Hedge Funds vs Mutual Funds

When the stock market is doing poorly, talk of using hedge funds tends to increase. Although hedge funds are not mutual funds, people often mistake them as such. The word "hedge" implies defensive management or insurance against bad times, but the truth is hedge funds come in hundreds of varieties and often use leverage.Hedge Funds vs. Mutual FundsAssuming you understand mutual funds, let's take a look at the key differences between mutual funds and hedge funds:　Mutual FundHedge FundRegulationSEC registered investment vehiclesPrivate investment vehicles (not regulated)Minimum InvestmentUsually small minimum investmentsLarge minimum investments required (average $1 million)InvestorsNot limited to the number of investors and investors can purchase many fundsAre limited to 499 investors ("limited partners") who can invest in any one fundAvailabilityAvailable to the general publicMust be an accredited investor (net worth must exceed $1 million or individual income must have been in excess of $200,000, or joint income must have been in excess of $300,000 in the past two years, plus investor must expect the same level of income in the current year)LiquidityDaily liquidity and redemptionLiquidity varies from monthly to annuallyShort SellingMaximum 30% of profits from short sales (although other bear fund options exist)Manager may short sell oftenLeverageLess leverageMore leverageDown MarketsSome funds are defensively managed and others, like index funds, hold during bad markets.Most hedge fund strategies try to hedge against downturns in the markets, but effectiveness depends on the fund.DefinitionA public pool of investment capital organized to invest in a portfolio composed of often predetermined type of securities.A private pool of investment capital organized into a limited partnership to invest in a portfolio made up of a variety of securitiesFeesLimits Imposed by the SECNo Limits. Hedge funds typically charge high fees, usually a combination of 1-2% of your assets plus a percentage of the profits (usually 20%)Bottom LinePutting my mutual fund bias aside, I recommend potential hedge fund investors to proceed with extreme caution. There is limited information about hedge funds and the information that you do find is often plagued with survivorship bias and willingness to share performance bias (those that are doing well are more likely to share their performance). Try to stick with hedge funds that have been around for a while - you certainly don't want to invest with a company that has opened and closed many hedge funds. Lack of regulation, bad liquidity and high fees are other issues issues that should be considered. Most of all, don't put all your money into hedge funds.Of course, I am not an "accredited investor" - so what do I know?