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Difference between Hedge Funds and Mutual Funds

By HARSH AGARWAL

18th May 2022

3 mins read

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Imagine an IPL final.

The batsmen look to settle and gauge the pitch, saving wickets in the initial overs, while the bowling team looks to stop runs and hunt for wickets simultaneously. This phase of the match can be thought of as Mutual Funds.

But the real fun, as you all would agree, comes in the death overs when the batsmen look to clear the fence with their brutal bat swings while the bowlers look to execute toe-crushing yorkers to stop these aggressive batsmen from hitting half a dozen of runs with their willow. This latter part is analogous to Hedge Funds, where Fund Managers are ready to push it to the limits to make a cent into dollars.

A reckless approach or not, we will leave it to you. But let us explore Hedge Funds in detail.

Hedge Funds

Hedge refers to an investment made to cover one's investment in times of crisis. A typical example would be investments in a non-cyclic sector or evergreen sectors like the power or food sector in a portfolio consisting of cyclic or seasonal sectors like consumer products or travel sector. However, this fundamental definition seems to be an orthodox one in the present scenario. Today’s hedge fund managers are focused on the sole motive of growing the money. This might include riskier modes of making money like shorting stocks, trading future and options, trading derivatives, and even trading stocks where they’d have received special knowledge.

The 2 and 20 Rule

While it may vary from one fund to another, hedge funds mostly charge funds in this same fashion, 2% of the assets under management and 20% of the profits generated (these proportions vary from one fund to another). The 2% commission is very similar to the expense ratio in the case of a mutual fund. However, the main distinguishing factor comes from the latter part. This 20% or any x% of the profits generated incentivises the fund managers to make sure your money sweats sweet returns.

While there are a lot of other charges and associated dynamics to each, the next time you see a hedge fund manager in the crispest suit ever projected on your retina, you know he’s working damn well for his clients.

But enough, about this new guy in town. Let’s see how it differs from our old friend, Mutual Fund.

Mutual Funds Hedge Funds
They do not have any restrictions on the type of investor who can put in their money. These funds allow only accredited, high-worth investors.
The starting amount may be in thousands or hundreds. The starting amount is usually upwards of crores.
Charge a single fee, not depending upon the profit generated or losses incurred (expense ratio). Charges a proportion of generated profit and the management fees(similar to expense ratio).
Examples - Aditya Birla Sun Life Flexi Cap Fund, ICICI Prudential Liquid Fund, Aditya Birla Sun Life Balanced Advantage Fund. Examples - Motilal Oswal’s offshore and hedge fund. Singular India Opportunities Trust, India Zen Fund

FAQs

Are hedge funds a get rich quick scheme?

Amongst all the arguments against hedge funds, the biggest one would be the lack of transparency. However, as fishy as it might seem, hedge funds have been there a long time and usually cater to a high-worth clientele with the risk appetite to make big or none.

Do hedge funds reveal their holdings?

As far as the holdings are concerned, the hedge funds are more or less opaque to the general public. However, some information regarding fund size, auditors, etc., might be provided to the public.

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