I get kinda irritated when the kids I teach ask me questions for which they can find answers on the web. What is a hedge fund and what is a mutual fund is a question that I have been asked a zillion times..so here is an attempt..I hope you like it..expect it in the next semester’s question paper:

Let us get it clear – mutual funds are regulated by SEBI, but Hedge funds are not. Both are pools of funds, both have a fund manager, and both are run by a fund manager. So both of them do look like brothers!

However Hedge funds (frankly I do not think there is any legislation in India where a hedge fund is even defined). In India hedge funds are created as SPVs – and is tax inefficient, so not very popular.

Mutual funds are retail products under a lot of supervision, and hence does not deal in the more risky varieties of assets. Hedge funds can run a concentrated portfolio (only equity shares of auto companies for a month for example), or move into full cash when they feel so. Largely hedge fund managers look for absolute returns – over a period of time. Say they may run a fund for 5 years and have very heavy withdrawal penalties. There are times when the fund is closed and times when it is kept open.

Mutual funds charge you say 2% of the assets as a fee and no share of the profit. This means the fund manager is purely acting as a professional. In case of a hedge fund the fund manager acts like a manager as well as a part owner. The hedge fund manager gets 2% of the assets and 20% of the profits.

Big hedge funds move across world markets looking for arbitrage opportunities, reducing risk, leveraging (hedge funds can borrow, while mutual funds are specifically prohibited from borrowing for investing). Hedge funds are a product meant for the real rich who can afford to risk a big part of their capital. Mutual funds on the other hand is for people who can invest an amount as small as Rs. 500 per month.