in the MF industry is expected to reach an impressive INR 91,854,000 crore by the fiscal year 2024.
A HF, on the other hand, is more like a private club where a small group of wealthy investors pool their money. Gaining entry into a HF is often strictly by invitation. These funds use various bold strategies for high returns. Because the investors are typically more affluent, they are fewer in number and have a high tolerance for potential losses. Let’s explore this in more detail.
Differences between mutual funds and hedge funds and why it matters: An overview
HFs and MFs both collect money from investors and entrust it to professional fund managers. However, their similarities largely end there. HFs are notably more aggressive than MFs, employing riskier tactics in pursuit of greater gains. They enjoy extensive freedom in their investment choices, spanning stocks, derivatives, real estate, cryptocurrencies such as Bitcoin, and unconventional assets like life insurance policies or remote mining ventures. In contrast, MFs are largely confined to publicly traded securities, adopting a more conservative approach aimed at achieving lower but steadier returns. The table below lists their differences.
Differences |
Mutual funds |
Hedge funds |
|
1. |
Do not take a share of the profit - MFs are permitted to levy a fixed percentage of the AUM as a management fee. They do not take a share of the profit. | Take a share of the profit –The fund manager receives a percentage of the fund's profits, in addition to the management fees. They usually earn 10% to 15% of the total profits generated by the fund during the year. |
|
2. |
Available to the public - This means that anyone can invest in an MF, regardless of their income or net worth. | Available only to high-net-worth investors - This is because they are a riskier investment than MFs, and therefore require investors to have a high level of financial knowledge and risk tolerance. The smallest amount you can invest is INR one crore in India. |
|
3. |
Charge a management fee – MFs charge a fee that is paid to the fund manager to cover the costs of managing the fund. SEBI has allowed a maximum fee of 2.55% (subject to change) covering all expenses, including brokerage costs. | Charge a management fee and performance fee - The fund manager typically receives 1% of the total assets under management at the beginning or end of the year. They also receive a percentage of the fund's profits, as mentioned above. |
|
4. |
Cannot make high-risk investments - MFs are regulated by the Securities and Exchange Board of India (SEBI), which limits the types of investments that they can make. | Can make high-risk investments - HFs are regulated by SEBI but do not have to register with the regulatory body or disclose their NAV. This gives them more freedom in their investment choices. |
|
5. |
Are likely to perform worse than HFs – MFs usually perform less favourably than HFs due to their lower risk tolerance and investment strategies. | Known to perform better than MFs - HFs are allowed to take on more risk, which can lead to higher returns. |
The power of expertise in mutual fund and hedge fund choices
Whenever we talk of HFs, we also think of highly intelligent fund managers orchestrating massive financial movements across various asset classes. However, this does not have to be the expectation for all investors. What's essential is having expert guidance to navigate the dynamic world of HFs and MF investments. MFs are subject to strict regulations regarding the amount of capital they can invest, the timeframe for investing earnings, and their overall investment approach. In contrast, HFs face very few such regulatory constraints. This is one of the reasons for the stringent criteria governing who can invest in a HF in the first place. Collaborate with a domain expert to assess, research, track, and make informed decisions on buying and selling stocks, as well as selecting the optimal MF and HF options. Liaison with India’s fastest-growing broker to access a wide range of investment opportunities and expert guidance.
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