Question

There are various types of financial institutions and intermediaries such as commercial banks, investment banks, mutual funds, hedge funds, pension funds, insurance companies, etc. Why are there so many different financial intermediaries other than commercial banks? How does an investor’s risk attitude and/or wealth play a role in his/her selection of a financial institution or intermediary? If you were an investor seeking moderate return for your investment, how would you select a financial institution or intermediary? Choose one and explain your reasoning. What are the main differences between mutual funds and hedge funds in their ways of investing? Hedge funds are not regulated by the Securities and Exchange Commission (SEC). What does this mean?

Answer 1

Both mutual funds and hedge funds are managed portfolios. This means that a fund manager picks securities that he or she feels will perform good in coming time and then groups them into a single portfolio.

Now what are portfolios? A portfolio is a group of financial assets such as stocks, bonds, commodities, currencies and cash equivalents, etc, which may also include mutual funds, exchange-traded and closed funds.

The main advantage to investors is that they get instant diversification and professional management of their money which they might not get in any other form of investment.

The key difference between hedge funds and mutual funds is their redemption terms. In Mutual funds, the investors can redeem their units on any given working day and receive the NAV (net asset value) of that day. Whereas in hedge funds, such liquidity is not available. Some offer weekly or monthly redemptions, whereas others only quarterly or annually. Many hedge funds also impose a lock-up period, where you cannot withdraw your money at all.

During periods of market volatility, several hedge funds suspend redemptions entirely so that they can protect the remaining investors from a potential fire sale of the fund’s portfolio. Thus this makes hedge funs more riskier.

Hedge funds are not subject to some of the regulations that are designed to protect investors of mutual funds. Some hedge fund managers may not be required to register or to file public reports with the SEC, but this depends on the amount of assets in the hedge funds advised by a manager. But these funds are subject to the same prohibitions against fraud as are other market participants.

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