The basic concept of hedge funds and mutual funds is similar. Both pool the resources of a large group to invest across a broad number of investments to minimize risk. A key difference is that hedge funds are generally limited to institutional investors and very wealthy individuals. Hedge funds are not covered by regulations that limit the investments of mutual funds.
Stock Holdings
Both hedge funds and mutual funds usually hold stocks. Mutual funds are generally limited to investing in publicly traded stocks, whereas hedge funds do not have this limitation. Hedge funds often invest in private corporations whose financial details and stability is not known to the general public.
Bond Holdings
Both hedge funds and mutual funds usually invest in a certain percentage of bonds to offset other risks. Bonds are safer investments but generally don't have the high returns of stocks over time. As with stocks, mutual funds generally can buy only government bonds and bonds offered by publicly traded companies. Hedge funds can use private loans to private corporations as a part of their portfolio.
Other Investments
Mutual funds are generally limited to commonly known investments such as publicly traded stocks and bonds. However, hedge funds are relatively unregulated and can invest in anything the fund manager deems profitable. Hedge funds can invest in privately held corporations and companies, art, futures and real estate. In addition, they can invest in lesser known investments, such as debt derivatives.
Benchmarking
In general, mutual funds compare their performance to one of the major indexes. The major indexes are the S&P 500, the Dow Jones and the NASDAQ. A fund that performs well will generally outperform the index that lists most of its stock investments. Hedge fund managers try for absolute growth targets without regard to the markets. This is often because the investments in hedge funds are not tied to stock markets.
Risk
In theory, both mutual funds and hedge funds mitigate risk by buying a broad range of securities and investments. However, because hedge funds are relatively unregulated, they often invest in more risky investments. Hedge funds are riskier investments than mutual funds. To offset the risk of complete bankruptcy with hedge fund investments, American hedge funds are open only to investors with very high overall net worth.
