Difference between Hedge Funds vs Mutual Funds
Hedge funds
Hedge funds are alternative investment avenues that pool money from accredited investors, including HNIs, UHNIs, institutional investors, pension funds, banks & insurance companies, and many more, to invest in various different securities in the market to generate returns. They generally deploy complex investment strategies for the purposes of investment-related decision-making. As the name implies, "hedge," these funds target to protect downsides or reduce risks through their exposures to related instruments which are available in the market.
Hedge funds are, thus, quite popular in developed markets like the US, UK, etc. In India, the hedge market is relatively small & young as they were brought under the regulations of SEBI in 2012 as "Alternative Investment Funds." According to SEBI AIF classification, hedge funds in India come under the Category-3 of AIFs. Category-3 AIFs include alternative investments such as PIPE funds, hedge funds, etc., which deploys complex trading strategies and uses leverages to invest in listed or unlisted securities to generate returns on investments. As per the latest data available, the Indian hedge fund industry has approx. Rs. 35,777 crores of total assets.
The Category-3 AIF investments have seen slow growth in their assets in the last few years because of the government's exorbitant taxes levied on them. Further incentives & relaxation of tax rates by the Indian Government would be needed for the growth of this industry.
Features of Hedge Funds
- Investors in hedge funds are generally the High Net-worth Investors(HNIs), UHNIs, Insurance companies, pension funds, institutional investors, etc.
- These funds generally invest in different asset classes like equity & equity-related instruments, derivatives, fixed income instruments, bonds, etc.
- Hedge funds require a high minimum investment. As per the SEBI rules, the minimum ticket size is Rs.1 crore in India. However, the minimum amount varies across funds.
- These funds can generate higher returns than other investments as it deploys complex investment strategies to generate returns. However, at the same time, risks are higher in these funds.
Mutual Funds
Mutual funds are made from the investments pooled by different investors. The pooled money is invested in the capital market in various asset classes as per the investment objective & strategy of the fund. The funds invest the collected money in different securities & instruments like equities, debt, and other securities.
The risk-return characteristics of mutual funds depend upon the chosen type of asset class and mutual fund category. Mutual funds are one of the trendy investment options among retail investors because of their high accessibility.
Features of Mutual Funds
- Investors in mutual funds are generally retail investors.
- Mutual funds invest the pooled money in different asset classes depending upon the fund's investment objective.
- Mutual funds are taxed as per the applicable long-term capital gains and short-term capital gains on a type of mutual fund. The tax rate for the LTCG and STCG is different for the debt & equity.
- Mutual funds have a low minimum investment requirement. The minimum amount for investment varies across funds and fund houses. Investors can start with an amount as low as Rs.100.
Hedge funds vs Mutual funds
| Hedge Funds | Mutual Funds | |
| 1. Type of Investors | HNIs, UHNIs, Insurance Companies, Banks, Pension Funds, etc. Few Investors. | Preferable by Retail Investors, others also invest. A large number of investors. |
| 2. Management | Actively managed | Except index funds, actively managed |
| 2. Costs | Generally, Fixed fees on Assets and Performance fees on profits. | Fees only on AUM. |
| 3.Contributions/Minimum Investments | Minimum Investment- 1 crore Promoters also need to contribute 5% or 10 crores whichever is less. | Minimum Investment- Rs.100 No requirement of contributions by the promoters. |
| 4. Risk-Returns | Risk- Depends upon strategy but they aim to reduce risks through hedging. Use Leverage, therefore higher risks. Returns- Higher potential returns than mutual funds. | Risk- Depends upon the type of fund, their underlying assets, & strategies. Do not use leverage. Returns- Returns depend upon markets. |
| 5. Correlation | Aim to make investments with low correlation to the markets. | High correlation with the markets. If the market falls, MF’s Nav will also fall. |
| 6. Taxation | 43% Tax at the fund level. No passing of tax obligation to investors. | Different taxation for debt & equity MFs. Lower tax than hedge funds. |
| 7. Regulations | Low Regulations & Transparency. | High Regulations & Transparency. |
| 8. Transparency | Low level of transparency | High transparency |
Frequently Asked Questions (FAQs)
1. What are hedge funds?
Hedge funds are alternative investment avenues that pool money from accredited investors, including HNIs, UHNIs, institutional investors, pension funds, banks & insurance companies, and invest them in different asset classes as per the objective. It makes complex investment strategies to generate high returns and reduce or protect the downside risks.
2. What are mutual funds?
Mutual funds pool the investment from a large number of investors including retail, and institutions as well. They allocate the collected money as per the objective of the fund in different asset classes. The risk-return characteristics of mutual funds depend upon the chosen type of asset class and mutual fund category.
3. Are hedge funds regulated?
Hedge funds are regulated by the SEBI. But the regulations are less as compared to the regulations on mutual funds.
4. What are the different strategies of hedge funds?
Hedge funds use complex strategies to hedge their downside risks and generate high returns for investors. Different strategies used by hedge funds are:
· Long-Short
· Global Macro
· Event-driven
· Fixed Income Arbitrage
· Relative value strategies
· Short only
· Quantitative
· Multi-Strategy
5. How are hedge funds and mutual funds different?
Both hedge funds and mutual funds pool money from accredited investors in market securities based on the fund's investment objective. Hedge funds invest in different instruments employing complex strategies to generate returns and hedging the downside or reducing associated risks by investing in the related instruments available in the market. These funds also use leverages to invest in listed or unlisted securities to generate returns on investments, which are riskier as compared to mutual funds. The minimum investment requirement of these funds is very high, making them suitable for only high net worth investors. On the other hand, mutual funds have very low minimum investment requirements, making them accessible to every kind of investor.