Which is riskier hedge fund or mutual fund? (2024)

Which is riskier hedge fund or mutual fund?

Mutual funds are generally considered safer investments than hedge funds. That's because fund managers are limited in their ability to use riskier strategies such as leveraging their holdings, which can increase returns, but it also increases volatility.

Hedge funds have the same basic pooled fund structure as mutual funds. However, hedge funds are only offered privately. Typically, they are known for taking higher risk positions with the goal of higher returns for the investor.

Generally, equity funds are known to inherently carry the highest risk, followed by hybrid funds and, finally, debt funds. There can be variations in risk levels within the category of equity funds, too.

The risk of fraud is more prevalent in the hedge fund industry compared to mutual funds, due to the lack of regulation for the former. Hedge funds do not face the same stringent reporting standards as other funds, and therefore the risk of unethical behavior on the part of the fund and its employees is heightened.

No investment is risk-free and while mutual funds are generally low-risk because they invest in low-risk securities, they are not completely risk-free.

Because they are not as regulated as mutual funds or traditional financial advisors, hedge funds are only accessible to sophisticated investors. These so-called accredited investors are high net worth individuals or organizations and are presumed to understand the unique risks associated with hedge funds.

Flexibility – the hedge fund manager has fewer constraints to deal with; he can sell short, use derivatives, and use leverage. He can also make significant changes to the strategy if he thinks it is appropriate. The mutual fund manager cannot be as flexible.

Sectoral funds: These are the riskiest category of equity mutual funds which invest a minimum of 80% of their portfolio in companies belonging to the same sector. Low diversification adds to their overall risk with returns dependent on the performance of a single sector.

Money market funds are ultra low-risk mutual funds that invest in securities with short maturity periods, making them among the lowest-risk investments available outside of government bonds.

Why not to invest in hedge funds?

Be careful with hedge funds

Hedge funds often have high fees. A 2% management fee and 20% performance fee are not uncommon. Of course, those fees might be absolutely justified if the manager is doing something unique and the returns are within your expectations even after paying the fees.

Hedge funds have always had a significant failure rate. Some strategies, such as managed futures and short-only funds, typically have higher probabilities of failure given the risky nature of their business operations.

According to a Capco study, 50% of hedge funds shut down because of operational failures. Investment issues are the second leading reason for hedge fund closures at 38%.

However, mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high expense ratios charged by the fund, various hidden front-end, and back-end load charges, lack of control over investment decisions, and diluted returns.

Mutual funds help provide instant diversification since they invest across dozens or sometimes hundreds of individual stocks, bonds, or other securities. Further, history shows that large groups of stocks tend to ride out market volatility better than individual stocks.

The concept of the "safest investment" can vary depending on individual perspectives and economic contexts, but generally, cash and government bonds, particularly U.S. Treasury securities, are often considered among the safest investment options available. This is because there is minimal risk of loss.

BlackRock manages US$38bn across a broad range of hedge fund strategies. With over 20 years of proven experience, the depth and breadth of our platform has evolved into a comprehensive toolkit of 30+ strategies.

To invest in hedge funds as an individual, you must be an institutional investor, like a pension fund, or an accredited investor. Accredited investors have a net worth of at least $1 million, not including the value of their primary residence, or annual individual incomes over $200,000 ($300,000 if you're married).

Answers: No. Technically speaking Berkshire Hathaway is not a hedge fund, it is a holding company. Although Berkshire operates similarly to a hedge fund in terms of investing in stocks and other securities, it does not take performance fees based on the positive returns generated every year.

While mutual funds are available to a wide range of investors, including normal investors, hedge funds are exclusive and often only open to high-net-worth investors. Mutual funds are made to provide diversity within the asset class or investment strategy of their choice.

Why are hedge funds better than mutual funds?

The key difference between the two is that hedge funds chase the big fish – investments that are high risk, high reward. Mutual funds, on the other hand, stick to the shallows where they can catch smaller but more reliable returns.

Mutual funds and ETFs may hold stocks, bonds, or commodities. Both can track indexes, but ETFs tend to be more cost-effective and liquid since they trade on exchanges like shares of stock.

Money market funds

Because their underlying investments are typically high quality, they are generally less volatile than other types of mutual funds, such as stock funds. Money market funds offer diversification and liquidity.

Unlike checking or savings accounts, mutual funds and other securities carry a certain amount of risk. While some amount of risk may be necessary for big profits to be made, investors know going in there is a chance that they could lose everything.