What Is the Difference Between Mutual Funds and Hedge Funds?

The intricacies of financial portfolio management are numerous, to say the least. Both mutual funds and hedge funds are complex investment funds designed to perform in financially advantageous ways. But they are dissimilar in many respects. In order to better understand the similarities and distinctions between mutual funds and hedge funds, it is helpful to attain a strong understanding of how each functions. Let’s discuss the process of setting up a hedge fund and setting up a mutual fund.

Mutual Funds

Like a hedge fund, a mutual fund is broadly constructed when a manager or managers select securities to be bundled together in a portfolio. Once created, the securities contained within the portfolio will operate as a whole as opposed to the sum of its individual parts. This performance ultimately impacts those investors who are subject to the profits and/or losses associated with the portfolio investment.

But unlike the creating a hedge fund, the process of creating a mutual fund tends to be a risk-averse process. These funds are generally more limited in their returns and are ultimately attractive to investors with little capital to waste because the mutual fund risks tend to be “safer bets.” Because they are regulated on the exchanges, they are subject to greater transparency and held to higher standards in terms of management. The mutual fund risk is low compared to hedge funds.

These funds are bound by the fund’s prospectus which outlines both its objectives and the strategies that will be utilized to attain them. In addition, they must be handled by a professional fund manager bound by the fund’s prospectus and compelled to maximize returns within the bounds of the law. All of these limits tend to inspire consumer confidence and security, mitigating mutual fund risk. This helps to make up for the fact that these funds tend to generate more limited returns than successful hedge funds achieve.

Hedge Funds

While mutual funds risks tend to be risk-averse, hedge funds are aggressive by nature. Hedge fund managers are specifically tasked with employing both diverse and aggressive strategies in order to better enable their funds to perform. This reality makes these funds more risky and, when successful, more rewarding than mutual funds. Partially because they are riskier, their investment pool tends to be smaller and wealthier than the investment base associated with mutual funds. The minimum investment required in a hedge fund is rarely less than $10 million. You should consult with a financial advisor when setting up a hedge fund.

Despite the risks associated with hedge funds, they are not subject to the kinds of reporting requirements that mutual funds are. In addition, only hedge funds that exceed a threshold of $100 million are even required to register with the U.S. Securities and Exchange Commission.

Answers for Additional Questions

If you have additional mutual funds questions and/or hedge funds questions, please feel free to reach out to the team at LawTrades. We have significant experience in the financial industry and would be happy to advise you on setting up a hedge fund or setting up a mutual fund. Our team members have a minimum of eight years of experience so that they are prepared to either answer any question you may have or know who to consult if the necessary answer is not immediately apparent.