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What is the Difference Between Hedge Funds and Private Equity?

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  • Written By: M. Rosario
  • Edited By: Susan Barwick
  • Last Modified Date: 24 September 2016
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Hedge funds and private equity funds are two types of investment firms that operate primarily by gathering their respective members’ financial resources and engaging in expensive ventures. It is easy to confuse the two, especially for those who do not have much experience with financial matters. There are however, several fundamental differences between the two firms, such as asset classes, management strategies, risk management and investor commitment.

Both hedge funds and private equity funds generally make large investments. What they invest in, on the other hand, is quite different. A hedge fund commonly invests in a highly liquid asset class. Publicly traded stocks, bonds and commodities in addition to currencies, derivatives and equity securities are preferred by hedge funds because of their potential for quick returns.

Private equity funds, meanwhile, often invest in other businesses. They mostly do this by purchasing stakes in privately held companies. The businesses the fund owns are collectively called portfolio companies. A private equity firm may engage in leveraged buyouts to acquire companies with distressed investments or that are in the brink of bankruptcy. Additionally, the fund may acquire stakes in healthy companies by supplying them with growth capital.

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The preferred asset investments of hedge funds and private equity funds greatly affect their management strategies. Hedge funds frequently look at how stocks would perform in an immediate timeframe. An adept fund manager is permitted to purchase a significant volume of stock if he or she speculates that its value will increase in the near future. Conversely, when the stocks are predicted to drop, the hedge fund manager can short them, which allows the company to profit from falling stock value.

In this respect, hedge funds more closely resemble stock trading than traditional investing. The market’s inherent volatility stimulates income for the investors. In some cases, a hedge fund may invest in start up businesses by providing them with venture capital.

The profit of a private equity fund is directly related to the performance of its portfolio companies. As such, private equity management is normally focused on long term scenarios. It is common for private equity firms to build up a struggling company by replacing its upper management and influencing board decisions.

Investor commitment is different between hedge funds and private equity funds as well. The fast pace involved in hedge funds is reflected by investment liquidity. Investors can cash out whenever they choose to. Since returns from private equity funds takes time to mature, however, most investors are committed for a set time period.

Risk management between hedge funds and private equity funds is vastly different. Hedge funds minimize risk by “hedging” high risk investments with safe ones. Private equity funds meanwhile may control risk by utilizing secondary investments.

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