Hedge funds and private equity funds are alternative types of investments that can strengthen and diversify an investor’s portfolio. But while they offer ways to generate profit, there are factors that draw a line between the two.
|Hedge Fund||Private Equity|
|An open-ended investment fund||A close-ended investment fund|
|Usually used for tradeable commodities such as derivates, bonds, and stocks||Usually used for funding private companies or properties|
|Focuses on short-term returns||Focuses on long-term returns|
|An immediate one-time investment is necessary||Does not involve an immediate one-time investment|
|Involves higher risks||Involves lower risks|
|Performance is measured based on a specific benchmark||Performance is measured based on an Internal Rate of Return (IRR) and a hurdle rate|
A hedge fund is an investment vehicle used by accredited investors who pool funds from different sources to invest in local and international markets.
A private equity fund is a collective type of investment scheme used by high-net-worth individuals who invest in private companies and firms in exchange for equity ownership.
Hedge Fund vs Private Equity Fund
Each investment vehicle has its own character, and these two are no exception. Below are some of the main differences between a hedge fund and private equity:
A hedge fund is an open-ended investment fund that offers flexibility in terms of transferability. As the term implies, this type of fund is always open, meaning investors can either invest or redeem funds anytime as long as it is under liquidity parameters.
This is completely opposite for a private equity fund, which is a close-ended investment fund that follows restrictions in terms of transferability and cannot be marked to the market for a specific period of time. Put simply, the funds are locked up and cannot be redeemed within three to five or seven to ten years, depending on the contract.
Hedge funds are commonly used to grow tradeable commodities where the portfolio of funds can significantly change on a daily basis. Examples of these commodities include derivates, bonds, and stocks. Private equity funds, by comparison, are focused on funding the operational costs of private properties or companies.
A hedge fund focuses on assets that can be liquidated immediately or within a shorter time frame, while a private equity fund is geared towards long-term returns that can range from three to ten years, depending on the investor.
To invest in a hedge fund, investors need to immediately provide a one-time investment, which is funded on marketable securities. A private equity fund, by contrast, is an investment vehicle that does not necessitate immediate funding. Instead, the investor makes a commitment to pay a certain amount once the fund is called for.
Risks are inherent in all types of investments, but between the two, hedge funds involve greater risks since it focuses on getting the highest short-term returns.
Since the portfolio of a hedge fund dramatically changes even on an intra-day basis, its returns are evaluated based on a specific benchmark. These funds are continuously measured since investments are made on varying security markets in real time.
The performance of private equity funds, on the other hand, is measured based on an Internal Rate of Return (IRR) and a hurdle rate, which is a required minimum rate of return set by the investor. Unlike a hedge fund, the return of the investment is realized after achieving the hurdle rate, which usually happens during the later years of investment.