Hedge Fund vs Private Equity Investments

Hedge Fund vs Private Equity Investments

Let's talk the big money. Specifically, we'll discuss hedge fund vs private equity investment differences.

We're assuming you already know what is private equity in regards to this discussion and what a hedge fund is, so we're going to dive directly into the differences between private equity funds vs hedge funds. But if you don't know what these two investment models are, start reading here and then come back. So let's get into it...

Basic Differences Between Private Equity Funds vs Hedge Funds

Although both hedge funds and private equity investor profiles are often similar, there are rather large differences between the types of investments and the objectives sought by the two.

Both private equity and hedge funds appeal to high net worth individuals (many require minimum investments of $250,000 or more), are normally structured as limited partnerships and involve paying the managing partner's basic management fees plus a percentage of investment profits.

When considering the main objective of a hedge fund, you'll find that the goal is to provide the highest investment returns possible as fast as possible. In order to reach this goal, fairly liquid assets are the investment aim because this enables the fund to quickly move profits gained on one investment into another investment that is more immediately promising. Hedge funds invest in nearly everything imaginable – bonds, individual stocks including options & short selling derivatives, arbitrage, commodity futures, currencies – whatever investments the hedge fund manager assesses as offering potentially large ROI in a short time frame. In short, hedge funds are primarily focused on attaining maximum short-term profits.

Private equity funds on the other hand, invest directly in companies, primarily by purchasing private companies. In this sense, they more closely resemble venture capital firms.

At times they also look to financially acquire controlling interest in publicly traded companies through stock buys.

Private equity funds often use leveraged buyouts to gain control of financially distressed companies. This is one of the biggest differences between private equity vs hedge funds, while hedge funds aim for quick turn around profits, the main objective of private equity funds is to build on the long-term earning potential of the portfolio of companies that they have acquired or hold an interest in.

Once private equity funds control interest in or fully acquire a company, their aim is to improve the company through various methods, for example, streamlining business operations, making management changes, or even expanding, with the long-term goal of selling the company for a profit, either through an IPO in the stock market or through a private sale.

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In order to meet their investment objectives, it's common for private equity funds to have, not only the private equity fund manager, but also a panel of corporate management experts who can be empowered to run the acquired companies. The essence of private equity fund investments insists upon more patience and a long-term investment focus, depending on assessments that their return on investment will grow over the span of years rather than seeking the faster short-term ROI focus of hedge funds.

The Liquidity Difference: Hedge Fund vs Private Equity

The liquidity difference in the comparison of hedge fund vs private equity fund variances is a key detail to take note of. Hedge funds are primarily focused on investing in more liquid assets, with that being the case, investors can usually cash out on their hedge fund investments much sooner than private equity funds.

The hedge fund vs private equity fund liquidity difference is considerable, private equity funds are more of a holding game, so investors are usually required to commit their invested funds for a minimum time period, at least 3-to-5 years is common, and some funds even commonly require 7-to-10 years.

Varied Risk-Level: Hedge Fund vs Private Equity

Another one of the notable differences between private equity funds vs hedge funds is the inherited risk of investment with each model.

What you lose in liquidity with private equity funds, you gain in lowered level of risk in comparison to hedge funds. This is no small matter for many cautious investors that are considering the major hedge fund vs private equity fund differences.

While both investment models practice risk management by combining a number of safer investments together with higher-risk investments, because hedge funds are aiming to gain maximum short-term profits, there is generally a higher level of risk expected.

What Is a Hedge Fund Really? The Evolution To Today's Hedge Fund Definition

Some may argue that there are hedge funds that fit the traditional hedge fund definition – funds designed to provide protection of capital invested in traditional investments – but in today's investment world, that isn't considered the common usage of the term "hedge fund" anymore. We'll discuss what a hedge fund was originally, and what a hedge fund is for today's investor...

The Classic Hedge Fund Definition & Origins

In 1949, former sociologist and author Alfred Winslow Jones’s company, A.W. Jones & Co. started the first hedge fund. While writing a piece for Fortune magazine in 1948 about investment trends in that era, the writer was inspired to try a new style of investing. He raised $100,000 and employed a method of minimizing the inherited risk in holding long-term stock positions by short-selling other stocks. The investing model he created is now known as the classic long/short equities model. Jones also employed leverage to enhance returns.

The result? By the 1960s, hedge fund investments began dramatically outperforming most mutual funds and became very popular after a 1966 article in Fortune showcased an obscure investment that beat out every mutual fund on the market by double-digit figures over the past year and by even higher double-digits over the last 5 years.

But change came over the years and hedge fund trends evolved, many "hedge funds" turned away from Jones' original strategy which focused on choosing stocks coupled with hedging and instead dove into riskier strategies based on long-term leverage in an effort to maximize returns.

These investment strategies led to huge financial losses in the late 60s and early 70s, and there were a number of hedge fund closures as a result.

The hedge fund industry was relatively stagnant for over twenty years until a 1986 article came out in the Institutional Investor that showcased the double-digit performance of Julian Robertson's Tiger Fund. With another high-performing hedge fund grabbing the investing public's eye, investors flocked to an industry that now offered thousands of hedge funds and an ever-increasing array of exotic investment strategies, including derivatives such as futures and options, as well as currency trading.

What is a Hedge Fund To Today's Investor?

Hedge funds have evolved, for current day investors hedge funds are alternative investments using pooled funds that employ various strategies in view of earning an active return, or alpha as it's also known, for their investors. Hedge funds have the flexibility of being managed aggressively or make use of derivatives and leverage in both domestic and international markets with the objective of generating high returns (either over a specified market benchmark or in an absolute sense). Be aware of the fact that hedge funds are typically only accessible to accredited investors as they require less regulations through the SEC than other types of investment funds.

The fact that hedge funds face less regulation than mutual funds and other investment vehicles is one aspect that has set the hedge fund industry apart.

Hedge funds are designed specifically to take advantage of certain identifiable market opportunities, they use different investment strategies and thus are often classified according to investment style. There are substantial varying levels of diversity in risk attributes and investments among the different styles.

Legally, today's version of hedge funds are most often set up as private investment limited partnerships that are open to a limited number of accredited investors and demand a substantially large initial investment minimum. In the hedge fund vs private equity debate, hedge funds win the liquidity battle. But still, hedge funds investments are not very liquid, investors are often required to keep their money in the hedge fund through a "lock-up period", which usually lasts at least 12 months. Withdrawals may also only happen at certain intervals such as quarterly or bi-annually.

VIDEO: What Is a Hedge Fund?

What Is Private Equity?

Above we highlighted hedge fund vs private equity differences, but let's discuss private equity funds specifically. Private equity is a source of investment capital from both institutions and high net-worth individuals for the purpose of investing and acquiring ownership equity in companies.

Private equity has successfully attracted the best and brightest financial minds in corporate America, including top performers from Fortune 500 companies along with elite management and business development consulting firms.

Partners at private equity firms raise funds and manage these monies to yield favorable returns for their business shareholder clients, typically with an investment horizon between 4-7 years.

These investment funds can facilitate buys in shares of private companies, or even in public companies that eventually become delisted from public stock exchanges under go-private deals. The minimum capital investment required vary depending on the fund raised and firm. Some funds have a $250,000 minimum investment requirement; others can require millions of dollars.

The fee structure for private equity firms can vary, but it usually consists of a performance fee and a management fee (in some cases, 20% of gross profits upon sale of the company and a yearly management fee of 2% of assets managed). How private equity firms are incentivized can vary greatly.

Many finance whizzes mull over the difference between hedge fund vs private equity. And it's clear to see why the private equity industry attracts elite-level talent when considering that a private equity firm with a billion dollars of assets under management might have no more than a couple dozen investment professionals, and that 20% of gross profits can easily produce tens of millions of dollars in fees for the firm. At the middle market level ($50 million to $500 million in deal value), associates can earn salaries and bonuses in the low six figure range, VPs can earn approximately $500,000 and principals can earn more than $1 million in (realized and unrealized) compensation every year.

VIDEO: What Is Private Equity? - Hedge Fund vs Private Equity


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