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What Is the Difference Between Private Equity and Hedge Funds?

Although hedge funds and private equity funds are often mentioned in the same sentence, there are actually several important differences between the two types of funds. In this blog, we explain some of the key differences between private equity and hedge funds.

Difference Between Private Equity and Hedge Funds

The difference between private equities and private hedge funds is that private equities funds invest in private non-publicly traded businesses and companies. Hedge funds, on the other hand, invest in a vast variety of categories where the goal is to maximize short-term profits.

Know What You Are Buying

Hedge funds typically invest in tradable securities like stocks, bonds, or derivatives (such as options). Some hedge funds also invest in commodities and futures derivatives. These instruments are tradeable on the open market and can be bought or sold on short notice. The portfolios in these funds often change on an intraday basis.

Private equity funds are usually invested in companies or properties with the intention of managing, growing, and eventually selling these assets. Private equity investments can take 3-5 years or longer to become fully realized.

Structural Differences

Private equity funds generally have a capital-raising term of several years, and will schedule closings of subscriptions once the fund has received capital commitments of a predefined amount, usually from $25 million to $100 million. In addition, private equity funds usually have a set term of 5 to 10 years, which can be extended even further in certain cases. Private equity fund investors generally do not have liquidity in their investment during this timeframe.

On the other hand, hedge funds generally accept investor subscriptions on an ongoing basis until they reach 100 investors or the general partner decides to close the fund to new subscriptions. Hedge funds do not have a set investment term and are perpetual in nature. Hedge fund investors can generally redeem their investment in the fund within 30-90 days after an initial lock-up period of up to one year.

Allocations & Distributions

There are some major differences between how private equity and hedge funds allocate and distribute funds between investors and fund managers. For private equity, distributions are made as investments are liquidated or upon other set times. Sometimes, investors also receive “preferred returns”, which are payable before the general partner is paid. Any remaining sums are then split between the investors and the general partner.

Hedge fund investors usually do not recover their investment until they withdraw from the fund. (An exception to this is a hedge fund created to generate income for investors; such funds will often distribute profits to investors regularly.) The general partner of a hedge fund usually receives a performance fee based upon the monthly, quarterly, or annual performance of the fund. This performance fee is allocated as a “carried interest”, i.e. as an interest in the fund rather than a cash distribution, for tax reasons.

Want to learn more about the differences between private equity and hedge funds? Call (888) 252-8277 to speak with our Houston securities attorney today.