Hedge Fund vs. Private Equity – Which Is the Better Investment?

Private equity and hedge funds are very similar in a number of ways. To compare these two options, we should first compare what they have in common:

• Both types of funds use investor money to buy assets, providing all investors with a share in the returns they generate.
• Hedge funds and private equity firms aren't subject to most of the Standards and Exchange Commission's regulations. This means that they can legally trade in securities that aren't registered with the SEC, opening many new investment opportunities. In fact, private equity firms often buy private companies that aren't listed publicly – this is something they can only do because they are exempt from most SEC regulations.
• Both hedge fund and private equity firms require you to be an accredited investor before they can do business with you. This is one of the few SEC-mandated regulations they are subject to. In other words, before you can access these investment firms, you need to prove your status as an accredited investor. Even CARL is not exempt from this requirement, although we do everything in our power to provide access to high-performance quants to ordinary private investors.
• Minimum investment limits are something you'll encounter with both of these investment vehicles – private equity firms often require $250,000 or more as a minimum investment, while hedge funds typically start at around $100,000 – with the exception of CARL's quantitative investment strategies, which are available starting at only $20,000.
• In contrast to many traditional investment funds (mutual funds, ETFs), hedge funds and private equity funds require investors to pay for their expenses and upkeep – firms working in either field typically use the "two and twenty" model: A 2 % management fee based on the total assets under management (AUM) and a 20 % performance fee for investment profits over a certain threshold (known as the hurdle rate).

As we can see, some of the fundamental aspects of these two types of funds are very similar. Most importantly, you need to be an accredited investor to be legally allowed to invest in them.

While they share various similarities, hedge funds and private equity funds also differ in some core respects:

• Investment universe: Private equity firms focus exclusively on investing in companies. They either buy companies outright or purchase enough shares to take a majority shareholder position, then seek to improve the company's everyday operation, increasing its value in time. Once the company's value is high enough, they sell their shares for a hefty profit. Meanwhile, hedge funds can potentially invest in almost anything, from the public stock market to financial derivatives – and even private equity and private equity firms.
• Time horizon: Hedge funds invest in whichever asset promises maximum returns within an acceptable time horizon – usually a few years at most. Meanwhile, private equity funds are structured to hold onto their investments for many years before they sell, as the value of a company doesn't increase quickly.
• Risk: As they seek maximum returns, hedge funds are widely considered to be riskier than private equity, as such funds are enticed to invest aggressively. That being said, they also have a more comprehensive range of potential risk-management methods available to them, as they can diversify into many more areas than private equity funds (the latter only invest in company shares, hedge funds can diversify into anything).
• Liquidity: As private equity firms are structured to maximize the return of investment in the long run, they often prevent investors from being able to withdraw their money for significant amounts of time, even decades. Since hedge funds often have lock-up periods between 6 and 12 months, this makes them more liquid, though CARL's quants are even more liquid than that, allowing monthly investments or withdrawals.
• Investment structure: Most private equity funds are close-ended. That means they're set up with a specific time horizon. They also usually only accept new investors during an initial period, after which all you can do is wait for your investment to pan out. In contrast, hedge funds are typically open-ended, which means they're designed to be run ad infinitum, and you can withdraw your money or invest in the fund whenever you like (though fund-specific limitations will apply).

While there is always some risk associated with hedge fund investing, new funds are usually seen to be the riskiest. That's because they often still have to prove themselves, especially if there's no famous hedge fund manager, well-known star investor, or astoundingly innovative strategy involved from the beginning. If you're an investor, chances are you'll want to see some proof that the new hedge fund has a chance at making money. In short, you'll want to see the financial pedigree of the people involved or the numbers that suggest the fund follows a sound investment strategy.