While many individuals prefer investing in mutual funds, stocks, and bonds, investors, on the other hand, strengthen their portfolios and venture into private equity and hedge funds. These funds are classified under-investment forms that attract Limited Liability Partnerships or Companies.
However, despite having similar investor profiles, private equity and hedge fund remain significantly different.
Key Takeaways
- Private equity firms invest in and acquire private companies, focusing on long-term value creation, while hedge funds use diverse investment strategies to generate high returns for their investors.
- Private equity investments often involve active management and operational improvement of portfolio companies, whereas hedge funds focus on financial returns through trading and investing.
- Private equity funds have longer investment horizons, while hedge funds can have shorter-term, more liquid investments.
Private Equity vs Hedge Fund
Private equity is the capital that people invest to claim full ownership of a business enterprise or organization, which takes seven to ten years, and there is low risk involved. Hedge fund is an investment done by pooling funds while different strategies are used to ensure high profit.
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Comparison Table
| Parameter of Comparison | Private Equity | Hedge Funds |
|---|---|---|
| Capital Investment | Investment is directly made in the enterprise. | Investment is made in the highly liquid assets of the enterprise. |
| Investment Time | The average investment time is seven to ten years. | Investment is made between a few days to a few years. |
| Structural Difference | Closed-ended investment fund | Open-ended investment fund. |
| Strategy | Investment involves the firm’s highly liquid assets | Investment is made by purchasing the whole enterprise or selected assets. |
| Risk Involved | Low-risk level involved | High-risk level involved |
What is Private Equity?
Private equity refers to the capital individuals invest to gain ownership of a business enterprise.
Private equity acts as venture capital where accredited investors invest in the business to manage, grow, and sell the assets.
Additionally, private equity is also used in converting the public company to a private domain, making the enterprise enjoy less scrutiny from public investors.
Notably, an investment takes three to five years to become fully realized.
What is Hedge Fund?
Like a vestment partnership, a hedge fund refers to an investment made by pooling funds where several strategies are employed to ensure investors make high profits.
Under hedge funds, investments are made initially in highly liquid assets.
The goal is to quickly generate returns on one investment and move the money to another promising investment.
Main Differences Between Private Equity and Hedge Funds
Private equity and hedge fund differ from each other in the way each operates. The differences include the terms, capital investment, the risk involved, the strategy applied, and the time horizon.
The following discusses the differences between private equity and hedge fund.
Capital Investment
Private equity and hedge fund differ because accredited investors invest capital. When investing in private equity, investors commit the capital they wish to invest; hence, money is invested only when called upon.
Notably, investment is made directly in companies.
On the other hand, investors in a hedge fund only invest their money in one go. However, the cash invested can be liquidated at request.
Notably, the investment in a hedge fund is made in highly liquid assets.
Investment Time
Private equity and hedge funds have significantly different investment times. Private equity concentrates on the long-term profit potential of an investment in a company.
However, private equity investors are neither interested in the company’s acquisition nor in running or investing in companies requiring a turnaround. The average investment time for private equity ranges between five and seven years.
On the other hand, hedge funds are focused on the short-term profit potential of an investment in a company’s highly liquid assets.
The preference by hedge fund managers to invest in highly liquid assets is to assist investors in quickly shifting from an investment to a more promising one. With a theme of making gains as soon as possible, hedge funds can last for a few days to years.
Structural Difference
The legal structure of private equity and hedge funds is different. Notably, private equity falls under a closed-ended investment fund.
Its structure follows that its current market cannot be readily determined or transferred for a certain period.
Hedge funds, on the other hand, are open-ended investment funds. The hedge funds’ structure follows the fact that there are no restrictions on the transferability of the funds.
Additionally, the assets involved in a hedge fund are market-to-market.
Strategy
Private equity is invested by purchasing an entire enterprise or acquiring selected assets that belong to the firm. In most cases, businesses where private equity is invested are underperforming.
Therefore, private equity investors purchase the businesses or assets to improve the firm’s performance using their professional expertise. Unlike private equity, hedge funds are managed and operated by investment professional market traders.
The traders move in and out of financial instruments looking for the best possible returns from investments in the subject enterprise. The investors’ funds are pooled to invest in a range of securities, with the help of different investment techniques to generate returns per the specified risk level.
Notably, the investors reach out for the highest risks to reach the highest possible returns.
Risk Involved
Both private equity and hedge funds offset high-risk investments or safer investments. However, a hedge fund’s risk levels are significantly higher than private equity’s.
The high risks in hedge funds are attributed to focusing on making the highest returns in the shortest investment time frame.
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
Hi Piyush,
So according to you, which one is better?
Hi honey,
there are so many factors at play. the main point to consider before making a decision between private equity and hedge fund is the risk involved.
For me and my family, I have always considered private equity to be the best option for investment. Good to know how it differs from hedge funds.