Mutual funds and Hedge funds are similar in that they are investment instruments which allow an investor to spread their investment risk over a number of companies' stock rather than one or two stocks.
Say you have only $10,000 to invest. You could buy the stock of say two companies with this money. But your investment would be risky since these shares may rise or fall suddenly.
In a mutual fund and hedge fund, a pool of money is created by accumulating money from many many investors. The fund would invest across many companies...not just two. So your investment is less risky since you are not dependent on the success of just two companies. You would buy shares in this mutual fund or hedge fund...the price of the shares would reflect the value of the pool of shares and how much money the mutual fund has.
The difference between a Mutual fund and a Hedge fund is that you know all the details of a Mutual fund. You know who manages the fund, the companies that they invest in and the management fees charged. These funds are required by law to make this information available.
A Hedge fund is private. No such information is made available publicly. Decisions that are made within this fund are secret. They can engage in stock market practices such as "short selling" and "leverage" which are not allowed in Mutual funds.
As a result it is difficult as an investor to evaluate a Hedge fund. These practices such as "Leverage" can make a lot of money in a short period of time but in bad times (like those of today's market) the value of a Hedge fund can suddenly plummet.
As a result investment in Hedge funds are "volatile" meaning they are given to huge swings in value.
To me this is ironic since the word "hedge" means to protect yourself.
For example, a manufacturer might use a hedge by purchasing foreign money on the futures market (say a contract for 6 months from now) while the price may be low, rather than waiting until he absolutely requires the money (when the foreign money may cost more). So he is protecting himself here.
But in typical American marketing hype, they use a word that literally means something positive and make it meaningless.
- For Teachers