Bridging the knowledge gap: Difference between hedge funds and mutual funds

Mutual funds are financial instruments that pool in money from investors to invest in different types of securities. If investors stay invested for a long period, mutual funds are likely to offer high returns, thus growing the wealth of investors. Hedge funds, on the other hand, are defined by SEBI as “unregistered private investment partnerships” and are available to accredited investors only.

Both the terms have been widely used since as early as 1950s-60s and there are quite a few similarities between them. Both the funds pool money from investors, invest in different asset classes, and aim at offering attractive returns over the years to their investors. But hedge funds function as private investment partnerships, while mutual funds are public.

Hedge funds make use of the funds collected from select banks, High Net-worth Individuals, and insurance and pension firms, among other investors. Unlike mutual funds, hedge funds do not need to disclose their Net Asset Value (NAV) regularly. In the case of mutual funds, investors can get all information about their fund’s performance, NAV, and profit on their investments at any time.

Hedge funds are costlier compared to mutual funds, as the minimum ticket size in these funds is Rs. 1 crore. In case of mutual funds, an investor can start a Systematic Investment Plan (SIP) with as little as Rs. 500, with some platforms offering plans for as low as Rs. 100, and for this flexibility and transparency, many investors might prefer mutual funds.

What is the difference between a hedge fund and a mutual fund? 

  • Lock-in period is significantly long for hedge funds, whereas investors can redeem their investments at any time in mutual funds, with a few exceptions
  • While both mutual funds and hedge funds can have a high risk element, investments in hedge funds could involve higher risks due to the nature of operations of these funds. Investors need to be aware of risks before opting for any investment
  • Unlike mutual funds, it is not necessary for hedge funds to be registered with a market regulator
  • Hedge funds are accessible only to accredited investors, which is not the case with mutual funds
  • Since hedge funds involve risks, the operational fee for these funds is on the higher side compared to mutual funds

Who can invest in hedge funds? 

Any investor who is willing to take risks and is able to invest a huge amount can start their investment journey in hedge funds. The Securities and Exchange Board of India has a defined category of investors called ‘accredit investors’ who can invest in these funds. It might be complex for some, but once investors get their accreditation and understand how these funds work with the help of a fund manager, they can invest in hedge funds.

For mutual funds, the process is much simpler, though understanding how they work is critical here too. The risk involved in mutual funds is comparatively less and so is the amount needed to invest in SIPs. One of the advantages of mutual funds investments is that investors can check NAV at any time, and it is updated at the end of each business day. If investors want to redeem their mutual fund investment amount, they can do so in easy steps and the amount is credited to their bank account within a few hours or days depending on the asset management company and the type of mutual fund scheme.