Mutual Funds: Investment Strategy & Professional Money Managers - Essay Sample

Introduction

Mutual funds refer to a type of fund that utilizes money from different investors to invest in bonds, stocks, and other types of investments. Wermers (2011) argued that the portfolio or fund manager is the one who makes a decision on how the money should be invested and is, therefore, paid a fee that emanates from the money in the fund. Wermers (2011) further maintained that mutual funds are run by some professional money managers, who assign fund's assets and tries to generate capital gains or income for the investor of the funds. The portfolio of the mutual funds is designed to fit the objectives of the investors as outlined in its prospectus. Mobius (2007) claimed that mutual funds offer individual or small investors access to the professionally managed portfolio of bonds, equity as well as other securities. Every shareholder, thus, undergoes proportionate participation in the losses or gains of the funds. Wilson (2018) further claimed that mutual funds invest in numerous numbers of securities, and its performance is mainly traced to the change in the total market cap of the funds that are obtained from the aggregating performance of the underlying investments.

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On the other hand, hedge funds refer to an alternative investment that makes use of pooled funds that utilizes various strategies to get for their investors an active return, or alpha. Wilson (2018) argued that hedge funds may be managed aggressively or can employ the usage of derivatives and leverage in both international and domestic markets that mainly aim at realizing huge returns either by conducting a specified market benchmark or in an absolute sense. Kim (2016) further maintained that hedge funds are only accessible generally by investors who are accredited since they need minimal security regulations than other types of funds. It is due to its minimal regulations that the hedge funds industry has been set apart as opposed to its counterpart, mutual funds.

Differences

As evidenced in the above definitions, mutual funds and hedge funds display numerous differences. Some of which are as discussed below.

Accessibility

Even though both mutual funds and hedge funds show some aspects of limitations on investing, such as the minimal initial investments, unlike mutual funds, hedge funds are not as accessible to the mainstream investors (Wermers, 2011). For instance, it is a requirement for certain hedge funds to ensure that the minimum net worth of an investor is $1 million, or they may have a minimum initial investment that is much higher than that of mutual funds (Mobius, 2007). The minimal initial funds for certain mutual funds are as low as $100, and besides, are not characterized by net worth requirements (Wermers, 2011).

Expenses

Hedge funds typically have much higher expenses than mutual funds. For example, hedge funds often have expenses exceeding 2.00%, whereas most mutual funds have expenses that are 1.00% or below (Mobius, 2007). Moreover, the hedge funds may undertake a cut of the profits prior to submitting them to the investors, which is not the case with mutual funds.

Performance/Objective

The main objective behind the design of hedge funds is to generate positive returns in any market or economic environment, even in bear markets or recession. Nevertheless, owing to its defensive nature, the returns for hedge funds may not be as high as for certain mutual funds, especially during bull markets. For instance, the rate of return for hedge funds may be about 5-6% during the bear market, whereas the average stokes funds decline by 20% in values (Mobius, 2007). Wilson (2018) argued that in the bull market, the hedge funds might still generate a low return, whereas the stoke mutual funds can generate a high return. Wilson (2018) further argued that low-cost stock mutual funds could generate a higher average annual return in the long run than the hedge funds.

Similarities

Despite the differences that are evident from the discussion above, both the mutual funds and hedge funds have certain aspects of similarities. Some of which are as discussed below.

Diversification

Both mutual funds and hedge funds offer diversification by undertaking investments in numerous securities. Kim (2016) argued that it is worth noting that certain funds are, however, concentrated in one particular sector of the economy or security type. Hedge funds are typically diversified highly in various kinds of security like bonds, stock as well as commodities, while a stated objective characterizes mutual funds thus undertakes investments in just one type of category or security (Mobius, 2007). It is, therefore, worth noting that both mutual funds and hedge funds have the same aspect of diversification.

Professional Management

Kim (2016) argued that when undertaking an investment, either mutual funds or hedge funds, it is not at the discretion of the investor to make any choice of the security in the portfolio, but instead, the management or a manager team is the one responsible for selecting the securities. Mobius (2007) claimed that hedge funds are actively-managed, meaning that the management or the manager can utilize discretion in the selection of security as well as the timing of traders. Similarly, mutual funds can be actively managed besides being passively managed. If this happens for the latter, the manager of the mutual funds does not make use of discretion in the selection of the security or trade timing, but rather, they simply fit the holdings with those of the benchmark index like the S&P 500 (Mobius, 2007).

Top Performing Hedge Funds and Mutual Funds

Wilson (2018) claimed that Carlson Capital is the top-performing hedge fund that built a $69 million investment in Morgan Stanley shares besides a $54 million stake in Bank of New York Mellon (Mobius, 2007). He further maintained that the top-performing mutual fund is Fidelity Contrafund with an associate yearly return of 16.85% (Mobius, 2007).

Conclusion

There are various types of funds that one might consider investing in. The most common types of funds are hedge funds and mutual funds. Both funds exhibit some aspects of similarities as well as differences. Some of the differences revolve around accessibility, expenses, and performance. On the other hand, the similarities between hedge funds and mutual funds are based on diversification and professional management.

References

Kim, J. (2016). Size and value effects in equity hedge funds. Investment Analysts Journal, 45(sup1), S17-S31. https://doi.org/10.1080/10293523.2016.1175074

Mobius, M. (2007). Mutual funds (1st ed., p. 250). Wiley.

Wermers, R. (2011). Performance Measurement of Mutual Funds, Hedge Funds, and Institutional Accounts. Annual Review of Financial Economics, 3(1), 537-574. https://doi.org/10.1146/annurev-financial-102710-144856

Wilson, R.(2018) The Hedge Fund Book (1st ed., p. 866). Wiley.