Hedge Fund vs Private Equity: Comparison Breakdown & 101

Learn more about hedge funds versus private equity and how they compare to ETFs.

kent
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Research Lead
Reviewed by: Lisa Barr
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Edited by: Lisa Barr

Hedge funds and private equity funds are similar in that they offer alternatives to exchange-traded funds and mutual funds, as well as the potential for higher returns. However, these alternative investments are not available to all investors, and they also have distinct investment strategies and risk and return characteristics. 

Learn the basics and the differences between hedge funds and private equity and see how each compares to ETFs. 

What Is the Difference Between a Hedge Fund vs. Private Equity Fund? 

Hedge funds and private equity funds are both investment funds that offer potential for higher returns by using alternative investment strategies. However, they serve different purposes and cater to investors with distinct risk profiles and investment objectives. Investors should carefully evaluate the strategies, risks and historical performance of each fund before deciding to invest. 

What Is a Hedge Fund?  

A hedge fund is a type of pooled investment fund that uses various sophisticated strategies to generate returns for its investors. These funds are typically open to accredited or qualified investors, including high net worth individuals, institutions and certain financial professionals. Hedge funds are known for their flexibility in investment strategies and their ability to invest in a wide range of assets, including stocks, bonds, commodities, currencies and derivatives. 

What Is a Private Equity Fund? 

A private equity fund is a type of investment vehicle that raises capital from institutional investors, high net worth individuals and other accredited investors to invest in privately held companies or acquire stakes in private equity deals. Private equity funds have a longer-term investment horizon compared to many other investment funds, and focus on actively managing and improving the companies in which they invest. 

Hedge Fund vs. Private Equity Fund: Key Differences Breakdown 

Hedge funds and private equity funds are both types of investment funds, but they have distinct characteristics, investment strategies, target assets and time horizons. 

Here are the key differences between hedge funds and private equity funds: 

  • Hedge funds: Hedge fund strategies may include long and short positions, derivatives trading, arbitrage and other complex investment techniques. The goal of a hedge fund is to generate positive returns regardless of market conditions, and they often aim to provide positive returns in both bull and bear markets. Hedge funds typically have shorter investment horizons and may frequently buy and sell assets to capitalize on short-term market movements or specific opportunities. 
  • Private equity funds: Private equity funds invest in companies with the expectation of significant growth over the long term. Private equity funds usually buy companies, restructure or improve their operations, and eventually exit the investment through a sale or public offering. Private equity investments involve a longer investment horizon. It may take several years for the private equity fund to realize its investment through an exit strategy, such as an initial public offering (IPO) or sale to another company. 

Hedge Fund vs. Private Equity Fund vs. ETF 

Hedge funds, private equity funds and exchange-traded funds are all different types of investment funds, each with distinct investment strategies, fee structures, and risk and return characteristics for investors to consider. Here's a comparison of hedge funds, private equity funds and ETFs: 

Investment Strategy 

  • Hedge funds: Hedge funds employ a wide range of investment strategies, such as long and short positions, arbitrage, leverage and derivatives trading. Their goal is to generate positive returns regardless of market conditions. 
  • Private equity funds: Private equity funds focus on investing in private companies or acquiring stakes in private equity deals. They actively manage their portfolio companies to create value and generate returns over the long term. 
  • ETFs: ETFs track the performance of an underlying index or asset class. They can provide exposure to various asset classes, such as stocks, bonds, commodities and precious metals, but their investment strategy is typically passive and designed to replicate the index's performance. 

Fees 

  • Hedge funds: Hedge funds typically charge several types of fees. Management fees for hedge funds often range from 1% to 2% of AUM. They may also charge a performance fee, which is usually calculated as a percentage of the fund's gains, typically ranging from 15% to 20%. Some hedge funds impose redemption fees when investors redeem their shares.  
  • Private equity funds: Private equity funds also charge different types of fees. Like hedge funds, private equity funds charge a management fee, typically ranging from 1% to 2% of AUM. Private equity funds may also have a carried interest charge, which represents a share of the fund's profits earned from successful investments. Carried interest is typically 20% of the profits above a specified hurdle rate or preferred return. 
  • ETFs: ETFs typically have a more straightforward fee structure compared to hedge funds and private equity funds. The expense ratio is an annual fee expressed as a percentage of the fund's AUM. It covers the operating expenses of the ETF, including management fees, administrative costs and other expenses. Some ETFs have expense ratios as low as 0.05% or even lower. 

Investment Horizon 

  • Hedge funds: Hedge funds often have shorter investment horizons, and their strategies may involve frequent buying and selling of assets to capitalize on short-term market movements or specific opportunities. 
  • Private equity funds: Private equity investments involve longer investment horizons, often spanning several years, as the fund actively manages and improves the companies in which it invests. 
  • ETFs: ETFs offer a flexible investment horizon. Investors can buy and sell ETF shares on the stock exchange at any time during market hours, providing short-term or long-term investment options. 

Liquidity 

  • Hedge funds: Hedge funds generally have more liquidity compared to private equity funds, as investors can redeem their shares or units periodically, often on a monthly or quarterly basis, depending on the fund's redemption terms. 
  • Private equity funds: Private equity investments are less liquid. Investors typically commit their capital to the fund for a fixed term, and it may not be easy to exit the investment before the end of the term. 
  • ETFs: ETFs are highly liquid, as they are traded on stock exchanges throughout the trading day, and investors can buy or sell shares at prevailing market prices. 

Regulation 

  • Hedge funds: Hedge funds are subject to some regulatory oversight, but they often have fewer regulatory constraints compared to mutual funds or other retail investment vehicles. 
  • Private equity funds: Private equity funds may also have fewer regulatory requirements compared to publicly traded funds, but they must adhere to certain regulations based on the jurisdiction and the type of investors they target. 
  • ETFs: As investment companies, ETFs are regulated investment vehicles subject to specific regulatory requirements and disclosure obligations, including those relating to investment objectives, risks, expenses and other information in their registration statements and periodic reports. 

Investor Base 

  • Hedge funds: Hedge funds typically target accredited or qualified investors, including high net worth individuals and institutional investors. 
  • Private equity funds: Private equity funds also cater to institutional investors, pension funds, endowments and high net worth individuals seeking long-term investment opportunities. 
  • ETFs: ETFs are more accessible to a broad range of investors, including from professional money managers to retail investors, due to their lower investment minimums and ease of trading. 

Risk and Returns 

  • Hedge funds: Hedge funds can carry higher risk due to their complex strategies, use of leverage and short-term trading. Returns can vary significantly based on the fund's performance and market conditions. 
  • Private equity funds: Private equity investments involve higher risk compared to traditional public equities, but they may also deliver higher returns if successful in creating value in their portfolio companies. 
  • ETFs: ETFs typically aim to replicate the performance of their underlying index or asset class, offering returns commensurate with the market they track. They generally have lower risk compared to hedge funds and private equity funds due to their passive investment approach. 

Bottom Line on Hedge Fund vs. Private Equity Fund vs. ETF

Hedge funds, private equity funds and ETFs serve different purposes and cater to investors with distinct investment goals and risk tolerances. Hedge funds are known for their active trading strategies; private equity funds focus on long-term investments in private companies; and ETFs offer low-cost passive exposure to various asset classes.  

Each type of fund has its pros and cons, and investors should carefully assess their individual financial objectives and risk tolerance before choosing the most suitable investment option.  

Kent Thune is Research Lead for etf.com, focusing on educational content, thought leadership, content management and search engine optimization. Before joining etf.com, he wrote for numerous investment websites, including Seeking Alpha and Kiplinger. 

 

Kent holds a Master of Business Administration (MBA) degree and is a practicing Certified Financial Planner (CFP®) with 25 years of experience managing investments, guiding clients through some of the worst economic and market environments in U.S. history. He has also served as an adjunct professor, teaching classes for The College of Charleston and Trident Technical College on the topics of retirement planning, business finance, and entrepreneurship. 

 

Kent founded a registered investment advisory firm in 2006 and is based in Hilton Head Island, SC, where he lives with his wife and two sons. Outside of work, Kent enjoys spending time with his family, playing guitar, and working on his philosophy book, which he plans to publish in the coming year.