Wednesday, May 28, 2008

Mutual Funds vs Hedge Funds: An analysis of the advantages and disadvantages

Mutual Funds


Mutual Firms are essentially a professionally managed investment company that collects from many investors and firms to invest these in bonds, securities, asset classes, stocks, commodities or short-term money instruments.

These mutual funds serve a purpose of collecting a large amount of capital from an unlimited number of individual investors. As additional money flows in, the fund manager purchases financial instruments in careful ratios or proportions according to his/his company's strategy. The main job of the fund manager is to trade the securities of his fund, while realizing any gain or loss, and pass the same to the investors.

Hedge Funds


A hedge fund is an investment company that accepts investment, not from everyone, but only from a small number of wealthy individuals, families or big institutions. In US, a hedge fund is open to accredited investors, who are people with a salary above $200,000 annually or have at least $1 million in assets. This is done usually to undertake more complex and riskier investments than what a mutual or public fund may undertake.

Advantages of the Hedge Fund:

  • Able to employ extremely aggressive investment strategies(such as using borrowed money to increase invested money or to buy more assets with someone else's money-called leverage buying)

  • Can put 'all eggs in one basket' and use no diversification thus very complex and risky investments made which will give either huge losses or sky-high profits.

  • The Fund Manager is motivated to outperform everyone and earn the highest return, for he has a share in the profits of the hedge fund. However, he does not have a share in the losses!

  • Can short sell or take on risky, unhedged positions to earn large profits. If the market turns against them, losses mean closure of the fund.




Facts:

Currently, the worldwide value of all mutual funds total to more than $26 trillion. Hedge funds, still growing, and open to a select few, have assets worth much less.

In 2006, the hedge fund advisory group Hennessee, estimated the total assets to be $1.442 trillion. In 2007, Hedgefund.net concluded that total assets under hedge funds amounted to $2.68 trillion in 2007 (3rd quarter). Hedge funds have not quite taken off in India.

The most famous mutual fund manager remains Peter Lynch, while George Soros and John Paulson are the highest paid hedge fund managers at $2.9 billion and $3 billion respectively. However, Warren Buffet, chairman of Berkshire Hathaway Inc., is neither a mutual fund manager nor a hedge fund manager. He is just the owner of the world's largest investment company, listed on the stock exchange. Thats all for the day folks.

Chirag

ps. Feel free to comment

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