January 12, 2006

Advantages offered by hedge funds over mutual funds

For an investor selecting the right investment might be a difficult task. Essentially an investor would only look at investing in a tool that would work to his advantage. The market is gradually turning to investing in hedge funds instead of mutual funds because of the advantages that the former offers.

Hedge funds are highly flexible in their investment options as compared to mutual funds. This can be attributed to the fact that these use financial instruments generally beyond the reach of mutual funds, which have SEC regulations and disclosure requirements that largely prevent them from using short selling, leverage, concentrated investments and derivatives. This flexibility that includes the use of hedging strategies to protect downside risk, gives hedge funds the ability to best manage investment risks. 

The strong results shown by hedge funds can also be linked to performance incentives offered to fund managers. Unlike many mutual fund managers, hedge fund managers usually heavily invest in a significant portion of the funds that they run. As a result, they share the rewards as well as the risks with the investors. 'Investors fees' remunerate hedge fund managers only when the returns are positive, whereas mutual funds pay their financial managers according to the volume of assets managed, regardless of performance. This incentive structure tends to attract many of Wall Streets best practitioners and other financial experts to the hedge fund industry.

In the last decade, the number of hedge funds has risen by about 20 per cent per year and the rate of growth in hedge fund assets has been even more rapid. While the number and size of hedge funds are small relative to mutual funds, their growth reflects the importance of this alternative investment category for institutional investors and wealthy individual investors.

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