Finding the right investment vehicle is crucial for an investor in today’s changing financial landscape. Investors often face the dilemma of deciding where to invest between two popular options, such as hedge funds vs mutual funds. While both involve pooled investments, they differ significantly in risk, strategy, accessibility, and regulation.
Hedge funds cater to high-net-worth individuals with aggressive financial strategies, whereas mutual funds offer a safer, diversified approach. Therefore, to invest, you must understand the meaning and significance of each type of investment and decide which one is better for your unique needs.
Meaning and Significance of Hedge Funds
A hedge fund is a pooled and privately managed investment fund that uses aggressive strategies to generate returns for investors. They can use complex strategies such as derivative trading, short selling, and leverage as they are less strictly regulated than mutual funds. As an investor, you must have a high-risk appetite and huge capital to invest in hedge funds.
The significance of investing in hedge funds is that it enhances the return on investment by eliminating market inefficiencies and enabling price discovery. They offer better portfolio diversification than traditional investment options like stocks, bonds and mutual funds. Therefore, their speculative nature makes them more suitable for investors with long-term investment strategies.
Classification of Hedge Funds
In India, hedge funds operate under the Alternative Investment Fund (AIF) regulations set by the Securities and Exchange Board of India (SEBI). They are classified into the following types:
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Global Macro Funds
These funds earn profits from market movements caused by macroeconomic trends like geopolitical events, inflation, or interest rate fluctuations. Hedge fund managers create long or short trading positions based on market positions, actively managing them.
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Equity Hedge Funds
Hedge funds generally buy stocks that are expected to rise (long position) and sell borrowed stocks that are expected to fall (short position). These enable investors to get profits in both bullish and bearish markets.
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Relative Value Hedge Funds
These funds use quantitative models to exploit price differences between two closely related securities for low-risk profits. Such securities include bonds, stocks, or derivatives.
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Activist Hedge Funds
Companies, where there are diverse demands like asset restructuring, governance improvements, or cost-cutting, are known as activist hedge funds. Activist hedge fund managers can unlock additional value from the companies they invest in.
Understanding Investment in Mutual Funds
A mutual fund is an investment vehicle which pools funds from different investors to invest in various securities like stocks and bonds. They spread the investment over different assets, thus reducing risks and increasing liquidity. Moreover, skilled fund managers manage the scheme’s investment decisions, which helps maximise returns through security selection and asset allocation.
A major significance of investing in a mutual fund is the diversification of your investment portfolio. Since the risk is spread across different funds, your returns do not depend on the financial performance of a single stock or bond.
Classification of Mutual Funds
Mutual funds are classified based on their structure, asset class, risk appetite, and investors’ specific investment goals. Here are the different ways to classify mutual funds:
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Mutual Funds Based on Investment Goals
Every investor has unique financial goals depending on which they can invest in different types of mutual funds such as growth funds, income funds, liquid funds, tax saving funds, capital protection funds, and fixed maturity funds. These funds diversify one’s investment portfolio and reduce the risk.
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Mutual Funds Based on Structure
Depending on how you buy or sell units as an investor, mutual funds can be categorised into multiple types. As an investor, you can buy and sell units continuously or after a fixed maturity period. The different types of mutual funds based on structure are open-ended funds, close-ended funds, and interval funds.
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Mutual Funds Based on Asset Class
Mutual funds can be subdivided based on financial assets having similar characteristics. The types include equity funds, debt funds, hybrid funds, and money market funds. Each of these invests in various types of asset classes such as equity, debt, money market instruments or a combination of assets.
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Mutual Fund Based on Risk Appetite
As an investor, you may have varying preferences for taking risks. These risk levels can be high, moderate, and low. Therefore, depending on this aspect, mutual funds can be divided into specialised, sectoral, indexed, real estate, market-neutral, commodity-focused and leveraged funds.
Major Difference between Hedge Fund and Mutual Fund
Hedge funds cater to high-net-worth individuals and investors using aggressive strategies to maximise returns while mutual funds are designed for the general public. The table below shows the hedge fund and mutual fund difference:
| Feature | Hedge Funds | Mutual Funds |
| Investor Type | Accredited investors, institutions, and high-net-worth individuals | Open to the general public, including retail investors |
| Regulation | Have fewer disclosure requirements and are less regulated by the SEBI | Strict compliance requirements persist and regulated by the Securities and Exchange Board of India (SEBI) |
| Minimum Investment | The minimum investment in hedge funds in India is ₹1 crore | The minimum investment in mutual funds in India can be as low as ₹100 to ₹500 |
| Investment Strategies | Uses aggressive strategies such as leverage, derivatives, short selling, arbitrage, distressed assets, and alternative assets like real estate, commodities, and private equity | Primarily invests in stocks, bonds, and money market instruments, focusing on long-term growth and income generation |
| Risk Level | High risk due to speculative strategies and a lack of diversification. Also, there is potential for significant losses | Moderate to low levels of risk persist in mutual funds due to fund diversification, risk management, and regulatory safeguards |
| Liquidity | Low liquidity with lock-in periods and exit restrictions. Moreover, there are quarterly or annual redemption windows | High liquidity, investors can buy and sell shares at NAV daily |
| Transparency | Low transparency with limited public disclosure and reports available only to investors | Regular disclosures, prospectus, and annual reports are required giving rise to high transparency |
| Fee Structure | A performance-based model with around 2% management fee and 20% of profits. | Fixed management fees and fund houses can also charge an exit load of around 1% upon redemption. |
| Objective | Maximising absolute returns, often irrespective of market conditions | Achieving steady returns in line with market indices or investment goals |
| Lock-in Period | Usually requires investors to stay invested for a specific period | No lock-in period for open-ended mutual funds. However, close-ended mutual funds and ELSS have lock-in periods |
Where to Invest- Mutual Funds vs Hedge Funds
The choice between hedge funds and mutual funds depends on how much you want to invest and your risk appetite. If you are a high-net-worth individual (HNI) investor, investing in hedge funds can be a lucrative option. Institutional investors can also invest in hedge funds for potentially higher returns.
Apart from giving high returns, you must be aware that hedge funds come with potentially high fees, low liquidity, and limited regulatory oversight. These funds use aggressive investment strategies like leverage, derivatives trading, and short selling. Therefore, you will have a higher risk of losing capital compared to traditional investments.
In contrast, investing in mutual funds is a safer and more accessible option for you as an investor. This is because they are highly regulated, maintaining transparency and protection for the investor. Also, investing in mutual funds will diversify your investment portfolio, reducing the risks compared to hedge funds.
Investing in mutual funds is a long-term and safer investment option. However, if you have considerable wealth, a high-risk appetite and a strong understanding of financial markets, investing in hedge funds can be a better option for higher returns. As an investor, it is important to know the difference between hedge funds and mutual funds for a better investment strategy.
Mutual Funds vs Hedge Funds: Which is Better?
Choosing between mutual funds and hedge funds depends entirely on your financial goals, risk tolerance, and investment capacity. Here’s a clear comparison to help you decide:
- Accessibility:
- Mutual Funds: Open to retail investors with low entry points—starting investments can be as small as ₹100 to ₹500.
- Hedge Funds: Reserved for high-net-worth individuals (HNIs) and institutional investors with minimum investments of ₹1 crore.
- Mutual Funds: Open to retail investors with low entry points—starting investments can be as small as ₹100 to ₹500.
- Risk and Return Profile:
- Mutual Funds: Offer moderate to low risk due to diversification and strict regulatory oversight by SEBI. Returns are generally aligned with market benchmarks and long-term growth.
- Hedge Funds: Aim for high absolute returns through aggressive strategies such as leverage, derivatives, and short selling. However, this comes with significantly higher risk.
- Mutual Funds: Offer moderate to low risk due to diversification and strict regulatory oversight by SEBI. Returns are generally aligned with market benchmarks and long-term growth.
- Liquidity:
- Mutual Funds: Highly liquid—you can redeem units at Net Asset Value (NAV) on any business day.
- Hedge Funds: Low liquidity—withdrawals may only be permitted quarterly, semi-annually, or annually, often with lock-in periods.
- Mutual Funds: Highly liquid—you can redeem units at Net Asset Value (NAV) on any business day.
- Transparency:
- Mutual Funds: SEBI mandates regular disclosures, portfolio updates, and detailed reporting, ensuring transparency for investors.
- Hedge Funds: Limited transparency with fewer regulatory disclosure requirements.
- Mutual Funds: SEBI mandates regular disclosures, portfolio updates, and detailed reporting, ensuring transparency for investors.
- Cost Structure:
- Mutual Funds: Fixed management fees with occasional exit loads (typically around 1%).
- Hedge Funds: Higher costs, with management fees (about 2%) plus performance-based fees (typically 20% of profits).
- Mutual Funds: Fixed management fees with occasional exit loads (typically around 1%).
If you’re a retail investor seeking a safer, well-regulated, and cost-efficient investment avenue, mutual funds are a better choice. If you are an HNI or institutional investor with a high-risk appetite, strong market understanding, and a preference for aggressive returns, hedge funds could suit your goals. Always align your choice with your risk tolerance and long-term objectives.
Final Words
Hedge funds and mutual funds serve different investment needs. As an investor, evaluate your financial objectives and risk appetite to make investment decisions. Hedge funds are mainly for high-value investors who are risk lovers compared to mutual funds, which are comparatively safer and provide investment diversification.
Therefore, choosing the right option depends on your risk tolerance, investment horizon and financial objectives. After all, investing wisely will ensure a better future!
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