Difference Between Private Equity and Hedge Funds
By: Michael Megarit
There are several differences between private equities and hedge funds. This article will begin by defining what they are and go on to outline their differences. Hedge funds are alternative investments in which pooled funds are used and tend to employ a variety of strategies to earn returns to their investors. The primary aim of hedge funds is to provide the highest returns to their investors as quickly as possible. In order to achieve this goal, investments in hedge funds tend to be in highly liquid assets, which enables the funds to quickly take profits in one investment and then shift the funds into other investments. On the other hand, private equity investments are more like venture capital firms. They invest directly in companies by primarily purchasing those companies even though they also seek to acquire controlling interests in public traded companies. Unlike hedge funds which focus on the short term, private equity funds focus on the long term. The differences are outlined below:
Investment Time Horizon
Hedge funds tend to invest in assets that can provide them with good returns on investment within a short period of time. In this case, hedge fund managers prefer liquid assets so that they can easily and quickly shift from one investment to another. For private equity funds, investors are not looking for short term returns. Their primary focus is usually to invest in companies which have the potential to provide substantial profits for a long time frame. They are not interested in investing in companies that need a turnaround. Private equity firms usually acquire a controlling interest in the companies they invest in while hedge fund investments are focused on banking profits as quickly as possible and moving onto other investments.
Private equity investors commit the capital they wish to invest and so the money is only committed when they are called upon. However, investors in hedge funds invest their monies at once. Investors in private equity funds are required to commit their capital for a certain time period. This restriction does not apply to hedge fund investments because they can be liquidated at any time.
The legal structure for hedge funds is also different for private equity funds. Hedge funds are open-ended investments with no restriction on transferability. However, private equity funds are usually closed-ended investment funds with restrictions for transferability for a certain time period.
Fee Structure and Compensation
Private equity investors are generally charged 2% as a management fee along with 20% as an incentive fee, while for hedge funds the fee is usually based on the concept of a high-water mark. For private equities, there is a hurdle rate instead of a high watermark and they only earn incentives after this hurdle rate is crossed.
Level of risk
Private equities and hedge funds also differ in their level of risks. Both funds offset their high-risk investments with safer investments, but hedge funds tend to be riskier as they only focus on earning high returns on short time frame investments. However, individual funds vary based on their investing strategies.