Difference Between Hedge Funds, ETFs and Mutual Funds

13 June, 2024

Synopsis

• Investment vehicles like hedge funds, mutual funds, and ETFs offer different paths to financial growth, each suited to varying risk appetites, investment objectives, and regulatory frameworks.

• Hedge funds, targeted at affluent investors, employ complex trading strategies like leverage and derivatives to seek high returns, but with high risk and limited regulatory oversight.

• Mutual funds, regulated by SEBI and accessible to retail investors, pool money to invest in diverse asset classes. They offer transparency, liquidity, and varying risk profiles based on scheme mandates.

• ETFs, passively managed and traded on stock exchanges, track market indices like Sensex or Nifty, providing real-time traceability and low-cost diversification similar to mutual funds.

Going for vacations in a self-driven car is exciting – where it gives you the thrill of driving on unknown terrains, apart from the mental peace you get when far from the madding crowd. When you start your journey, you can choose your own route. It all depends on your time, the kind of experience you want, how much risk you are willing to take, and the budget you have earmarked for the vacation. Similarly, investment too is an exciting journey. There are different investment vehicles you can board, depending on the objective of investment, the kind of risk you want to take, and the time for which you want to invest. Today, there are various investment vehicles like mutual funds, exchange-traded funds and alternatives like hedge funds. For you to choose the right vehicle to start your investment journey on, you must be clear about the functioning, running and maintenance costs, and mileage of these vehicles – it will help you choose a vehicle that will take you to your destination in time set by you, in your budget and in which the risks are aligned with your risk appetite.

Let’s decode the characteristics and differences between hedge funds, mutual funds, and ETFs.

What Are Hedge Funds?

Hedge funds are privately organised investment funds that pool money from affluent individuals or institutional investors. The primary aim is to generate outsized returns through innovative investing and trading strategies. Some key features of hedge funds are:

• Use leverage, short-selling and derivatives to amplify returns

• Require high minimum investment, often upward of ₹1 crore

• Charge a performance fee of up to 20% of profits

• Offer limited regulations and disclosure

• Carry high risk due to complex investing approaches

• Require investors to be accredited

Hedge funds pursue an ‘absolute return’ strategy to deliver positive returns regardless of market conditions.

Understanding Mutual Funds

Mutual funds are professionally managed investment schemes that pool money from numerous retail investors to invest in equities, debt and other asset classes. Key characteristics include:

• Regulated by SEBI with multiple investor protections

• Offer diversification across stocks, bonds and assets

• Allow investing in small amounts

• Charge expense ratio up to 2.5% of assets

• Follows investing style based on scheme mandate

• Focus on generating returns aligned with markets

Mutual funds provide a simple way for retail investors to participate in capital markets by holding a basket of securities.

Defining ETFs

ETFs or exchange-traded funds are a special type of investment funds that are passively managed and track the performance of a market index. Here are some salient features:

• Listed on stock exchanges like shares

• Tracks index performance like Sensex or Nifty

• Allows buying/selling anytime during stock market trading hours

• Transparent holdings and inexpensive

• No active fund manager just replicates the index

• Combines aspects of mutual funds and stocks

ETFs offer diversification benefits of mutual funds but with real-time tradability like stocks.

What is the difference between Hedge funds, Mutual Funds and ETFs?

While all three offer pooled investment opportunities, hedge funds are targeted at ultra-HNIs, given the prohibitively high investment size and risks involved. Mutual funds and ETFs cater to retail investors with lower investment amounts and relatively lower risks and costs. Evaluate your specific needs to decide which vehicle suits you the best. If you are not confident about your driving skills, then HDFC Bank SmartWealth App is the instructor you should look at.

Download the HDFC Bank SmartWealth App from Playstore/Appstore now. This DIY app will help you board the right investment vehicle, which will take you to your investment destination on time in line with your risk appetite. The right time to onboard the HDFC Bank SmartWealth App is TODAY!

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