Despite coronavirus-related struggles in other industries, UK asset management funds are thriving. Total assets under management hit £8.5 trillion at the end of 2019, up 10% from the year prior.
There’s never been a better time to place your money with an investment fund. But when it comes to a hedge fund vs private equity, which one should you choose?
Today, we’re helping you out with this guide to understanding hedge funds and private equity firms. Ready to learn more? Then you better keep reading because this one’s for you.
What Hedge Funds and Private Equity Funds Share in Common
Hedge funds and private equity funds are different. But they share in common their target investor, type of business partnership, and revenue streams.
Check out the biggest commonalities between hedge funds and private equity funds below.
The Target Investor
Hedge funds and private equity funds have the same target investor. They both prefer high net worth individuals. Usually, that means investors must have $250k or more to invest.
The Partnership Structure
Hedge fund companies and private equity firms tend to have the same business structure. Namely, they’re both limited partnerships (LPs). LPs consist of a general partner(s) (also known as managing partner(s)) and limited partners.
The general partner(s) run the day-to-day aspects of the business and have full liability for any debts accumulated. The limited partner(s) has a contracted limited liability for any debts and doesn’t partake in day-to-day operations.
The Profit Scheme
Hedge funds and private equity funds have the same profit scheme for partners. Both types of funds pay general partners a contracted management fee. Plus, they pay each partner a pre-determined percentage of annual profits.
Management fees tend to equal approximately 2% of the value of the asset under management. For example, a private equity fund manager might make 2% off the sale of one of his portfolio companies.
PE and hedge funds base performance fees on profits. For example, a hedge fund manager might receive 20% of gross profits after the sale of stock.
What Is a Hedge Fund?
Hedge funds are institutions that make investments with money pooled from high-net-worth individuals. Because they trade on borrowed funds, hedge funds are risky. This is especially true during times of economic downturn.
Hedge funds tend to be less regulated than similar investment institutions. This has to do, in part, with the fact that hedge funds don’t work with smaller investors. You must be an accredited investor to invest in a hedge fund.
Keep reading for three additional factors that explain the hedge fund vs private equity distinction.
Hedge Funds Goals
A hedge fund’s goal is to make as much money in as short of a time as possible. This is called a short or short-term investment strategy.
Note that the short-term nature of hedge funds’ investments means investors can cash out any time.
Hedge Funds Investment Strategies
Because they’re short-term investors, hedge funds tend to only invest in strongly liquid products. These products can easily and quickly be turned around for a profit, which the hedge fund can then invest in new assets.
Hedge funds are less picky when it comes to the specific type of investment they’ll make. Stocks (take a look at this S&P 500 heat map), futures contracts, currencies, derivatives, and bonds are all fair game for hedge funds.
Hedge Funds Investment Structures
Hedge funds feature an open-ended investment structure. This means investors can not only take profit whenever they want, but they can also add more money into the fund whenever they want.
This is due to the short-term nature of hedge fund investments.
What Is Private Equity?
Like hedge funds, private equity (PE) funds accumulate wealth from high-net-worth individuals. Firms then invest that money into privately held companies. This makes PE investments far more stable than hedge fund assets.
A PE fund can be made up of a pension fund, which is a company’s retirement fund. More commonly, it’s an actual PE firm. Accredited investors fund PE firms in a similar fashion to hedge funds.
Here are three more factors that differentiate PE from hedge funds.
Private Equity Firms Goals
A private equity fund’s goal is to curate an investment portfolio with the potential for profits in the next 4–7 years. This is called long or long-term investing.
As you can imagine, long-term investing makes it trickier to cash out. Most PE firms require investors to commit to 3–5 years at the least. Some firms require investors to agree to invest for 7–10 years before realizing profits.
Private Equity Firms Investment Strategies
Private equity firms invest in private companies directly using one of two strategies. The first strategy is to purchase the company outright. This can be done either through a leveraged buyout (LBO) or a venture capital investment.
A less common strategy is to purchase controlling interest via a public company’s shares. When a private equity fund does this, it’s usually because investors plan to de-list the public company from the stock exchange.
Once a private equity fund acquires a company, it hands that account over to its fund managers. The fund managers monitor the company over time to ensure the investment will pay off in the long run.
Private Equity Firms Investment Structures
Private equity funds use closed-ended investment structures. In the same way that investors can’t take profits for 3–10 years, they can’t add new money to the investment either.
This is due to the long-term nature of private equity investment strategies.
Hedge Fund vs Private Equity: The Bottom Line
When it comes to the difference between a hedge fund vs private equity firm, the biggest thing to consider is the investment strategy.
If you want quick returns now, a hedge fund’s short-term investing strategy is for you. Meanwhile, investors in it for the long hall may benefit from investing with a private equity firm.
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