Table of Contents
What is a Hedge Fund?
Understanding all the differences between the hedge fund vs mutual fund can be confusing, let’s take a look at what makes them different.
A simple definition of the hedge fund is: a collection of money by different individuals 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 stock options, or other categories of investments. They invest aggressively with the goal of maximizing returns for its investors. 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 typically high which can create significant barriers to entry for most people, in addition to having high investment minimums, not all hedge funds accept new investors. Private investment companies are another name for hedge funds.
It is the details that make the hedge fund vs mutual fund different.
What is a Mutual Fund?
A definition of the mutual fund is essentially the same as a hedge fund: It is a collection of money to be invested.
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. One major difference is that the mutual fund was created for just about everybody.
Hedge Fund vs Mutual Fund, How Do They Compare?
Mutual Funds:
- Less ambitious approach to investing relative to the hedge fund
- Don’t split profits
- Less performance
- Available to anyone
- Charge a management fee (normally .5–2%)
- Cannot use stock options for generating profits
- legally limited in what they can invest in
Hedge Funds:
- Aggressive and creative approach to investing
- Outperform mutual funds
- Take 10-30% performance fee from the profits generated (profit split)
- Available only to individuals or institutions with high-income or assets by federal law
- Charge a management fee (1-2%)
- Investment flexibility
- Can use derivatives to generate profit
Accredited Investors
Hedge funds frequently do business with individuals that are accredited investors. Businesses and institutions, such as universities, must also be accredited with assets greater than or equal to $5 million dollars for qualification purposes.
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 married couples.
This isn’t the case for mutual funds. They are open to retail investors and often have a very low minimum investment requirement. 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 the hedge fund vs mutual fund comparison.
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 potential investors, with the added caveat that all the investors in the fund be accredited investors.
Hedge Fund Fees
Hedge funds typically charge a 1-2% annual fee, plus a fee in the form of a profit split that ranges from 10-30% depending on the fund.
Financial Risk and Risk Measures
What is financial risk? It is the risk of financial loss of capital, there are numerous methods that purport to measure it. 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.
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
- Maximum 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
- Highly diversified
Disadvantages of Mutual Funds
- Poor performance relative to hedge fund
- Lock up periods on occasion
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 the last 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.
Mutual funds returned an average of 4.67% per year between 1997 and 2017.
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 long, most-accomplished 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 hedge fund based in Seattle’s Eastside. Industry leading high-hurdle rates, accessibility, and top performance make this fund a good 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, select a top hedge fund. If you’re not an accredited investor, the top performing 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, extremely 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 excellent performance, public posting standards for their investment history, and accepts new investors.
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