Investors are often confused between the similarities and differences of hedge fund and private equity funds. In modern financial markets, many institutional investors allocate a substantial portion of their portfolios to alternative investments. It is often the case that hedge funds and private equity funds are included in the same alternative investment allocation.
A hedge fund is an investment vehicle that uses both types of investments to achieve its goals. A private equity fund is a professionally managed investment partnership that pools money from other investors and invests in, or lends money to companies that the managers believe have growth potential. Through due diligence and research, Real Estate Fund Managers invest in specific segments of a company in hopes of adding value through operational improvements and restructure.
A hedge fund is an investment fund that pools capital from accredited investors or institutional investors and invests in a variety of assets, often with complex portfolio-construction and risk-management techniques. It is administered by a professional investment management firm, and often structured as a limited partnership, limited liability company, or similar vehicle. Hedge funds are generally distinct from mutual funds, as their use of leverage is not capped by regulators, and distinct from private equity funds, as the majority of hedge funds invest in relatively liquid assets.
Hedge funds can be classified according to certain criteria; for example:
- Investment strategy (directional/non-directional)
- Investment objective (absolute return/relative return)
- Net asset value (single-manager vehicles/funds of hedge funds)
- Investor type (institutional/high net worth)
Hedge funds are an alternative asset class. That means they don’t trade on public exchanges like stocks and bonds do. Instead, hedge funds are usually private investment vehicles that sell shares only to accredited investors (people with a net worth greater than $1 million or annual income of more than $200,000 for individuals and $300,000 annual income for a couple).
The value of hedge fund shares can be based on the value of the securities owned, plus or minus any cash or other assets held by the fund, minus any liabilities it has. Since many Real Estate Fund Managers use leverage (borrowed money) to amplify their returns, this can mean that just a small decline in asset values can wipe out the entire value of shareholders’ equity in the fund.
Private Equity Fund
Private equity funds are a type of investment vehicle that pools together money from various institutions and investors in order to invest in the private equity of startup or operating companies through a variety of loosely-affiliated investment strategies including leveraged buyout, venture capital, and growth capital. Typically, a private equity fund has a fixed life of 10 years, with the possibility of two 1 year extensions. Private equity funds are often classified by their stage of development (early-stage venture capital or growth capital), their geographical location (regional, national/multi-national), or their stage of maturity (opportunistic, value-added, distressed debt).
Private Equity Fund Structure
Private equity funds are organized as partnerships and structured in two parts: the Limited Partnership (or “LP”) and the General Partner (or “GP”). The LP is composed primarily of institutional investors and accredited investors who provide the bulk of the capital for the fund. The GP is composed of professional fund managers who make investment decisions on behalf of the LP. GP’s typically receive management fees as well as performance compensation through carried interest.
There are many different types of funds that exist within private equity; some focus on acquiring certain types of companies while others focus on certain industries or regions. There are even funds that specialize in certain stages of financing (e.g., early-stage venture capital). Some funds will invest across multiple asset classes such as real estate, commodities, etc., which can make them more diversified than other types of funds.
Key Difference between Hedge Fund and Private Equity Fund
Hedge funds and private equity funds are two of the most significant investment vehicles available to investors. These funds differ from each other in many aspects. Some of the key differences between hedge fund and private equity fund include:
Investment Strategy – The major difference between a hedge fund and a private equity fund is their investment strategy. A hedge fund invests in liquid assets, while a private equity fund invests in illiquid assets. Hedge funds invest in stocks, bonds, derivatives, currencies, etc. Private equity funds generally invest in private companies, real estate or infrastructure projects.
Fund Size – Hedge funds are smaller than private equity funds. The typical hedge fund manages around US$100 million to US$300 million in assets under management (AUM). On the other hand, the typical private equity firm manages around US$2 billion to US$20 billion AUM. Moreover, large hedge funds can also manage more than $10 billion AUM as well. However, it is comparatively easier for a small hedge fund to raise capital than a small private equity firm.
Investment Targets – The main difference between hedge funds and private equity is what they invest in. Hedge funds generally invest in financial instruments that can be bought and sold quickly on public stock exchanges, while private equity firms tend to focus on acquiring entire companies or large portions of specific businesses through leveraged buyouts (LBOs).
Investment Risk – The private equity fund takes on more investment risk compared to the hedge funds. The investment of the private equity fund is highly illiquid. But the hedge funds can easily liquidate their investments. So, the hedge funds take low risk compared to the private equity fund.
Lock-up and Liquidity – A hedge fund normally does not have a lock-up period or waiting period for investors to redeem their investments. However, a private equity fund has a lock-up period ranging from three to five years which is called an “illiquidity premium” or “time premium”. In other words, investors cannot redeem their investments during the lockup period.
Similarities between Hedge Fund and Private Equity Fund
Both hedge funds and private equity funds are types of alternative investments. A typical investor in a private equity fund is an institutional investor, such as a pension fund, or a high net worth individual. Hedge funds typically have fewer restrictions on who can invest in them, and as a result can raise money from a wider pool of investors.
Here are some similarities between hedge funds and private equity funds:
- Both hedge funds and private equity funds invest other peoples’ money for a management fee, which is usually a percentage of assets under management (AUM).
- Both hedge funds and private equity funds provide an opportunity for investors to diversify their portfolios by investing in non-traditional asset classes.
- Both hedge funds and private equity funds employ leverage to boost returns. Private equity fund managers will use debt to finance buyouts while the majority of the hedge fund strategies use futures or options on futures contracts as leverage instruments.
If you’re an inexperienced entrepreneur and find teaching to be an alluring profession, but you’re hesitant to dive in, you may want to consider a hedge fund or private equity fund to further your business training. In order for you to innovate and be successful in this field, a proper education is essential. These investment vehicles can help a great deal in educating young entrepreneurs about the ins and outs of your chosen field of work.