Normally, hedge funds refer to professionally managed limited partnerships that offer their services to wealthy individuals and organizations. They require sophisticated mechanisms of making investments for instance; short selling, leverage and derivatives. Hedge funds, in comparison with mutual funds, are regulated less and can also demand higher fees. Mutual funds on the other hand are available for various investors and are regulated than the former. They purchase a broad ranged securities, though they generally employ an active trading strategy. Mainly, mutual funds are more popular than hedge funds and usually, they have lower costs and expenses. Hedge funds and mutual funds show differences such that decision-making on which to opt for depends on the capacity and willingness to take risks, investment goals, and financial circumstances.

Understanding Hedge Funds and Mutual Funds

These funds aim for high returns by employing different tactics that are not usual in the normal course of fund investment. Hedge fund managers can also invest in virtually any category of security including equities, fixed-income securities, commodities and others that may include derivatives. Most of them use refined methods of investing such as leverage, short selling and arbitrage with an aim of achieving their investment objectives. This freedom enable hedge funds to take more aggressive positions, and might therefore achieve large profits. However the same techniques, which leads to high levels of returns, also bring high levels of risks; and therefore, hedge funds are appropriate only for sophisticated purchasers who are comfortable with low probabilities of capital loss. Also, hedge funds are not as strictly regulated as other types of investment, thus more forceful strategies can be used, but, at the same time, little is known about it. There is a great deal of dependency upon the hedge fund manager as most of the investments are sophisticated and detailed analysis is required.

What Are Mutual Funds?

Mutual funds are investment vehicles where a large number investors condom their money to purchase a range of securities. Such assets may be stocks or bonds or any other type of securities and are under the control of the fund managers. In other words, the purpose of mutual funds is to give the investors, an opportunity for stock market participation and diversification. While hedge funds function under rather less legal restrictions, mutual funds are strictly governed by the legal standards aimed at reporting, disclosing, and investing. This regulation makes mutual funds relatively safer for investing for the general public because it regulates certain strategies that can be employed and at the same time, requires frequent reporting. There are many varieties of mutual funds, for instance, equity funds, bond funds and balanced funds; thus there is something for every investor, depending on his or her tolerance to risk. A major strength of mutual funds includes the fact that the investments in most mutual funds are relatively cheap and easy to access by even single investors. In the same respect, hedge mutual funds are also long-term investments: thus, they have a more conservative investment profile than hedge funds generally. This makes them ideal for those investors who are interested in earning fixed income and minimum risky investment.

Risk and Return on these Funds

The more risky ones are the hedge funds as compared to other investing entities, because of their high risk activities like hedging, short positions and derivatives. The said strategies are meant to work in the acquisition of the so called absolute returns; a situation whereby the hedge funds make profits in any situation that may prevail in the market. But the use of such styles may pose a lot of insecurity in the form of high variability in the performance of the fund. Since hedge funds participate in the sales and purchasing of securities in market conditions they can earn high revenue during bullish market and also suffer heavy losses during bearish markets. Another factor that increases the risk is the unregulated area where hedge funds operate with higher freedom and with less disclosure in comparison with other funds types. This lack of regulation implies that a lot of reliance must be made on the ability of the fund manager since all decisions made by the manager have a direct bearing on the performance of the fund. Relative to mutual funds, hedge funds are typically not appropriate for all types of investors; the investment is more appropriate for the highly risk-tolerant who follows and understands the financial markets and has no qualms about large swings in the value of their investment.

Risk Profile of Mutual Funds

Hedge funds appear to have a relatively higher risk compared to mutual funds, mainly attributed by the fact that mutual funds invest in multiple securities and companies, and operates within legal frameworks. ; Mutual funds involve the consolidation of investments in a large number and diversification of these investment on various forms of investment so that the effects of even a poor performing investment are felt less. This diversification strategy is one of the causes that make their returns more stable in the long run. Moreover, mutual funds enjoy a good legal framework providing high investors protection: limitations of the allowed use of the financial leverage, as well obligations to disclose the funds activities in certain periodic intervals. Such regulations increases the degree of responsibility hence enhance the prospect of mutual funds as an investment avenues more embracing and safer. For instance, mutual funds can be with low risk tolerance or those in search of stable returns on their investment. Due to the more emphasis on diversification and growth in the long-run, mutual funds are ideal investment avenue for people seeking to generate wealth slowly while avoiding short-term fluctuations in the stock prices. On balance, mutual funds may be described as a very fluid and flexible investment type which may adequately meet demands of the broadest spectrum of investors with different risk appetites.

Expected Returns and Volatility

The expected returns and volatility of hedge funds and mutual funds are dissimilar because of the strategies that are used and the risk that is taken. Frequently hedge funds are seeking higher returns using complex and fairly risky strategies that are intrinsically riskier. Applying this strategy can result in rather high returns on investment, however, it amplifies the chance of receiving high risk lessens, particularly during the fluctuations of the market. A shareholder in hedge funds has to be ready for large volatility in his portfolio, this is because hedge funds tend to deal in large risks to give their clients absolute returns. On the other hand mutual fund contains both, equal importance is given to growth rate but it also emphasizes on sustainable growth. Structure that is diversified in mutual funds assist in moderating returns and which lowers the market fluke in the overall portfolio. Though there might be comparatively lower returns from mutual funds than the hedge funds, the advantage here is a better controlled and hence a stable investment. It only remains that the two types of funds are defined by an investors overall appetite for risk, his financial objectives, as well as his investment time period.

Conclusion

Hedge funds and mutual funds both fit different investor requirement and have different advantages and disadvantages. Hedge funds are used by investors who demand potentially high returns through the use of strategies that entails a high risk, thereby suitable for sophisticated investors. With mutual funds on the other hand, the risks are more manageable, it promotes diversity, it has a longer-term requirement making mutual funds for a variety of investors. It is critical to distinguish between these funds in order to make investors the proper decisions depending on their objectives and tolerance for risk.