As your knowledge of investing continues to grow, you will likely begin to hear or read about different types of funds. Often, these funds will be mentioned in market-related news stories (when they are not focused on institutional banks), or just in casual conversation with others who are interested in investing. But what are they? More importantly, what differentiates them from one another? In this article, I will be breaking down the basics of four types of funds that you are likely to come across:
Due to their reputation for being aggressive investment vehicles, these funds have quite possibly become the most frequently discussed funds, or at least the type of fund with the largest name recognition. That said, even though most beginning investors are familiar with the term, they might not actually understand what a hedge fund is. Simply put, hedge funds are alternative investments, which function by using pooled funds. They employ many different strategies, such as taking both long and short positions, in order to earn active returns for their investors. Further, due to being less regulated by the SEC than other types of funds, hedge funds are generally only accessible to accredited investors. This means that hedge fund managers can decide what the criteria to make an investment will be and what types of fees will be charged. As result, many hedge funds have particularly high barriers to entry for investors. Ultimately, it is likely that their autonomous nature that makes them so popular. Examples of some of the world’s largest hedge funds are Bridgewater Associates, AQR Capital Management, and Man Group.
Like hedge funds, mutual funds are investment vehicles that are made up of pooled funds collected from many sources. Then, that accumulated capital is invested in securities such as stocks, bonds, and similar assets. These investments are made by money managers whose goal it is to produce capital gains for the investors. Generally, in order to establish investor confidence, each mutual fund has a prospectus that lays out the investment objectives for its investors, which ensures that there is structure to the portfolio. Finally, an important distinction between hedge funds and mutual funds is that mutual funds provide smaller investors with access to professionally managed, diversified portfolios of equities, bonds, and other types of securities, whereas hedge funds are known for their selectiveness.
Fund of Funds:
Investing in one of these funds is sometimes called making a multi-manager investment. This term comes from the fact that a ‘fund of funds’ is literally a fund that invests in multiple other funds, generally diversifying the types of funds it invests in; a sort of “Fund-ception” if you will… Accordingly, this investment strategy focuses on creating a portfolio that is made up of different underlying assets, rather than investing directly in stocks, bonds, and other types of securities.
Our last type of fund is a family office, which is generally comes in two forms: single family and multi-family. These offices operate as private wealth management advisory firms that serve extremely high net-worth individuals, families, and estates. Moreover, since they offer a completely outsourced solution to managing the financial and investment side of a wealthy individual, family, or estate, they are different than traditional wealth management firms. For instance, is it not uncommon for family offices to include offerings like insurance, charitable giving, family owned businesses, tax services, and budgeting. By and large, it is the goal of many investors to do well enough to one day have their own family office or be a part of a multi-family office.
Hopefully these explanations have been clear and will prove to be useful the next time you read market news or decide to have a conversation about investing with others who are knowledgeable on the subject matter. Of course, these were just basic descriptions and each of these types of funds is unique and intricate, so I recommend doing some more independent research on the ones you find the most interesting. Perhaps you will someday invest in one of these kinds of funds!