Hedge Fund vs. Private Equity

Jul 23, 2021 08:07 PM ET
Hedge Fund vs. Private Equity

A hedge fund is a special purpose firm formed by the pooling together of funds from typically high net worth individuals. The key driving force behind these funds is to invest in high-yielding investment opportunities, whose returns are usually realized within the short or medium-term. Hedge fund managers lead a team of highly skilled business and financial analysts who identify such investment opportunities as would be worth putting investors' millions of dollars into.

Ultimately, the hedge fund manager has the biggest responsibility in the fund, including having the final say on what investments to go for and the most suitable investors to approach. Most hedge funds identify specific segments of the economy that they consider high-potential. Following an assessment of the potential risk and potential rewards, they then source money to invest in them.

Over time, as the performance of these investments change, the fund may restructure its portfolio to include better-performing assets. A private equity fund is a consolidated fund consisting of the funds pooled from various investors with interest in the part-ownership of non-publicly traded companies.

In some instances, private equities acquire whole companies and delist them afterward. The key motivation behind private equity funds is getting into high-yielding market segments using established firms as investment vehicles. For each of their targeted firms, private equity funds seek a controlling stake, thereby enabling them to define their investment paths. Typically, these funds invest in several companies, thus giving them a bigger say in specific segments of the economy.


1. Investment timeline

Hedge funds' business model is usually driven by the aim of making high profits from short-term engagements. Therefore, they target assets that are relatively high-risk compared to private equity funds. Importantly, they almost exclusively invest in liquid assets due to their tendency to shift from one investment to another within short time spans. In some instances, they trade in the stock market for a few minutes or seconds through scalping or day trading.

Private equity funds, on the other hand, target companies with a well-established presence in a market, with an aim of using them as vehicles to generate long-term profit. For this reason, private equity funds will hardly acquire companies facing financial downturns.

Therefore, decision-making in these firms is done with a long-term perspective. Usually, private equity funds embark on a restructuring of the acquired companies with the aim of minimizing costs and optimizing profits. Some of the common ways to approach this include downsizing employees, adopting new technology, etc.

2. Approach towards capital investment

By investing in a hedge fund, you enjoy peace of mind knowing that you can liquidate your capital on short notice. In contrast, investors in private equities have the burden of locking up their capital for a fixed period.

The other key difference between the two funds is that hedge fund investors typically contribute to their capital in a single tranche. In contrast, private equity investors receive periodic invitations to contribute towards the fund (usually every 3-5 years). This is known as a capital call. In the event that you are unable to deliver the required capital, it can attract penalties from the fund.

3. Level of risk

Hedge funds are built on risk-taking. They invest in assets that can accumulate high earnings within a short time but which can equally lead to great losses over a short time. Hedge fund managers, therefore, have the burden of ensuring that the investment they put the fund's money in pays off. 

Which choice is better?

In any investment you intend to put your money into, your most important guiding principle should be the extent to which the investment will help you achieve your objectives. As intimated above, hedge funds are ideal for those who aim to make profits in the short term but are also willing to take the comparatively higher risk that accompanies it.

You should opt for private equity if you are keen on building a portfolio whose returns will last for the long term. However, remember that this also requires you to commit substantial amounts of your money towards the fund through periodic contributions.

For private equities, the degree of risk exposure is comparatively lower compared to those of hedge funds. However, in some instances, the companies acquired by private equity funds often fail to yield the expected profits even in the long term.

You should also consider the differences that come with liquidity. With hedge funds, you can easily get back your money by liquidating your assets. On the contrary, private equity ties up most of your assets in forms that are difficult to liquidate.

The common denominator in both forms of investment funds is that they attract management fees. The funds are run by skilled financiers and business people who know how to spot opportunities, make deals, generate profits, and minimize losses.

Hedge fund and private equity managers are among the most highly-paid persons in the corporate world, with the aim of and their pay and those of their teams come from bonuses and standard salaries from investor contributions.

In summary

Whether you want to invest in a hedge fund or you are willing to wait for the long-term yields of private equity, your overriding factor should be your investment objectives. These two forms of investment are worthwhile but require relatively high capital and willingness to take risky but potentially rewarding ventures.

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