Private Equity vs Hedge Fund: How They Compare

Q: Which is riskier: hedge funds or private equity funds?

While any kind of investment is risky, hedge funds tend to be more volatile and high risk. That being said, they may also offer high returns on investment.

Q: Can a hedge fund also be a private equity fund?

No, hedge funds are different from private equity funds. Hedge funds aim to seek high returns in a short time period, whereas private equity funds are focused on a company’s long-term potential.

Q: Do hedge funds typically outperform private equity?

It depends on the investment and its return, but hedge funds can have high rates of return over a shorter period of time than private equity.

Private Equity vs Hedge Fund: How They Compare

Susan GuilloryUpdated September 8, 2023

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There are many different types of investment opportunities for your small business, including hedge funds and private equity financing.Here, we’re exploring what hedge funds and private equity are, similarities and differences between the two, and alternative ways to get the funding you need for your business.

What Are Hedge Funds?

Hedge funds, available primarily to accredited investors, are a pooled group of investments that earn returns. These investments tend to be highly-liquid assets so investors can get high returns as soon as possible.Hedge funds can include stocks, bonds, options, futures, currencies, and other investments that can offer short-term potential, and they may be high-risk. They are not regulated by the Securities and Exchange Commission.

How Do Hedge Funds Work?

An investor works with a hedge fund manager, who invests the funds into the assortment of investments that make up the hedge fund. The investor can cash out on the investment at any time.The fund manager may charge a management fee and/or a performance fee.

Pros and Cons of Hedge Funds

When it comes to private equity vs. hedge funds, hedge funds are the ones you’ll be interested in if you’re an investor. Here are the benefits and drawbacks of hedge funds.

Pros of Hedge Funds

Hedge funds, because they aren’t regulated by the SEC, can get creative in how they work. It’s common to use short selling, leverage, and derivatives to get a return. And while they are high-risk, they also may come with high returns over a short period of time.

Cons of Hedge Funds

Because the SEC doesn’t regulate hedge funds, there isn’t always transparency about what a fund manager does to choose investments. There may also be rules about funds needing to be locked up for a certain period of time, which means investors can’t pull out if the fund isn’t doing well. And of course, they are high risk, which doesn’t guarantee high rewards all of the time.Recommended: Hedge Funds vs Venture Capitalists Compared

What Is Private Equity?

Private equity involves an investor having a stake in a private company in exchange for providing capital. Often the investor wants controlling interest and will look for businesses that are struggling to turn around.

How Does Private Equity Work?

A private equity investor provides capital to a business who then uses it to improve operations or sales. The investor may be involved in the day-to-day decisions. Once the company sees improved profitability, maybe because of a change in leadership or management strategy as well as that capital, the company may follow its exit strategy by being acquired. At this point, the investor may cash out.Recommended: Guide to Late-Stage Funding & Funds

Pros and Cons of Private Equity

If you run a company and are looking for an investment, be aware of the pros and cons of private equity.

Pros of Private Equity

A private equity investor provides a large amount of capital that a business can use to grow the business or get out of a slump. And because that investor may have experience and contacts in the industry, they may be able to help make decisions that will propel the business forward.

Cons of Private Equity

On the other hand, having someone with such a large share of your business may feel stifling, and you might not agree with every decision they make. Often, these investors will take drastic measures if a company is struggling, such as replacing leadership roles.

Hedge Fund vs. Private Equity

There are both similarities and differences between hedge funds and private equity.

Similarities Between Hedge Funds and Private Equity

Both private equity and hedge funds are forms of investment. Beyond that, there aren’t many similarities, other than both having a 1-2% management fee.

Differences Between Hedge Funds and Private Equity

Hedge Funds	Private Equity
Short-term gains	Long-term gains
Investor takes passive role	Investor takes active role
Gains are subject to tax rates	Gains aren’t subject to tax rates
More risky	Less risky

One difference between private equity and hedge funds is that private equity investors look for long-term gains, while hedge fund investors want a quick return on their investment.Also, a private equity investor wants a controlling stake in a company and wants to be involved in the daily decisions. A hedge fund investor, on the other hand, is a passive participant. Other than providing capital for the initial investment, hedge fund investors aren’t involved in the companies they invest in.When it comes to taxes, the gains from private equity investments aren’t subject to tax rates, while they are for hedge funds. And private equity may be less risky than hedge funds because the investments are given to mature, established companies with a long-term return, whereas hedge funds are high risk with high potential reward over the short term.

Other Financing Options

If you run a business and are looking for capital, there are options outside of private equity and hedge funds. There are different types of business loans, crowdfunding for startups, angel investors, and more.Options for small business financing include business term loans, equipment loans, invoice financing, business lines of credit, or merchant cash advances as a way to get quick access to cash. Additionally, you may find having a business credit card a useful way to pay for purchases.

Private Equity vs Hedge Fund: The Takeaway

While there are similarities, hedge funds are quite different from private equity. While both are investment tools, private equity is more aligned with helping a single business succeed, while hedge funds are a way for investors to make a quick return on investment.

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Frequently Asked Questions

Which is riskier: hedge funds or private equity funds?

Can a hedge fund also be a private equity fund?

Do hedge funds typically outperform private equity?

Photo credit: iStock/SunnyVMD

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About the Author

Susan Guillory

Su Guillory is a freelance business writer and expat coach. She’s written several business books and has been published on sites including Forbes, AllBusiness, and SoFi. She writes about business and personal credit, financial strategies, loans, and credit cards.

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