Hedge funds intro | Finance & Capital Markets | Khan Academy

Summary

This video explains the key differences between hedge funds and mutual funds. Hedge funds are more secretive, unregulated by the SEC, and unable to market themselves to the public. Only accredited investors can participate. Hedge fund managers typically receive higher management fees and a significant percentage of the profits, often around 20%, creating a stronger incentive to actively manage the fund. In contrast, mutual fund managers are paid based on the fund's size, with less focus on performance. The video sets up a comparison of returns between hedge and mutual funds for the next discussion.

Takeaways

• 🔍 Hedge funds are often mysterious and can have a bad reputation due to secretive and sometimes strange activities.
• 📜 The key difference between hedge funds and mutual funds is that hedge funds are not regulated by the SEC.
• 🚫 Because hedge funds are not regulated, they cannot market themselves like mutual funds can.
• 📰 You won't see ads for hedge funds in financial magazines or on financial shows, unlike mutual funds.
• 💰 Hedge funds cannot take money from the general public; they can only accept investments from accredited investors.
• 🏦 To invest in a hedge fund, one typically needs a certain net worth, income, or level of sophistication.
• ⚖️ Mutual fund managers earn a percentage of the assets they manage, with a focus on growing the fund's size.
• 📈 Hedge fund managers are motivated differently, often earning 1% to 2% management fees and a percentage of the profits (typically around 20%).
• 💼 Some hedge fund managers earn significantly more than 20% of the profits, with successful ones receiving 25% to 30% or even more.
• 🔄 The next video will explore the mechanics of returns in hedge funds versus traditional mutual funds.

Q & A

What makes hedge funds different from mutual funds in terms of regulation?

Hedge funds are not regulated by the SEC, unlike mutual funds. This lack of regulation allows hedge funds more flexibility but also prevents them from marketing themselves to the public.

Why are hedge funds often seen as mysterious or secretive?

Hedge funds are perceived as mysterious because they do not market themselves publicly and often engage in complex or secretive market activities. Additionally, many people are unaware of the largest hedge funds due to their lack of public visibility.

Who can invest in hedge funds, and why?

Only accredited investors can invest in hedge funds. These investors need to have a certain net worth, income level, or sophistication to qualify, as hedge funds are not regulated by the SEC to protect less knowledgeable investors.

Why don't hedge funds advertise themselves like mutual funds?

Hedge funds cannot market themselves because they are not regulated by the SEC. This prevents them from advertising in financial shows or magazines, unlike mutual funds which frequently advertise.

How are hedge fund managers compensated differently from mutual fund managers?

Hedge fund managers are compensated by both a management fee and a percentage of the profits, typically around 20%. In contrast, mutual fund managers earn a fee based on the total assets under management, without receiving a share of the profits.

What is the typical management fee for hedge funds compared to mutual funds?

Hedge funds typically charge a management fee of 1% to 2%, sometimes more, while mutual funds charge around 1%. Hedge funds also take a percentage of the profits, which mutual funds do not.

How do hedge funds incentivize managers to outperform the market?

Hedge fund managers are incentivized to outperform the market because they earn a percentage of the fund's profits. This is different from mutual fund managers, who earn fees based on the size of the fund and have less incentive to beat the market.

Why can't hedge funds take money from the general public?

Hedge funds can't take money from the general public because they are not regulated by the SEC, and therefore, can only accept investments from accredited investors who meet specific financial or knowledge criteria.

What happens if a mutual fund doesn't perform well in the market?

If a mutual fund doesn't perform well, it risks losing assets as investors may withdraw their money. However, the managers still earn fees based on the remaining assets, giving them less incentive to actively beat the market.

What is the potential downside of hedge funds not being regulated by the SEC?

Since hedge funds are not regulated by the SEC, there is less oversight, which can lead to risky or secretive activities. This lack of regulation is one reason why hedge funds are often viewed with suspicion.