Hedge Funds vs Mutual Funds

What is a Hedge Fund?

Understanding hedge funds vs mutual funds can be confusing. Let’s take a detailed look at what makes them different.

A simple definition of the hedge fund is: A collection of money to be invested.

Below you will find a definition of hedge fund that is more detailed.

Hedge funds collect money from investors and invest in stocks or other categories of investments. They invest aggressively with the goal of maximizing returns. They are less regulated than mutual funds and have less restrictions. They’re designed for people who demand investment performance and have the financial resources to invest in them. Investment minimums are considerable, which create significant barriers to entry for middle class people. Private investment companies are another name for hedge funds. In addition to having high investment minimums, not all hedge funds accept new investors.

It is the details that make mutual funds vs hedge funds different.

What is a Mutual Fund?

A definition of the mutual fund is the same as a hedge fund: It is a collection of money to be invested.

Again, it is the details that make hedge funds vs mutual funds different.

Below is a more detailed definition of the mutual fund.

Mutual funds collect money from many people and companies or organizations, and purchase stocks, bonds, or other types of securities. They are typically large in size as mutual funds are a very common investment option.

How do they compare?

Mutual funds:

  • Less ambitious approach to investing
  • Don’t split profits
  • Less performance
  • Available to just about anyone
  • Charge a management fee (normally 1–2%)
  • Cannot use stock options for generating profits
  • legally limited in what they can invest in and how they do it

Hedge funds:

  • Aggressive and creative approach to investing
  • Outperform mutual funds
  • Take 10-30% performance fee from the profits generated
  • Available only to individuals or institutions with high income or savings by law
  • Charge a management fee (2%), plus a performance fee (10–30%)
  • Investment flexibility and how they do it
  • Can use derivatives to generate profit

Accredited Investors

Hedge funds typically do business with individuals that are accredited investors. Businesses and institutions, such as universities, must also be accredited.

A person with a net worth of at least $1 million as an individual or jointly with their spouse is an accredited investor. One additional way to be an accredited investor is to have an income of at least $200,000 for an individual or $300,000 for those with joint income for the two previous years.

This isn’t the case for mutual funds, which are open to retail investors and often have a low minimum investment threshold. How much money do you need to invest in a hedge fund? Hedge fund minimum investment can range from as low as $50,000 to over $1 million, depending on the fund. This is an important difference between hedge funds vs mutual funds.

Rule 506(b)

This is a well-known legal rule that allows companies to raise an unlimited number of shares and money to an unlimited number of accredited investors. The rule does not permit the use of advertising to sell shares in the investment fund.

Rule 506(c)

This particular rule allows companies to advertise and solicit to investors. However, all investors must have accreditation.

Hedge Fund Fees

Charge a 1-2% annual fee and fee in the form of a profit split that ranges from 10-30%.

Financial Risk and Risk Measures

What is financial risk? It is the risk of financial loss on investments. There are numerous methods that purport to measure it precisely. There is also the risk of large-scale stock market crashes, such as those experienced in 2000 and 2008. This risk is extremely important too but is often a neglected aspect of risk, rarely formally addressed.

Risk Metrics

Alpha

This measure of risk compares investments to its related benchmark index or the market. If a stock rises more than its benchmark, that stock is said to have a positive alpha. If a stock falls more than than its related benchmark, then it has a negative alpha.

Beta

The beta measures the volatility, or the price changes of a fund compared to the market or a particular benchmark index. A beta value greater than one indicates price fluctuation is expected to move greater than the market or benchmark as a whole. A beta equal to zero indicates price volatility is expected to move about the same as the market. And a beta value of less than one indicates expected volatility is less than that of the broad market.

R-Squared

This measures how much of the price change in an investment is attributable to its benchmark index. R-squared means the correlation between an investment and its associated benchmark index. An R-squared value of 98 is highly correlated to general market movements. A value of 50 is considered lowly correlated.

Standard Deviation

This metric measures how much an investment diverges from normal or expected returns. Or, explained another way, how much return an investment is deviating from common returns .

Sharpe Ratio

This metric subtracts the risk-free rate of return on an investment, such as the U.S. Treasury Bond, from the actual rate of return of the investment. Divide this by its standard deviation and this generates the Sharpe Ratio.

Form D SEC

This is a standard form that investors in hedge funds must complete. A hedge fund that wants to solicit to investors must file a Form D with the SEC at least 15 days before advertising begins. Funds also need to file an amended Form D within 30 days of the offering’s termination. Failure to follow these rules will likely result in a ban from creating additional securities for a year or more.

Advantages of Hedge Funds

  • Excellent performance
  • Max investment options
  • High degree of flexibility
  • Access to world’s most talented asset managers

Disadvantages of Hedge Funds

  • Less liquid
  • Lock up periods

Advantages of Mutual Funds

  • More liquid
  • Diversification

Disadvantages of Mutual Funds

  • Poor relative performance
  • Lock up periods

Mutual Fund Fees

fees range from 0.5-2% of the investment. Mutual funds do not share profits.

Mutual Fund Returns Average

American Century Investments (TWCIX) is a top mutual fund due to their returns over 40 years. The fund returned 12.57% per year. good, given the restrictions mutual funds must abide by. The best return for the fund was 45.76% in 1980. The worst year occurred in 2008, losing 39.67% of their investors’ money.

According to one source, mutual funds returned an average of 4.67% per year between 1997 and 2017. Therefore—it follows that this mutual fund is above its category average.

Hedge Fund Returns

Most of the world’s top investment skill is located at the best hedge funds. Warren Buffett was a hedge fund manager before taking control of Berkshire Hathaway in 1964. Click here for an article about how rare it is to be really good at investing.

Perishing Square Holdings returned 58.1% to its investors in 2019 according to Reuters.

Tiger Global management is a top hedge fund due to its recent performance. Between 2016 and 2019, the fund returned 22.4% annually.

Hedge Funds to Invest in

Renaissance Technologies is a world class hedge fund because they have a very lengthy and excellent track record.

Perishing Square Capital Management returned a whopping 58.1% to its investors in 2019, and is an excellent choice among top hedge funds.

The Winvest Investment Fund is a Seattle based hedge fund. Industry leading transparency standards, accessibility, and top performance make this fund an attractive option.

Top Hedge Funds

Renaissance Technologies is a top hedge fund averaging a 71.8% annual return from 1994 through mid-2014. This is $71,800 per year of average profit on a $100,000 portfolio.

Top Mutual Funds

Fidelity investments offer a good mutual fund through the ticker symbol (FCNTX). The fund has returned an average of 12.65% over the past 40 years.

Where to Invest Money

In conclusion, if investment performance is what you’re searching for, go with hedge funds. If accredited investor status is not attainable, the top mutual funds will still leave you with good investment options.

Perishing Square Holdings led by legendary investor Bill Ackman is a great choice.

Renaissance Technologies is a top hedge fund investment option. With decades of experience, ridiculously high investment returns and teams of mathematicians, it’s no wonder this company makes the top of the list.

American Century Investments and Fidelity Investments both offer respectable mutual fund track records and are worth considering.

The Winvest Investment Fund offers fantastic performance, public posting standards for their investment history and accepts new investors, therefore it is an excellent investment option.

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