Mutual and hedge funds manage portfolios made from pooled funds that aim to diversify their returns. Mutual funds managed by institutional fund managers provide investors at retail and institutional levels with a wide range of investment opportunities. Investors with a significant amount of wealth are the focus of hedge funds. For participation in these funds, investors must possess certain accredited features.

Mutual Funds

MFS Investment Management was the first to create a mutual fund. Mutual funds have evolved over the years to offer investors various options in passive and actively managed investments. Passive funds allow investors to invest in an index that provides targeted market exposure at a very low cost. An investment product that provides professional portfolio management, active funds are an alternative to passive funds. According to ICI, there were 7,945 mutual fund managers with assets under management of US$21.3 trillion as of December 31, 2019.

Two regulatory directives are used by the Securities and Exchange Commission to regulate mutual funds: The Securities Act of 1934 and The Investment Company Act of 1940. For transparency and investor education, the 1933 act requires that a prospectus be documented.

Open-end and closed-end mutual funds trade on the financial markets every day. Open-end funds offer different share classes with different fees and sales loads. These funds are priced daily at the net asset value (NAV) close of trading. Closed-end funds provide a limited number of shares in initial public offerings (IPO). They trade in the same way as stocks during trading hours. All investors can use mutual funds. Depending on the fund, some funds may have minimum investment requirements of $250-$3,000.

Mutual funds are generally managed to trade securities according to a specific strategy. Although strategy complexity may vary, most mutual funds don't heavily rely on derivatives or alternative investing. This makes mutual funds more suited to mass investors by limiting their exposure to high-risk investments.

Hedge Funds

Mutual funds and hedge funds share the same basic pooled funds structure. Hedge funds can only be purchased privately. Hedge funds are often known for taking higher-risk positions to achieve higher returns for investors. They may also use leverage, short-selling, or other strategies. Hedge funds tend to be managed more aggressively than mutual funds. Many hedge funds seek to take global cyclical positions or to earn returns in falling markets.

While based on the same principles as mutual funds, hedge funds are structured and regulated differently. Hedge funds can offer private investments, but they must include accredited investors. This allows them to create their fund structure. Regulation D of 1933 requires private hedge funds to invest from accredited investors.

Accredited investors have a greater understanding of financial market investing than regular investors. They also tend to be more risk-tolerant. For the chance to earn higher returns, these investors will often bypass the protections provided to mutual fund investors. Hedge funds are also different from private funds in that they typically use a tiered partnership structure, which usually includes a general and limited partner.

Hedge funds' private nature allows them to be flexible regarding their investment provisions and investor terms. Hedge funds are often more expensive than mutual funds because they charge higher fees. Hedge funds can offer lower liquidity due to their flexibility in terms of lock-up periods, redemption allowances, and other features.

Some funds will close redemptions in volatile markets to protect investors from potential portfolio losses. Hedge fund investors need to be fully informed about a fund's strategic risks and terms. These terms are not publicized like a prospectus for mutual funds. Hedge funds use private placement memorandums to manage their operations and a limited partnership agreement or operating agreement and subscription documents. According to "BusinessInsider.com" as of May 2018, the three largest hedge fund managers included:

• Bridgewater Associates
• AQR Capital Management
• Renaissance Technologies

Comparison of Performance

Indexes are one of the most reliable ways to measure the performance of different market segments and sectors. Hedge fund performance data are not publically available. It can be useful to compare hedge fund indexes with the S&P 500 to understand the performance metrics involved when comparing hedge funds to standard mutual funds.

Performance comparisons can also be affected by fees. The operational fees for mutual funds can range from 0.05% to 5%. Hedge funds often include what is called a "two and twenty fee," which typically includes a management fee (2%) and a performance fee (20%).