With all the talk of hedge funds surrounding the most recent activity surrounding GameStop, it’s probably a good time to remind you that hedge funds are just one type of investing in the broader investment universe. We hope that this article makes it easy to understand the difference between a hedge fund, a managed fund and an equity fund.
So, what are hedge funds?
Hedge funds are generally managed funds, a pooled investment vehicle, that are actively managed by fund managers. Hedge funds usually invest in more complex instruments, strategies, sometimes currencies and often different asset classes. Often, the fund manager has broad flexibility to invest across different asset classes, such as commodities, options, currencies, and even into more esoteric assets such as film or music rights.
A common characteristic of a hedge funds is the ability to “go short” and use leverage to amplify investor returns. Short selling has been covered a lot recently due to high-publicised short selling of US based GameStop.
Most hedge funds are only available to wholesale, sophisticated and institutional investors who are already wealthy and these funds are often subject to “lock-ups”, where the investor cannot readily withdraw their invested capital.
There is a reason access to hedge funds is restricted – they can be complicated and risky. The reward for this risk is the possibility that the fund manager may earn investors outsized returns that are generally less correlated with the overall market.
ASIC defines a hedge fund in two ways:
The fund itself is promoted by the responsible entity as a ‘hedge fund’, or
The fund exhibits two or more of the following five ASIC-defined characteristics:
- Complex investment strategy or structure
- Use of leverage
iii. Use of derivatives
- Use of short selling
- Charge a performance fee
What is a more traditional equity fund?
By contrast, a more traditional equity fund is a fund that invests in a portfolio of shares only. They can still be actively managed by a fund manager, but they generally do not use or have limited use of simple derivatives such as index options and do not engage in short selling. This is called “long only”.
Naturally, this means the fund managers portfolio is likely to be somewhat correlated to the market and the success of the fund manager is usually measured by their fund’s outperformance relative to their market benchmark or index.
As these funds have generally less complex investment approach, it means they can be better understood by retail investors and are more accessible.
Traditional equity funds can be accessed via a variety of structures including unlisted unit trusts, managed funds or Active ETFs. Here at eInvest, the eInvest Future Impact Small Cap Fund (Managed Fund) (ASX:IMPQ) and eInvest Income Generator Fund (Managed Fund) (ASX:EIGA) are examples of equity funds in an active ETF structure. Read more about different structures here.
Just because they are not taking on the additional risk of complex instruments, derivatives, “going short” etc does not mean that equity funds are risk free. They still carry many forms of risk, some of which have been detailed in this article.
So hold up, what is a managed fund?
Essentially, in a managed fund, your money is pooled together with other investors. A fund manager then buys and sells assets, such as shares or bonds, on your behalf. Hedge funds vs equity funds are simply a descriptor for the approach taken by the fund manager. Hedge funds and equity funds can be found in a managed fund legal operating structure.
Why does all this matter?
We think it is important for investors to recognise that not all forms of investing are the same. Not all fund managers are hedge fund managers and there exists a broad spectrum of styles and approaches when it comes to investing.
Disclaimer: Please note that these are the views of Jodi Pettersen, Investor Relations at eInvest and is not financial advice. To find out how to invest in our active ETFs, visit here. The product disclosure statement and more can be found at www.einvest.com.au