Determining where to invest your money is never a simple decision to make. There are endless different investment opportunities, methods, and options from which to choose. While raising capital is always a goal, business set up tends to rely on that more than anything else, especially in the beginning.
In the world of business setup, there are always two primary investment options that tend to be widely known: a hedge fund and an investment bank. Although they may seemingly work the same way, they are very different ways to invest your money. So, the big question becomes, what’s the difference between a hedge fund and an investment bank?
The primary difference between hedge funds and investment banks involves the primary focus of the two. Hedge funds maximize a number of risk management techniques to invest in multiple products from a source that is a pool of investors’ money. Investment banking is a financial institution that provides financial advisory services to help raise overall capital.
Rather than spending countless hours researching the differences between the two, read through our article to see if you can determine which makes more sense for your current setup.
What is a Hedge Fund?
Hedge funds are known for their extraordinarily high returns, which, of course, come with a price of extremely high risk. The funds are monitored closely by using different risk management and hedging techniques but are, overall, the portfolios get invested incredibly aggressively. The portfolios themselves are created by pooling several investors and institutional investors’ funds and placing them in varying assets typically pooled.
One particular characteristic of hedge funds that makes them stand out amongst other investment options is that they are exclusive to only a limited group of investors. Liquid assets are the primary source of hedge fund investments, making them only available to extremely high net worth individuals and institutional investors.
Types of Hedge Funds
Several different strategies are offering varying degrees within hedge fund options. A few of the more common types include macro, equity, and relative value.
Macro Hedge Funds
Macro hedge funds aim to primarily profit from macroeconomic changes by investing in stocks, bonds, and currencies. Examples of macroeconomic changes that would impact macro hedge funds include fluctuations in global interest rates and economic policies worldwide.
Equity Hedge Funds
Equity hedge funds seek to short overvalued stocks by investing in popular stocks and hedge against downturns in equity markets. You will see that equity hedge funds can exist globally or be specific to one country.
Relative Value Hedge Funds
Relative value hedge funds will ultimately take advantage of price inefficiencies in the market.
Hedge Fund Characteristics
It is common for hedge fund management teams to act more similarly to traders than traditional investors. Here are some of the common characteristics found in hedge funds that help set them apart from other investment options.
As mentioned previously, hedge funds are exclusive to high net worth individuals. Typically, a minimum net worth of $1 million or annual income greater than $200,000 for the last two years is required to be considered eligible for hedge fund investing.
Hedge funds have no limitations and can invest in nearly anything. Some common things you will see hedge funds invest in include land, real estate, and currencies.
Returns amplify in hedge funds through the use of leverage (borrowed money). Because hedge funds are known for their extremely high risk, this is one component of that risk level. A prime example of this being detrimental was during the Great Recession.
Hedge funds charge clients not only an expense ratio but also a performance fee for their services. One of the most common fee structures known to hedge funds is the two and twenty in which clients are charged 2% from asset management and 20% from gains.
What is Investment Banking?
Financial corporations divide into many different sectors, one of which being investment banking. In investment banking, they are responsible for supporting businesses with advisory-based transactions. The clients that investment banks service include individuals, corporations, government, and other investment institutions.
In the world of corporate finance, investment banking acts as the company’s agent to raise capital by issuing securities. Investment banks also assist in serving mergers and acquisitions.
How are Investment Banks Different From Commercial or Retail Banks?
Commercial and retail banks, while offering similar services, have differences between them as well. The clientele they serve are different; investment banks handle institutions while retail banks serve individuals or small businesses. While there is some overlap between the three types of banking, they all serve different purposes.
In short, a retail bank provides banking services and loans to individuals or small businesses. A commercial bank will handle basic needs like deposits or loans for individuals or companies. An investment bank will deal with the purchasing and selling bonds and stocks for companies and assist with issuing IPOs.
Although their functions may overlap in some areas, the significant differences between the three types of banking regard regulations, risk levels, and benefits.
How Investment Banks Run
Sell-side and buy-side are two brackets in which investment banks separate their activity. The sell-side bracket includes the trades of securities for cash or other securities for the organization they are serving. On the other side of the business, the buy-side is the bracket for purchases of the same organization’s investment services.
The investment banker’s role is to assist the corporation, government, or other groups they manage to help them save time and money through risk management. Ideally, businesses can turn to their investment bankers in time of question for advice on managing their development.
In addition to providing financial advice to companies, investment bankers can ensure that organizations follow all regulatory requirements while maximizing their revenue.
Another critical role that investment bankers will fill is when companies are holding their IPO. Investment bankers can act to sell the shares on the market on the company’s behalf.
How to Hedge Funds and Investment Banks Compare?
Although those descriptions of hedge fund and investment bank clearly define the roles of the two, it can still be a little complicated to understand how the two match up. Take a look at the chart below for a side-by-side comparison of hedge fund and investment banking by different categories:
|Hedge Fund||Investment Bank|
|Meaning||Group that invests in financial products via investors’ pooled funds||Financial intermediary offering investment and advisory services|
|Focus||Increase return for investors as quickly as possible||Growth, safety, and overall income|
|Risk||Extremely high||Minimal in comparison|
|Investment||Liquid assets||Various; stock selling, finding investing partners, etc|
|Concentration||Short term||Long term|
Hedge Funds vs. Investment Banks – Primary Differences
Through analyzing the chart listed above, we can break down the primary components of hedge fund and investment banking into five significant distinctions: meaning, focus, risk, investment, and concentration.
In hedge funds, investors’ money pool together to invest. Comparatively, investment banks use the money from the individual or company to offer financial advisory and investing services.
The main goal for hedge funds is to obtain considerable returns in a minimal amount of time. Opposite to that is investment banking, which seeks to focus on safety and gradual growth over time.
High risk and high reward is the name of the game for hedge funds. On the other hand, investment banks tend to have more control and, as a result, less risk involved.
Hedge funds pursue highly liquid investments, while investment banks tend to propose plans filled with stocks and shares from multiple investment options for security.
By having a concentration that lies on opposite ends of the spectrum, hedge funds are concerned with short term gains, and investment banks prefer to focus their time and energy on long term investments.
While there are many differences between hedge funds and investment banks, a simple determining factor includes the client base they serve. Hedge funds seek to help high net worth individuals only, and investment banks choose to focus on financial institutions.
When trying to determine between the two investment options, it is crucial to consider the model in which both operate. Hedge funds are an excellent way for those who are eligible to make a lot of money quickly. In comparison, investment banking is a reliable option that prioritizes financial stability over the long run.
If you are looking to develop your organization, investment banking is likely the better option for you. You will seek out financial advisory support by opting for investment banking, whereas you would not have that option with hedge funds.
Much like everything in life, there are pros and cons to both investment options. Knowing the difference between the two is the first step in educating yourself to make the right decision.
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Emily is a professionally trained freelance writer who covers a wide range of topics but specializes in business, law and hospitality content. With over a decade of professional writing experience in the hospitality industry, Emily comes from a strong background in the field backed with a BS from the world-renowned William F. Harrah College of Hospitality at UNLV. When she is not spending her time freelance writing, Emily enjoys growing her social media skills and spending time with her rescue puppy. Find out more about Emily’s extensive background or reach out directly at www.linkedin.com/in/Emily-Kho.