Mutual funds and hedge funds received praise from investors because of their ability to generate high returns. Mutual funds and hedge funds behave similarly by pooling investors together and purchasing assets with the accumulated money. However, some major differences exist between mutual funds and hedge funds. Understanding these differences helps you make wise investment choices.
The Security and Exchange Commission (SEC) requires mutual fund companies to register with the SEC before engaging in any investment activity with the public. Mutual funds are subject to the stringent oversight of regulatory bodies and must adhere to specific tax rules outlined in the Internal Revenue Code. The National Securities Dealers (NASD) regulates all advertisements made by mutual funds. The SEC does not require hedge funds to register. Hedge funds are not under the supervision of regulatory bodies, which gives hedge funds more options when making investment decisions.
Mutual fund fees and expenses are regulated by NASD, which limits the amount of fees mutual funds can charge. Mutual funds must include a list of their fees in the beginning of their prospectus and explain them in detail. Hedge funds are not limited in the amount of fees they can charge investors. In most cases, a hedge fund manager charges investors an asset based fee and a performance fee. An asset based fee reflects the percentage of assets you own in a portfolio and a performance fee reflects the performance of the portfolio.
Types of Investors
Mutual funds cater to both small and large investors. Many mutual fund companies require a minimum of $1,000 to begin investing, and some require even smaller minimum amounts. Hedge funds are only made available to private investors with large sums of money to invest. The Investment Company Act requires certain hedge funds to only accept investors with a minimum of $5 million in their accounts to invest.
Mutual funds investors who are not satisfied with the performance of a fund may sell their shares on any business day and receive the current net asset value (NAV) for shares sold. An investor must simply inform the mutual fund manager of the desire to redeem his units and cash out. The rules for redemption are generally different for hedge funds. Each hedge fund decides when investors can redeem units. Some hedge funds allow it on a weekly basis, while others allow it monthly or quarterly. According to Fabio Campanella of Financial Post, some hedge funds establish a lock-up period, which prohibits investors from redeeming units for a certain period of time.
The Invest Company Act prohibits mutual funds from using leveraging techniques or borrowing against the value of its assets to increase profits. Federal law requires mutual funds companies to cover their position when investing in future and forward contracts, stock options or short-selling stocks. Hedge funds commonly use leveraging techniques in an effort to earn high returns. In the past, leveraging played an important role in the investment strategies of hedge funds, but many hedge funds currently use other investment techniques to earn profits.
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