Hedge funds, mutual funds and ETFs are all popular pooled investment vehicles in which investors entrust their money to fund managers who in turn invest on their behalf in different kinds of publicly traded securities.
Hedge Fund
A hedge fund is a private portfolio of investments that uses investment and risk management strategies to generate returns. It is a relatively aggressive type o funds that is used by high net worth investors.
Hedge fund is basically a pooled investment that is often open to only a limited number of accredited investors. The fund manager then invests the pooled money into different types of assets to generate returns.
Hedge funds are usually set up as limited partnership or limited liability company that require a large minimum investment. These are less regulated as compared to mutual funds and ETFs. Hedge funds are very much illiquid as they require investors to keep the investment for at least a year, i.e., they have a lock in period of one year.
Mutual Fund
A mutual fund, as the name suggests, is a pool of funds collected from investors to invest in financial instruments. These funds are controlled and managed by a fund manager on behalf of the investors. The fund manager decides which stock or bond to buy and how much. A mutual fund distributes the entire investment amount into small units which are purchased by investors instead of directly investing in stocks and shares themselves.
Since a mutual fund is a collective investment, the risk gets divided among the investors. A small amount of investment in mutual funds can get the investor the benefit of portfolio investment.
There are various types of mutual funds:
- Balanced mutual funds
- Debt funds
- Equity mutual funds
- Money market funds
Mutual funds can also be divided on the basis of investment goals:
- Pension funds
- Fixed maturity funds
- Growth funds
- Income funds
- Liquid funds
- Tax saving funds
Exchange Traded Funds
An Exchange Traded Fund (ETF) is a marketable security that tracks a commodity, bond or an index or a basket of assets. ETFs are listed and traded on a securities exchange. It tracks the yield and returns of the financial instrument it follows.
When an investor invests in ETFs, the money is invested in a bunch of market securities which are a part of a pre-determined index. The investment is made in the same proportion of the index. These ETFs experience price changes throughout the day.
For instance, the country’s first ETF, Nifty BeES (Nifty Benchmark Exchange Traded Scheme) tracks the S&P CNX Nifty index.
ETFs are considered to be more tax efficient because frequent trading leads to higher capital gains.
| Parameter | Hedge Fund | Mutual Fund | ETF |
| Return | Absolute return | Relative return | Relative return |
| Management
| Actively managed | Comparatively less actively managed | Passively managed |
| Fees | Performance based fee | Percentage of assets managed fees | – |
| Transaction Price | – | NAV | Quoted price |
| Transparency | Information disclosed to investors only | Annually published reports and disclosure | Daily disclosure of holdings |
| Regulation | Less regulation | Regulated by SEBI | Regulated by Securities and Exchange Commission |
| Liquidity | Low | High | High |
| Cost | – | High average expense ratio | Low average expense ratio |
| Investor Type | High net worth individuals | Retail investors | Retail investors |
| Fractional Shares | No | Yes | No |
| Ownership of Fund Manager | Substantial ownership | Non substantial ownership | – |
| Owners | Few owners | Many owners | – |
| Minimum amount to be invested | High | Low | Low |
| Tax | – | High percentage of tax levied on capital gains | Comparatively lower tax percentages are levied |
In short, if you are an amateur in investing and want to invest in one of these options, then analyse all three on the basis of your requirements and available resources.
Disclaimer: the views expressed here are those of the author. Mutual funds are subject to market risks. Please read the offer document before investing.
