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If you want your hard-earned money to grow, you’re better off investing it than letting it sit at the bank. While there are plenty of traditional investment channels, such as stocks and bonds, those with higher net worth can consider two alternative options: hedge funds and private equity funds.
But what exactly are these funds? And which one should you invest in? These are the questions we’ll tackle in this article.
What is a Hedge Fund?
Hedge funds pool money from their clients or investors. The investments are then invested in high-risk financial instruments such as derivatives trading, emerging markets, and short-selling. Despite the seemingly risky portfolio of a hedge fund, they are still the investment vehicle of choice for high-net-worth individuals seeking higher returns and short investment horizons.
Top Hedge Fund Firms
Here is Investopedia’s list of the world’s top hedge fund firms based on total assets under management (AUM):
- Citadel Advisors
- Bridgewater Associates
- AQR Capital Management
- D.E. Shaw
- Renaissance Technologies
What is a Private Equity Fund?
A Private Equity (PE) Fund is an investment vehicle that pools capital or investments from various investors, including high-net-worth individuals and corporations. The pooled money is used to acquire companies with the intention of making a profit, whether through selling ownership stakes or through an initial public offering (IPO). Those with lower risk tolerance and a higher level of control over assets tend to prefer this investment option.
Top Private Equity Fund Firms
Here are some of the top players in the world of private equity funds based on total equity:
- The Blackstone Group, Inc.
- KRR & Co. Inc.
- CVV Capital and Partners
- The Carlyle Group
- Thoma Bravo
The Similarities Between Hedge Funds and Private Equity Funds
Aside from being considered non-traditional or alternative investments, there are other notable similarities between private equity and hedge funds. Here are the main ones:
Similar Investor Profiles
The target clients of both hedge funds and private equity firms are the same. These clients include wealthy individuals or those who have high net worth, institutional investors, companies, and the like. In short, only those with strong financial capacity can invest in private equity and hedge funds.
Both Require Pools of Capital
Hedge funds and private equity funds both pool money or capital from multiple investors. This pool is where they get the funds to operate and execute investment strategies. A large capital allows funds to pursue bigger investment opportunities and diversify their portfolios for better returns and risk mitigation.
Both Need Professional Financial Services
Since large sums of money are involved in the dealings, both options require services from financial experts. Fund managers, investment advisors, and other professionals use their skills and expertise to make sound business decisions. The importance of fund administrators in all facets of the fund is significant. Besides finding the best investment opportunities, they also help ensure that all transactions comply with the regulatory requirements and are executed with due diligence to manage risks.
Investors Have Limited Liability
Both options offer minimized risk exposure to their investors. In unfortunate cases where an investment performs poorly, the investors can still safeguard their personal assets. This means they will have no other obligation beyond what they’ve already invested.
Which is a Better Investment Option?
Now that you’ve had an overview of the two options as well as their similarities, it’s time to make the big decision. However, the answer still isn’t as straightforward. But here are things you may want to consider as you find the option that best aligns with your investment strategy.
Period of Investment
One of the most apparent differences between hedge and private equity funds is their investment horizons. Investments in private equity funds are more long-term investments spanning years, some 3-5, some reaching a decade. On the other hand, hedge fund investments generally have shorter life spans. Some impose a locked period of as short as one year. So it’s essential to assess your investment strategy as well as your short-term and long-term financial goals when choosing between these two options.
Risk Aversion
While this can depend highly on the firm you are transacting with, the risk associated with hedge funds is significantly higher than that of private equity funds. Hedge fund firms typically use the pooled capital on high-risk, high-return investments, so if you’re more on the risk-averse side, private equity funds or other investment vehicles may be a better option.
Level of Control
Private equity funds offer a more active management approach than hedge funds. Investors can participate in decision-making involving business strategies as well as operational improvements. In contrast, investment decisions are handled by a fund manager in a hedge fund setup. So if you’re considering investing in a hedge fund, it’s best to find out whether your fund manager or advisor is an expert in their field and has a track record of making winning deals.
Conclusion
There is no 100% right investment option, as any investment does come with its own risks. But what you can do is try and learn about your preferred investment horizon, risk tolerance, and preferred level of control. If you’re still on the fence, consider consulting with a financial advisor to help you find the most suitable investment option.
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