Introduction

When it comes to investing, there are a lot of options to choose from. Two types of investment vehicles that are often compared to one another are hedge funds and mutual funds. But what is the difference between the two, and how do you know which one is right for you? Keep reading to learn more about them, and how to decide which is right for you!

What are Hedge Funds?

A hedge fund is an investment fund that pools together money from investors in which a professional fund manager uses a variety of strategies to generate absolute returns. Hedge funds often come with high minimum investments, thus, are typically only available to sophisticated investors, which includes individuals (either independently or jointly with their spouse) with a total net investment exceeding RM1 million excluding the amount of borrowings used in such investments. (Securities Commission, 2021)

There are a variety of different hedge fund strategies, but some common ones include long/short strategy, event-driven strategy, and global macro strategy. Hedge funds can be a great way to diversify your investment portfolio and potentially generate higher returns. However, they are also considered to be high-risk, so it is important to do your research before investing in one.

The examples of hedge funds in Malaysia are under MTC Asset Management (M) Sdn. Bhd. and Cross-Asset Strategic Alpha Fund (CASAF) under Cross Light Capital Sdn Bhd. The Securities Commission Malaysia has granted both businesses the license to offer accredited investors private mandate services. MTC concentrates its long-biased strategy on global blue chip equities mainly in the US but primarily focused on Asia. CASAF on the other hand adopts a long-short strategy investing in multi-asset classes.

Apart from directly investing in a hedge fund, a feeder fund is a type of investment fund that pools the capital commitments of investors and feeds it into a master fund. Malaysia has its first artificial intelligence (AI) feeder fund called Kenanga Global Multi-Asset Fund. The master fund in this case is TCM Global Index Fund (Cayman) Ltd. A long or short basket of 25 liquid global indexes forms the basis of the fund, which is rebalanced once per day based on movement predictions. (Nur Haziqah A Malek, 2017)

What are Mutual Funds?

A mutual fund is an investment vehicle that is made up of a pool of funds from many investors. The money in the fund is used to purchase a variety of assets, such as stocks, bonds, and other securities. Mutual funds are a popular choice for investors because they offer professional management, diversification, and liquidity. The fund manager seeks to generate returns for investors by investing in a variety of assets that have the potential to grow in value over time.

There are many different types of mutual funds, such as stock funds, bond funds, and money market funds. Each type of fund has its own objectives and strategies. Mutual fund shares are purchased by investors. Each share reflects a shareholder's ownership interest in the fund and the income it produces.

Mutual funds are one of the most popular types of investments, as they can be used to achieve a variety of financial goals. Before investing in a mutual fund, you should research the fund to make sure it aligns with your investment goals.

Mutual funds that we generally see are open-ended funds which can issue an unlimited number of shares. In Malaysia, the two terms ‘mutual funds’ and ‘unit trusts’ are used interchangeably as no difference can be derived from them.

As of 30 September 2022, there are 750 unit trusts funds managed by 41 approved management companies in Malaysia. (Securities Commission, 2022) For example, Public Mutual Berhad, Hong Leong Asset Management Berhad, Affin Hwang Asset Management Bhd and many more. Each fund operates differently and generates different rates of returns.

Pros and Cons of Hedge Funds

Pros of Hedge Funds

Hedge funds usually offer high and performance-based fees to their managers. With this, they are able to attract highly talented investment managers who can implement sophisticated strategies. These strategies bring forth investment opportunities that are distinct from those available in the public investment space. They also motivate top managers and are designed to align the interests of the managers with the investors. It is important to note that how managers are compensated can change the nature of an investment, including its risks and returns as hedge funds are heavily reliant on the fund manager’s expertise.

Hedge funds may also optimise the use of leverage to increase the potential returns of the fund. This means that both investors’ capital and borrowed money are invested. The borrowed money is used to buy more assets, which amplifies the gains or losses of the fund. It can lead to higher returns for investors if the investment strategies implemented are successful.

Cons of Hedge Funds

However, looking at the other perspective, high management fees and incentive fees significantly reduce an investor’s net return. The common fee structure in hedge funds is 2% management fees and 20% carried interest. In addition, sales charges and withdrawal fees are also imposed.

Leverage simultaneously magnifies potential loss as well as potential gains. It can either make or break the fund. Hedge funds are also highly volatile and there is a risk of losing all of your investment. It is important to be aware of the risks involved with leverage before investing in a hedge fund.

Investments in hedge funds are viewed as illiquid as lock-up periods are imposed. Investors typically are not allowed to withdraw their funds for at least a year. Additionally, withdrawals might only be permitted occasionally, like every quarter or biannually.

Pros and Cons of Mutual Funds

Pros of Mutual Funds

Contrarily, mutual funds have lower minimum investments and are accessible to all investors. Mutual funds offer a convenient and easy way to diversify, which means they are less risky. A mutual fund’s portfolio can consist of various assets from different industries and countries with different risk characteristics. This is possible thanks to the sizable money pot, which also aids in establishing economies of scale.

Moreover, mutual funds are liquid investments as investors can easily enter and exit positions by purchasing or selling units of the fund. Capital gains and dividend income are automatically reinvested into an open-ended fund which enables it to benefit from the compounding effect. While for close-ended funds, it is distributed to investors on a monthly or quarterly basis. Distributions received by unit holders are net of tax as they are subject to tax on their share of the total taxable income of the fund.

Additionally, mutual funds are professionally and actively managed by a team with extensive and real-time information resources. Therefore, allowing them to make buying, holding or selling decisions to enhance portfolio returns. It is attributed to researching and selecting optimal investments that will generate the most returns in the long term.

Cons of Mutual Funds

The drawback to mutual funds is the annual fees and transaction fees that are charged to the fund. For example, the annual management fees range from 1% to 1.5% for equity funds in Malaysia. (Inter-Pacific Asset Management Sdn Bhd) Other types of annual fees but are not limited to are trustee fees, auditing fees as well as marketing and advertising expenses.

Nonetheless, all investments do contain risk. As the value of securities held by a fund may decrease, mutual funds also have the risk of losing some or all of the money. With market conditions changing, dividends may also alter. The past performances of a fund are not useful in forecasting future returns. They only show how stable and volatile a fund has been over time.

Comparison between Hedge Funds and Mutual Funds

So, Which is Right for You?

It depends on your investment goals and risk tolerance as to which is right for you. If you are aiming for high returns and are willing to take on more risk, then a hedge fund might be a good choice. If you are looking for a lower-risk investment, then a mutual fund might be a better option.

In order to identify hedge funds that fit their investment goals, investors often look at the size of the fund or firm, the track record and longevity of the fund, the minimum investment required, and the redemption terms of the fund. Understand the level of risk involved in the fund’s investment strategies and if they meet personal investing goals, time horizons, and risk tolerance.

In the end, whether or not a mutual fund is a good investment for you depends on your personal financial goals and objectives. But if you are seeking a way to grow your money over time, mutual funds may be worth considering.

Bottom line

Many investors will find these types of funds beneficial, especially those looking to diversify their investment portfolios by adding some exposure to non-conventional equity funds. Before making any investments, it is important to do your research. There is no one right investment, but by doing your research, you can increase your chances of success.

References

• Inter-Pacific Asset Management Sdn Bhd. WHAT IS UNIT TRUST (PART 2).
• Nur Haziqah A Malek. (December, 2017). Kenanga Investors launches 1st AI feeder fund.
• Securities Commission. (August, 2021). TECHNICAL NOTE NO.1/2021 - CATEGORIES OF HIGH-NET WORTH INDIVIDUALS AND HIGH-NET WORTH ENTITIES UNDER SCHEDULES 6 AND 7 OF THE CAPITAL MARKETS AND SERVICES ACT 2007.
• Securities Commission. (September, 2022). List of launched funds in relation to unit trust funds as at 30 September 2022.

Author

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This article is written by Joyce Lok Wye Jen, Research Analyst Intern

Joyce Lok Wye Jen is currently majoring in Finance at Tunku Abdul Rahman University of Management and Technology (TAR UMT). Joyce interns at TED Optimus Sdn. Bhd. for 3 months. She participated in Bursa Inter-Varsity Stock Challenge 2022 (BISC). She is also a CFA Level 1 candidate. She is an in-house author from TED Optimus.