Hedge funds vs Mutual funds: What's the difference?

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If you’re looking into investing for the first time, you’ll need to understand the many different types of investment vehicles and instruments out there.

Funds are a popular way to invest, as they offer diversification, spread risk and often include professional management.

Two common types of funds are hedge funds and mutual funds. But what are the main differences between them?

Here, we’ll run through what each fund type is, the key differences between them and everything else you need to know.

What are mutual funds?

Mutual funds combine money from multiple investors in one pot, and invest it on their behalf.

Whenever you see a fund or OEIC (Open Ended Investment Company) advertised on an investment platform, this usually refers to a mutual fund.

This kind of fund can be actively managed by a professional fund manager, who will build and manage a portfolio of stocks.

Some are passively managed, where the fund simply aims to match the performance of a particular stock index, such as the S&P 500 or the FTSE 100.

There are two ways to earn returns from a mutual fund. Either the fund's assets rise in price and you sell your investment, or you earn income from dividends/interest.

Types of mutual funds

There are a few types of mutual funds available in the UK, including:

• Multi-asset funds - these contain a mix of assets in one portfolio, such as shares, bonds and property for example.
• Equity funds - these funds mainly invest in stocks
• Index funds - these aim to track the performance of a specific index, such as the FTSE 100
• Bond funds - these invest in debt assets, such as government or company bonds
• Money market funds - these funds focus on low-risk, short-term assets such as cash and government bonds
• Income funds - these are designed to provide regular income to investors, generating interest through investment in government and high-quality corporate debt.

Who are mutual funds best for?

Mutual funds are ideal for new or less experienced investors, or those with little time to manage their own portfolio.

This is because these funds are often professionally managed. They also include a spread of investments, which means a more diversified portfolio and less risk attached - although remember that no investments are without risk.

What are hedge funds?

A hedge fund is a partnership between investors, who pool their money in a collective investment pot. This is then used to invest in often high-risk assets, with the aim of making above-average returns. Investment strategies are often aggressive, making use of short positions, leverage and derivatives to achieve ambitious goals.

Hedge funds are structured in a similar way to limited partnerships, where investors become limited partners and the company is a general partner.

Unlike with mutual funds which are open to the public, only accredited investors can invest in hedge funds. This means high-net-worth (HNW) individuals with an income of at least £200,000 a year or a net worth of at least £1 million (not including property).¹

Types of hedge fund

There are a few different types of hedge fund, including:

• Event-driven funds - these are funds specifically focused on corporate events such as mergers, acquisitions and bankruptcy, which can cause pricing inefficiencies they can take advantage of
• Directional funds - these funds make use of short selling, taking positions in the stock markets and profiting from falling as well as rising markets.
• Relative value funds - these funds take advantage of short-term differences in the value of related securities
• Global macro hedge funds - these funds profit from fluctuations in stock markets, caused by major economic or political global events (for example, trade wars, political elections, or changes in inflation or interest rates).

Who are hedge funds best for?

Hedge funds are limited to accredited HNW individuals, but they’re really only suitable for experienced investors.

These are people with knowledge of investment markets and strategies, who are willing to tolerate a much higher level of risk in exchange for potentially higher returns.

Hedge funds vs. mutual funds - the key differences

Here are the key differences between hedge funds and mutual funds, at a glance:

Don’t let currency conversion trip you up when investing - use Wise

In this article, we’ve looked at the key differences between mutual funds and hedge funds, so that you can make a more informed decision as an investor.

But there’s another important thing you need to know - if you trade stocks or invest in funds in different currencies, you could be hit with extra costs for cross border money transfer.

The good news is that you can use Wise to avoid hidden currency exchange markups. Open a Wise account to convert currency at mid-market exchange rates, for low, transparent fees*.

Why not hold your money in a Wise account until you decide to invest it in your chosen platform? Set up exchange rate alerts with Wise to be notified via email or push notification when the rate drops to your chosen threshold.

You can also use your Wise account to conveniently manage your money in currencies, sending payments worldwide at the mid-market rate for low fees*. Plus, there’s a dedicated secure service for sending large amounts.

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There’s even an extra feature, Wise Interest. With a Wise account you can earn returns on GBP, USD and EUR by opening a Wise account and investing in a fund that holds government-guaranteed assets. Capital at risk.

Investments can fluctuate, and your capital is at risk. Interest is offered by Wise Assets UK Ltd, a subsidiary of Wise Payments Ltd. Wise Assets UK Ltd is authorised and regulated by the Financial Conduct Authority with registration number 839689. When facilitating access to Wise investment products, Wise Payments Ltd acts as an Introducer Appointed Representative of Wise Assets UK Ltd. Please be aware that we do not offer investment advice, and you may be liable for taxes on any earnings. If you're uncertain, we urge you to seek professional advice. To find out more about the Funds, visit our website.

Sources used:

1. Unbiased - definition of an accredited investor
2. Which? - mutual fund management fees
3. Extract Alpha - hedge fund fee structure

Sources last checked 2-Jan-2025