Understand the Comparison between Hedge Funds vs Mutual Funds

Hedge Funds are the type of alternative investment that pools the investment from UHNIs, HNIs and Pension Funds etc. and the other side mutual funds are made from the investments pooled from the different investors.

What are mutual funds?

Mutual funds are made from the investments pooled from different investors. The pooled money is invested in the capital market in different asset classes as per the investment objective & strategy of the fund. The funds invest the collected money in different securities and 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. The mutual funds are one of the very popular options for investments 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 investment objective of the fund.
Mutual funds have a low minimum investment requirement. The minimum amount for investment vary across funds and fund houses. Investors can start with an amount as low as Rs.100.
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.

What are hedge funds ?

Hedge funds are the type of alternative investment that pools the investment from accredited investors like UHNIs, HNIs, pension funds, etc., and invest the collected money in various asset classes for generating the returns. These funds use different complex strategies for making investments. The funds aim to hedge the downsides of the fund or to reduce the risk of their investments by taking opposite exposures in securities as per the investment strategy.

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 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 have the capability to 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.

Hedge Funds vs Mutual Funds

	Hedge Funds	Mutual Funds
Investors	Few number of investors	A large number of investors
Types of investors	HNIs, UHNIs, Insurance Companies, Banks, Pension Funds, etc.	Mostly preferred by the retail investors
Management	Actively managed	Actively managed except in the case of index funds
Costs	Have the fixed management fees and percentage of the profit.	A fixed percentage on the AUM known as the expense ratio
Minimum investment	High requirement. As per the SEBI rules, the minimum investment is Rs.1 crore	Low minimum requirements. Generally, it is Rs.500 and starts from Rs.100.
Liquidity	Less liquid	Highly liquid
Risk	Have higher risk as they use complex investment strategies	Depends upon the investment objective of the fund
Return	High potential returns	Depends upon the market conditions, chosen asset class, investment horizon, etc.
Transparency	Low transparent	High transparent
Taxation	Comes under category 3 of AIF. Doesn’t have a tax-pass through status in India. Tax comes out to be around 43%	Taxed as per the LTCG and STCGs. Debt and equity have different tax rates
Regulations	Low regulations	High regulations

Difference between hedge funds and mutual funds

One of the major differences between mutual funds and hedge funds is that mutual funds are highly accessible as compared to hedge funds. The minimum investment required to enter in mutual funds is generally Rs.500, but hedge funds come with a minimum ticket size of Rs.1 crore.

Types of Investors

Hedge funds are only available to the HNIs, UHNIs, institutional investors, pension funds, etc. while mutual funds are accessible to all kinds of investors.

Returns

Hedge funds have the capability to generate high returns as they use complex investment strategies including mathematic models, quantitative trading, algorithmic models, etc. to generate returns for investors. While mutual funds have also the ability to generate good returns over long periods as per their investment objective and strategy.

Fees and cost

Both the mutual funds and hedge funds are professionally managed and they charge fees for the management. However, hedge funds also charge performance fees on the profits earned on the investments by clients. Globally, a cost structure of 2 & 20 is followed where 2% is the annual fixed management fee and 20% is the performance f0ees applicable only if the fund has generated profits or crossed a specified hurdle rate.

If we compare the fees of both, hedge funds charge higher fees than mutual funds.

Regulations

Hedge funds and mutual funds both come under the regulations of the SEBI. Both the funds work as per the rules and guidelines of the SEBI. But, hedge funds have fewer regulations than the regulation on mutual funds.

Also Read: What is SEBI

Transparent

Mutual funds are more transparent than hedge funds. Mutual funds have to regularly publish the daily performance reports, annual reports, quarterly reports, balance sheets, portfolio reports, and other important reports. However, information related to the performance of hedge funds is highly private and is not easily available in public domains.

Taxation

Investments in hedge funds have a high taxation as compared to mutual funds. Hedge funds come under the category-3 of AIFs and the tax rate for this category comes out to be around 43% because of being taxed at the fund level. However, the mutual funds are taxed as per the applicable long-term capital gains or short-term capital gains depending upon the type of investment i.e equity-oriented or debt-oriented.

Following taxation is applicable in case of:

Equity-oriented funds: If the units are held for less than 1 year, then STCG tax at the rate of 15% is applicable on the gains.

If the units are held for more than 1 year, then LTCG at the rate of 10% is applicable only on the gains above Rs.1 lakh in a financial year.

Debt-oriented funds: If the units are held for less than 3 years, then STCG tax is applicable in the hands of investors as per their applicable income tax slab rate.

If the units are held for more than 3 years, then LTCG tax at the rate of 20% is applicable after indexation benefits.

Also Read : Daily SIP Mutual Fund

Frequently Asked Questions(FAQs) About Hedge funds vs Mutual funds

Q. What are hedge funds?

A. Hedge funds pool the investment from affluent investors 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.

Q. What are mutual funds?

A. 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.

Q. Who invests in hedge funds?

A. Generally, the HNIs, UHNIs, pension funds, Institutional investors invest in the hedge funds as it requires high minimum investment.

Q. Difference between the taxation of hedge funds and mutual funds?

A. Mutual funds are taxed as per the LTCG & STCG in the hands of investors but hedge funds are taxed at the fund level. The category 3 AIF in India doesn’t have a tax pass-through status in India. Therefore, the taxation for these funds comes out to be around 43%.

Q. Do Hedge funds also have the cost like mutual funds?

A. The cost structure is different in hedge funds as compared to mutual funds. In the case of mutual funds, an expense ratio as fixed by the fund house is applicable on the AUM of the fund. However, in the case of hedge funds, the cost structure includes a fixed management fee which is levied on the total capital invested & a performance fee which is charged on the profits earned on that investment. The fees or expenses come out to be much higher in the case of hedge funds.

Q. What is the minimum investment requirement for hedge funds and mutual funds?

A. Hedge funds require a high minimum investment. As per the SEBI rule, the minimum ticket size for hedge funds is Rs.1 crore. But mutual funds generally have a minimum investment amount of Rs.500.

Q. Are the hedge funds regulated?

A. Hedge funds are regulated by the SEBI. But the regulations are less as compared to the regulations on mutual funds.

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