When it comes to investing, the debate between hedge funds and mutual funds has gone on for decades. While mutual funds are a cornerstone of traditional investing, hedge funds have long been seen as the purview of institutional investors and the ultra-wealthy. Both sides make some good points.

In 2007, Buffett made the “Bet of the Century.” He wagered $1 million that an S&P500 index fund would outperform a group of select hedge funds (chosen by hedge fund manager Ted Seides) over a decade. The result was decisive: the S&P 500 returned 126%, while the hedge funds collectively returned just 36%. Buffett made his point: for everyday investors,simple, low-cost mutual funds often outperform complex, expensive hedge fund strategies.

While this wager solidified Buffett’s strong stance on passive investing, hedge funds still have a place in the portfolios of sophisticated investors looking for higher returns and diversification that mutual funds simply cannot provide.

For example, if you had invested $100 into the Renaissance Technologies Medallion Fund back in 1988, it would have ballooned to $2.1M by 2018—a staggering 2,103,217%return. That breaks down to an average annual growth rate of 66% across a 30-year period, net of the fund’s high performance fees. (If you’d like to see the Medallion Fund’s year-by-year returns, just click the link.)

Of course, weare speaking of outliers here, not the center of the bell curve. Past performance is not indicative of future results, and with any non-guaranteed investment (like Treasurys), performance itself is not a guarantee.

So, which vehicle is right for your portfolio? That’s the multimillion-dollar question. In this guide, we’ll break down the key differences between hedge funds and mutual funds, unpack potential benefits and risks, and help you decide which one might be right for your portfolio.

What are Hedge Funds? What are Mutual Funds?

Hedge funds and mutual funds are both pooled investment vehicles, but they differ significantly in structure,strategy, and the types of investors they serve.

Hedge Funds

These are private investment partnerships that pool capital from accredited investors, aiming to generate high returns through a variety of strategies, including short-selling,leverage, and the use of complex derivatives. Hedge funds are typically much more aggressive in their approach to investing, seeking to outperform the market.

The most famous example of a successful hedge fund is the aforementioned Medallion Fund, while the largest hedge fund in the world is Citadel, which had $397 billion in assets under management (AUM) by August 2024.

Mutual Funds

Mutual funds are investment vehicles that pool money from many individual investors to invest in a diversified portfolio of assets. They aim for steady, long-term growth that may track a specific market sector (such as an industrial or real estate fund) or have a specific intended maturity date (like target retirement funds).

Mutual funds are typically less risky than hedge funds, focusing more on diversified ‘buy-and-hold’ strategies. They are easy to understand, have a much lower minimal capital commitment (if any)than hedge funds, and cater to a much broader base of investors, retail and institutional.

Key Differences Between Hedge Funds vs. Mutual Funds

Hedge Fund Strategies

Hedge funds are known for their active management and use of more sophisticated strategies, such as:

●    Long/Short Equity: Taking both long and short positions, betting on which stocks will rise or fall. This is a fairly popular hedge fund strategy that seeks gains in nearly all market scenarios.

●    Global Macro: ‘Big-picture’ investing based on global macroeconomic and geopolitical trends. George Soros, who cornered the British pound and made billions, is probably the most famous example of a successful global macro investor.

●    Event-Driven: Anticipatory/reactive strategies that exploit expected events, like mergers, acquisitions, asset sales, spinoffs, recapitalizations, and/or bankruptcies.

●    Arbitrage: Profiting from price discrepancies in markets, securities, and/or currencies across different exchanges and/or countries. The global crypto markets are well-known for their asymmetric arbitrage opportunities.

Mutual Fund Strategies

Most mutual funds focus on traditional asset classes (stocks, bonds, etc.), and their strategies are often less aggressive, including:

●    Buy and Hold: Long-term investments aimed at steady growth, particularly in equity funds, although mutual funds exist for just about everything, including bonds, debt, real estate, you name it.

●    Index Funds: Mutual funds that track a specific market index, such as the S&P 500. Firms like Vanguard have made index funds increasingly popular in the 21st century, and they now account fora significant percentage of the total daily securities volume.

●    Target Date Funds: Funds that gradually become more conservative as the target maturity date approaches. The most common target date funds are retirement funds that mature by a specific year,intended for investors within a specific age range.

Hedge Funds vs. Mutual Funds: Risk Profiles

Hedge funds typically assume more risk to achieve potentially higher returns, where as mutual funds can be far more conservative in their approach.

Hedge funds attempt to achieve market-beating returns by leveraging, short-selling, and utilizing complex instruments such as derivatives, thereby exposing investors to increased risk.It’s no surprise that there have been many high-profile hedge fund failures.

For example, Long-Term Capital Management (LTCM), founded by Nobel laureates, collapsed in 1998 after takingon excessive leverage, resulting in a $4.6 billion loss.

Meanwhile, mutual funds are designed to be less volatile and less risky, with a strong focus on diversification.They are largely considered safer investments for retail investors seeking consistent, long-term returns with minimal volatility.

Hedge Funds vs. Mutual Funds: Fee Structures

The fees for hedge funds and mutual funds are another key distinction, with hedge funds generally charging much higher fees due to their aggressive management styles.

Hedge Fund Fees

When Buffett won his wager against the basket of hedge funds, he invited Jack Bogle, the founder of Vanguard, to attend his annual Berkshire Hathaway shareholder meeting. There, in front of a packed audience, he thanked the then 88-year-old Bogle for helping millions of everyday Americans save billions with his low-cost index funds.

Notably, Buffett didn’t gloat over how the S&P 500 outperformed the five funds Seides had chosen for him to bet against. Instead, he focused on how hedge fund fees were too high, which ate into their returns.

That’s because a very common hedge fund fee structure is the "2 and 20" model:

●    2% Management Fee: This annual fee covers the operational costs of managing the fund and is based on total AUM.The fund pays this fee regardless of whether it turns a profit or loses money.

●    20% Performance Fee: This fee is charged on any returns above a predefined threshold, incentivizing managers to outperform the markets or specific target benchmarks.

Mutual Fund Fees

In contrast, the fees for mutual funds are typically much lower, usually comprising a management fee (typically between 0.5% and 1.5%) and, sometimes, an expense ratio that includes the costs of managing the fund’s assets.

Indeed, the S&P 500 mutual fund Buffett chose in his Bet of the Century charged an annual management fee of just 0.04%.

While mutual fund fees are far more affordable than those of hedge funds, many still carry sector-specific or strategy-specific risks. Not all mutual funds are index funds, and some essentially operate as more conservative hedge funds themselves.

Hedge Funds vs. Mutual Funds: Regulatory Differences

Hedge funds and mutual funds are also subject to different levels of regulatory oversight:

●    Hedge funds operate with fewer regulatory constraints than mutual funds, which allows them to employ riskier and more complex strategies. However, hedge funds are only available to accredited investors (those who meet certain income or net worth requirements),meaning they are not as widely accessible as mutual funds.

●    Mutual funds are highly regulated by the Securities and Exchange Commission (SEC), with strict reporting requirements to ensure transparency. They must disclose their net asset value (NAV) daily, andthis information is available to all investors, including retail investors with lower investment minimums.

Which One Fits Your Portfolio?

Choosing between hedge funds and mutual funds depends on your unique investment objectives, risk tolerance, and financial situation.

While both offer valuable opportunities for diversification, the decision ultimately comes down to whether you seek higher returns with higher risk or a more stable, long-term investment with less risk.

When to Choose Hedge Funds

●    Higher Risk Tolerance: If you have a high-risk tolerance and aim to achieve market-beating returns, hedge fundscould be a suitable option. They are ideal for investors who are comfortablewith volatility and want to capitalize on asymmetric opportunities. Someconservative hedge funds, true to their name, still ‘hedge’ long positions, butare endangered in the 21st century.

●    Seeking Absolute Returns: Hedge fundsaim to generate what investors refer to as ‘absolute returns,’ meaning theystrive to deliver uncorrelated profits regardless of market conditions. If youare seeking an investment that can perform well during market downturns, hedgefunds may be a more suitable choice.

When to Choose Mutual Funds

●    Lower Risk Tolerance: If you prefer stability and want to mitigate risks in your portfolio, mutual funds might be a better fit. They are designed to offer steady, long-term growth through diversified investments, making them suitable for investors who want to avoid the higher risk that comes with hedge funds.

●    Broader Accessibility: Mutual funds are more widely available and are suitable for retail investors who may not meet the stringent requirements for hedge fund investments. They offer a lower barrier to entry with significantly smaller minimum investment amounts.

How to Invest in Hedge Funds

If you are interested in hedge fund investing, there are several ways to access these opportunities, even for retail investors:

●    Direct Investment: Nearly all hedge funds allow qualified purchasers (those with over $5 million in investable assets) to invest directly. This investment avenue is closed off to retail investors and was the only way to buy a stake in a hedge fund.

●    Investment Platforms: Today, platforms like EquityZen and SharesPost offer retail access to hedge fund opportunities that were previously available only to large institutional investors and theultra-wealthy. These digital platforms allow accredited investors to pool capital and invest in hedge funds with lower individual minimums.

●    Feeder Funds: Feeder funds pool capital from thousands of investors, allowing everyday individuals to access exclusive hedge fund opportunities with minimum commitments as low as $100,000 per person. Our team helps you navigate hedge fund investments by providing thorough due diligence and tailored investment solutions.

Deciding Between Hedge Funds and Mutual Funds

Choosing between hedge funds and mutual funds ultimately depends on your investment goals, risk tolerance, and financial situation. If you're seeking higher returns and are comfortable with more risk, hedge funds may be the right choice for your portfolio. However, ifyou're looking for long-term growth with lower risk and greater liquidity,mutual funds may be a better fit.

At HUDSONPOINT capital, we offer access to both hedge funds and mutual funds, providing qualified retail investors with the tools and solutions needed to build well-rounded portfolios.

Whether you're interested in hedge fund investing or want to explore how these options can diversify your portfolio, schedule a consultation with one of our specialists to learn more about how we can help you achieve your goals.

‍

‍