The objective of investing for any individual or organisation is to generate profits. The general rule is that the higher the potential for profits, the higher the risk. Two such investment instruments that perfectly highlight this fact are mutual funds and hedge funds.
Both these instruments invest in the stock market, and while mutual funds and hedge funds are similar on some counts, they differ in many aspects as well.
Before seeking answers to the questions, “How are mutual funds and hedge funds different?”, you must know what these investments really are. Mutual funds pool investments from small and medium retail investors to invest in publicly-listed securities, like stocks and bonds.
Here, the performance of these funds is market-linked, and so they do come with risks. However, when compared to hedge funds, mutual funds take on much lesser risks.
Hedge funds are also a pool of investments. However, these investments are large and typically made by large institutional investors. They employ diverse and aggressive strategies to earn higher returns. Also, these funds have fewer restrictions, as compared to mutual funds.
The following table presents the key differences between hedge funds and mutual funds:
Basis |
Mutual Funds |
Hedge Funds |
Meaning |
These funds pool small investments to invest in a bunch of securities, including debts and equities. |
These funds pool large investments from a few well-established investors. |
Investment Horizon |
While most mutual funds are liquid in nature, Equity-linked Savings Scheme (ELSS) has a lock-in period of three years. |
Based on your investment goal, the investment horizon may range from a few seconds (such as funds from HFT firms) to years (Global Macro). |
Strategy for Investment |
Mutual funds do not take highly leveraged positioning, reducing their potential returns but making them less risky. |
Hedge fund managers use high-risk tactics like short selling and speculative positioning to make returns, irrespective of the market conditions. |
Fit for |
Small and medium retail investors can start investing with as less as ₹100 through Systematic Investment Plan (SIP). |
High Net-worth Individuals (HNIs) or large institutional investors as these funds require large investments, as the minimum investment amount is ₹1 Crore |
Investment Type |
With mutual funds, you can trade in publicly-listed securities, i.e., equities and debts. |
Hedge funds are free from any restrictions and can trade in derivatives, real estate, mines, cryptocurrencies, etc. |
Fees and Charges |
Mutual funds charge a management fee that ranges between 1%-2%. |
While hedge funds attract a management fee that usually is pegged at 2%, they also levy a performance fee ranging between 10%-30%. |
Applicable Regulations |
Mutual funds are highly regulated in how capital may be invested. |
Hedge funds do not have any restrictions relating to investment strategy. |
Mutual funds are a lot more accessible to the average investor. They are also a lot more transparent, as an investment tool. There is adequate disclosure and stricter regulations for mutual funds. Moreover, unlike hedge funds, they are closely monitored too.
On the other hand, hedge funds have limited disclosure. Moreover, since these funds charge a prohibition fee on top of a fixed fee, their cost may also be restrictive.
In contrast, you may choose hedge funds to pursue more flexible and riskier strategies to gain higher returns than mutual funds. However, the entry cost is also much higher, and losses can be massive.
Hence, when choosing between mutual funds and hedge funds, consider your investing capital, horizon, returns, and risk tolerance. For easy access to such investment instruments, and other financial products, visit Bajaj Markets.
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FAQ on the Difference Between Mutual Funds and Hedge Funds
How are mutual funds structured differently from hedge funds?
If you compare the structures of mutual funds vs hedge funds, you will find certain similarities as well as differences. Both of these funds are portfolios that pool investments from multiple investors.
While investors in hedge funds are typically large institutional investors, most of the investors in mutual funds are small and medium retail investors. Moreover, the minimum amount required to be invested in mutual funds is quite lower compared to hedge funds.
How does the asset mix in mutual funds and hedge funds differ?
The difference between hedge funds and mutual funds in terms of asset mix also exists. Mutual funds in India are highly regulated, and the asset classes they can invest in are limited. They can only use derivatives to hedge underlying exposures.
On the other hand, hedge funds allow investments in derivatives, structured products, global assets, real estate, art, as well as wines.
How is the performance of mutual funds and hedge funds evaluated?
There is also a difference between hedge funds and mutual funds’ performance evaluation methods. The performance of a mutual fund is typically linked to the movements in the underlying index.
However, hedge funds are focused mainly on absolute returns and are not linked with the performance of indices. These funds offer flexibility in investment as they allow fund managers to trade both on the long and short sides.
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