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Hedge Funds vs Mutual Funds

Hedge funds are frequently recommended as a place for investment whenever the market is going down. Do not fall in the common mistake of considering hedge funds as a type of a mutual fund. They are not! Generally, hedge funds are abundant in variations and leverage is applied when dealing with them. As their name implies, hedge funds can be successfully used when the market is going through bad times, but not all of them guarantee this insurance.

Hedge Fund Definition

Hedge funds are defined as private accumulation of resources for the purpose of investing, which is organized into limited partnerships. The goal of this limited partnership is to invest in a portfolio that includes different types of securities.

Mutual Fund Definition

Mutual funds are defined as public accumulation of resources for the purpose of investing in a portfolio that comprises pre-agreed types of securities.

This article provides a distinction between hedge funds and mutual funds according to the following criteria:

  1. Minimum Investment Required

    Hedge funds are characterized by high minimum amounts that are needed to start investing in them. On the other hand, mutual funds are famous among the investors for their low minimum investment amounts.

  2. Regulation Nature

    While hedge funds are defined as private investment vehicles, meaning that they are exempt by the regulations of SEC, mutual funds are highly scrutinized by the latter. They are defined as registered investment vehicles.

  3. Accessibility

    In order to have access to a hedge fund, you should have the appropriate accreditations. in order to receive the latter, you should be able to meet one of the following requirements:

    • An excess of $200,000 of the individual income
    • Net worth have to be more than $1 million
    • The accumulated income of the investors has to be in excess of $300,000 for the past two years

    If one of the previous criteria has been met, the investor has to prove that his/her income will keep the same level in the current year.

    On the other hand, mutual funds are open to the general public without having any of the above mentioned requirements.

  4. Investors

    Hedge funds limit the number of investors that can access a particular fund to 499 investors. They are referred to as "private investor". On the other hand, mutual funds don't put into boundaries the number of investors that can participate in a fund. Additionally, investors can purchase shares from different mutual funds.

  5. Leverage

    Hedge funds provide more leverage capabilities than mutual funds.

  6. Liquidity

    While the levels of liquidity of hedge funds vary from monthly to annually, mutual funds enjoy daily liquidity and redemption.

  7. Short Selling

    Hedge funds are characterized by the ability of their managers to frequently short sell. On the other hand, mutual funds set a limit of no more than 30% of profits that are from short sales. Nevertheless, an exception is made for some of the bear funds.

  8. Down Markets

    Even though the level of success for the management of the risk during declining markets varies from hedge fund to hedge fund, most of them attempt to protect their investors from the negative effects of down markets. As for mutual funds, during downturns in the market some fund managers apply defensive strategies, whereas others (e.g. index funds) hold while the recession persists.

  9. Fees

    Hedge funds are not regulated as regards to the fees they can charge. As a result, if you invest in a hedge fund you may end up paying as high as 1 - 2% of your assets and a percentage of the acquired profits. On the other hand, due to the high level of regulation executed by the SEC, the fees mutual funds can charge are confined.

Conclusion

If you decide to put your money in a hedge fund, you should deal with it with an extreme attention. Since hedge funds are not regulated, have low levels of liquidity and charge high fees you should carefully consider whether you really want to invest in a hedge fund. The lack of comprehensive information about hedge funds will represent another hindrance during the process of deciding on the hedge fund investment. Even if you decide to invest in a hedge fund, try to select a company that has been in the hedge fund business for a considerable time. Avoid companies with histories of sporadic opening and closing of hedge funds. Finally, don't risk your money by putting them all in hedge funds.

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