What is the Difference between Private Funds and Mutual Funds?

According to the SEC, “mutual funds are companies that brings together money from many people and invests it in stocks, bonds or other assets. The combined holdings of stocks, bonds or other assets the fund owns are known as its portfolio. Each investor in the fund owns shares, which represent a part of these holdings.” On the other hand, “hedge fund” is a general, non-legal term used to describe private, unregistered investment pools that traditionally have been limited to sophisticated, wealthy investors.

Hedge funds are not mutual funds and, as such, are not subject to the numerous regulations that apply to mutual funds for the protection of investors. These include regulations that: require a certain degree of liquidity, require that mutual fund shares be redeemable at any time, protect against conflicts of interest, assure fairness in the pricing of fund shares, require disclosure, and limit the use of leverage.

In looking at this basic explanation of mutual funds and how they differ from hedge funds, we can see that one similarity is that they are pooled funds that invest in securities managed by an investment manager. The differences arise in how they are structured. Mutual funds are “corporate” entities in which investors purchase shares, either from the mutual fund or in the open market on an exchange. Hedge funds are “partnership”- type entities in which investors get partnership interests. Mutual funds are entities registered with the SEC and subject to many rules and regulations on what they can invest in and liquidity restraints (so investors can get money out on a daily basis for the most part). Most importantly, anyone can invest in a mutual fund. Hedge funds are subject to SEC oversight but do not have these constraints.

The tradeoff for the hedge fund manager is that they cannot offer their fund to just anyone and can have only a limited number of investors in their fund. In order to invest in a hedge fund, you need to be an accredited investor (see detailed description later on), meaning you must meet high net worth standards and understand the risks involved with the fund. The minimum investment requirements are very high, usually a million dollars.

It is expected that the “mom and pop” investors in mutual funds read the fund’s prospectus to gain an understanding of the risks involved, but too often they don’t. There are typically no minimum amounts required to invest in mutual funds.