Hedge funds versus mutual funds have long been a popular topic of debate among financial experts. While there are advantages and disadvantages to both, most people agree that investing in hedge funds is less risky than investing in mutual funds. But how do hedge funds work?
Hedge funds are in an early stage now and haven’t really been widely recognized as just another form of mutual funds yet. While mutual funds have been around for decades, hedge funds are relatively new. They use very complex mathematical approaches to “hedge” risks and make high returns on investment. A typical hedge fund uses the funds raised from accredited investors including large banks, private equity firms, insurance companies, and high net-worth individuals. As with any investment, there are advantages and disadvantages to both.
The biggest difference between hedge funds and mutual funds lies in the asset classes they focus on. Managers and investment advisers who manage hedge funds usually have very strong investment portfolios, often containing hundreds of different asset classes. This allows them to take advantage of different market trends by investing in different sectors and/or industries. For example, some hedge funds may focus on real estate, stocks, or financial instruments, among others.
Another difference between hedge funds vs. mutual funds revolves around payouts. Hedge fund managers usually set their own pay ranges, which can vary greatly from company to company. If the fund’s compensation is based on performance, it’s possible for the compensation to be significantly higher for a manager who is wildly successful and wildly under-performing the rest of his or her employees and under-performing the overall market.
On the flip side, when hedge funds and mutual funds are compared, the similarities usually end there. In fact, there are many differences that can be drawn between the two-vehicle portfolios. For example, hedge funds often have significantly lower investment fees than most actively managed funds, and they do not require the same level of diversification. Managers also tend to have less involvement in day-to-day decisions, and they generally spend more time trying to identify good investments rather than focusing on the macro trends and fluctuations that affect the marketplace.
One of the major differences between hedge funds and mutual funds lies in their investment strategies. Most investors choose to invest in hedge funds because they employ investment strategies that focus on one or two specific investment strategies, allowing them to earn a higher return than the typical investor. Mutual funds, on the other hand, are designed to achieve a greater rate of return across the board, regardless of what an investor’s individual investment strategy may be. These investment strategies allow investors to make money regardless of their level of knowledge or experience with specific asset classes since their investment strategies are typically developed based on the strategies of professionals who deal with a wide variety of different asset classes. Additionally, investors with very strong investment strategies can sometimes benefit from diversification, which can lead to a lower overall risk level for any given portfolio.
The typical large asset management firms tend to hire a large number of investment managers. Because of this, some of these firms tend to have a much larger number of investment strategies than hedge funds, and they tend to have higher levels of overall risk. Hedge funds, on the other hand, generally prefer to focus on just one or two types of strategies, as well as pay close attention to the details that can affect the strategies. When hedge funds are compared to large asset management firms, the differences are usually determined by the quality of the underwriting and compensation practices employed by these firms.
A final note about comparing hedge funds and mutual funds: hedge funds often use stock pitches to get people to invest in their funds. By using stock pitches, hedge funds can effectively convince investors to invest in their funds, even if they don’t have the financial means to back up their claims. On the other hand, because the vast majority of mutual funds do not make stock pitches, they are less able to attract investors. By comparison, hedge funds tend to be less aggressive in their pursuit of investor capital, so they typically will not try to convince investors to invest unless they can back up their claims with hard evidence that the investment will yield a high return.