Two investors decide on the same Monday morning to take 100,000 dollars out of their funds. The first owns a mutual fund. She places the order before 4 p.m., gets that evening's price, and federal law gives the fund seven days at most to send her the cash. The second owns a stake in a hedge fund. His fund redeems once a quarter on 60 days' written notice, so he has already missed the September window. If he is still inside his one-year lock-up, he cannot leave at all. And if too many other investors ask to leave at the same quarter end, a gate can cut his payout to a fraction of what he asked for.
Almost every difference between the two kinds of fund traces back to one legal choice: a mutual fund registers with the SEC under the Investment Company Act of 1940 and accepts its limits, while a hedge fund stays private and accepts limits on who can buy it instead.
Hedge funds and mutual funds compared in one table
| Mutual fund | Hedge fund | |
|---|---|---|
| Legal status | Registered investment company under the 1940 Act | Private fund relying on section 3(c)(1) or 3(c)(7) |
| Who can invest | Anyone | Accredited investors, often qualified purchasers |
| Typical minimum | 0 to 3,000 dollars | Set by the fund, commonly six or seven figures |
| Borrowing | Bank loans only, 300% asset coverage | No statutory cap |
| Illiquid assets | 15% of net assets at most | No statutory cap |
| Average cost | 0.64% active equity, 0.05% index equity | 1.32% of assets plus 15.78% of profits |
| Getting money out | Any business day, paid within 7 days | Quarterly or less, 30 to 90 days' notice, lock-ups |
| Public disclosure | Prospectus, audited reports, quarterly public holdings | 13F long positions only, if the manager is large enough |
| Tax form | Form 1099-DIV | Schedule K-1 |
| Performance goal | Beat or track a benchmark index | Absolute return, positive in most markets |
Mutual fund costs are asset-weighted averages for 2025. Hedge fund costs are industry averages for the first quarter of 2026.
Why the law treats them so differently
A mutual fund sells its shares to the public, so it has to register as an investment company. Registration brings a written prospectus, an independent board, daily pricing, audited reports and a long list of restrictions on what the portfolio can do. At the end of 2025, 8,030 US mutual funds held 31.4 trillion dollars.
A hedge fund avoids registration by fitting inside one of two exemptions in section 3 of the Investment Company Act:
- Section 3(c)(1) covers a fund with no more than 100 beneficial owners that makes no public offering.
- Section 3(c)(7) covers a fund owned only by qualified purchasers, which for an individual means at least 5 million dollars in investments. There is no 100-investor ceiling, so the fund can take in far more investors.
The shares themselves are sold as a private placement under Regulation D. That rules out advertising in the traditional sense under Rule 506(b), and limits buyers to accredited investors in practice.
Hedge funds are regulated through their managers. A US adviser with more than 150 million dollars in private fund assets generally registers with the SEC, files Form ADV, reports on Form PF and faces examinations. Form PF is confidential by statute under section 204(b) of the Advisers Act, so regulators see a large fund's leverage and liquidity. Its investors and the public do not.
Who is allowed to invest in each
Anyone with a brokerage account can buy a mutual fund. Minimums vary by fund and share class, and Vanguard's Admiral shares generally require 3,000 dollars to open.
Hedge funds stack three separate tests, and a fund may apply one, two or all of them:
- Accredited investor
- Income above 200,000 dollars, or 300,000 dollars jointly with a spouse, in each of the last two years, or a net worth above 1 million dollars excluding the primary residence. Holders of the Series 7, 65 or 82 licenses also qualify.
- Qualified client
- The test a registered adviser must apply before it can charge a performance fee. Since June 29, 2026, it means 1.4 million dollars invested with the adviser or a net worth above 2.7 million dollars, up from 1.1 million and 2.2 million dollars after a five-yearly inflation adjustment. Contracts signed before that date keep the old thresholds.
- Qualified purchaser
- At least 5 million dollars in investments for an individual. Required for every investor in a 3(c)(7) fund.
Hedge fund minimums are written into each fund's offering documents, and no rule fixes them. Six and seven figure minimums are common because a 3(c)(1) fund limited to 100 investors cannot afford to fill its slots with small tickets.
What each fund is allowed to hold, borrow and short
The 1940 Act puts hard numbers on a mutual fund's risk.
- Borrowing. An open-end fund can borrow only from a bank, and must keep asset coverage of at least 300% under section 18(f). In plain terms, for every dollar borrowed the fund needs three dollars of assets.
- Derivatives. Under Rule 18f-4, a fund that uses more than a limited amount of derivatives must keep its value at risk below 200% of a reference portfolio's value at risk, or below 20% of net assets where no suitable reference exists. It also needs a written derivatives risk program and a named risk manager.
- Illiquid holdings. Rule 22e-4 bars a fund from buying an illiquid investment if that would push illiquid holdings above 15% of net assets.
Short selling is allowed for mutual funds, but most long-only equity funds never use it, and those that do run it inside the same leverage and derivatives limits.
A hedge fund has none of these statutory limits. Its leverage is capped by what its prime broker will lend and by the terms it agreed with investors. It can hold private loans, distressed debt, real estate or a single stock at 30% of the portfolio. At the end of 1997, Long-Term Capital Management held about 30 dollars of debt for every dollar of capital. It lost 44% of its value in August 1998, and in September fourteen banks and brokers put in 3.625 billion dollars to keep it from a disorderly collapse. The main hedge fund strategies use these tools in very different doses, and a market-neutral fund can carry less market risk than an equity mutual fund.
Fees: 0.64% against 1.32% plus 15.78% of profits
A mutual fund charges a single expense ratio, taken daily out of the fund's assets. In 2025 the asset-weighted average was 0.64% for actively managed equity funds and 0.05% for index equity funds. Some share classes add a sales load or a 12b-1 distribution fee on top.
A hedge fund charges two fees. The management fee is a percentage of assets, and the incentive fee is a share of profits. The old standard was 2% and 20%, known as "2 and 20". In the first quarter of 2026 the industry averaged a 1.32% management fee and a 15.78% incentive fee.
A mutual fund is legally barred from the one-way version of that incentive fee. Section 205(b) of the Advisers Act lets a registered fund pay only a "fulcrum fee", which rises when the fund beats its index and falls by the same amount when it lags.
Here is what each fee structure takes from 100,000 dollars in a year when the portfolio earns 10% before fees, and in a flat year. For simplicity the fee is charged on the starting balance, and the hedge fund example assumes no hurdle rate and a fund already above its high-water mark.
| Fund type | Fees in a 10% year | Investor keeps | Fees in a flat year |
|---|---|---|---|
| Index equity mutual fund (0.05%) | 50 | 9,950 | 50 |
| Active equity mutual fund (0.64%) | 640 | 9,360 | 640 |
| Hedge fund, 2026 average (1.32% and 15.78%) | 2,690 | 7,310 | 1,320 |
| Hedge fund, classic 2 and 20 | 3,600 | 6,400 | 2,000 |
At the 2026 averages, the hedge fund takes 27% of a 10% gross gain. It has to outperform the active mutual fund by about 2.4 percentage points a year before fees to leave the investor with the same result. Hurdle rates, high-water marks and crystallization dates change these numbers fund by fund, and our guide to hedge fund fees works through each of them.
Getting your money back
A mutual fund prices once a day, after the market closes, and every order placed before the cutoff gets that price. Rule 22c-1 requires this forward pricing, so nobody can trade on a stale price. Once shares are redeemed, section 22(e) bars the fund from delaying payment for more than seven days, except in narrow emergencies such as an exchange closure.
A hedge fund sets its own terms in the limited partnership agreement. Most funds allow redemptions four times a year or less and can suspend them altogether. The standard liquidity terms are:
- A lock-up, typically one to three years, during which capital cannot be withdrawn at all, or only with an early redemption fee.
- Quarterly redemption dates with 30 to 90 days' written notice.
- A gate that caps total redemptions on any one date, usually somewhere between 5% and 25% of the fund.
- A holdback of part of the final payout until the annual audit is complete.
In December 2008 alone, investors asked for an estimated 100 billion dollars back, and many funds met the wave with gates, suspensions and payouts in kind.
What you can see inside each fund
A mutual fund publishes a prospectus with its fees, strategy and risks before you buy, then audited annual and semi-annual reports. It also files its full portfolio with the SEC every month on Form N-PORT. Only the report for the third month of each quarter is made public today. A 2024 rule that would publish every monthly report has had its compliance date pushed to November 2027, and in February 2026 the SEC proposed keeping publication quarterly.
A hedge fund's investors get a private placement memorandum, the partnership agreement, monthly or quarterly letters and an annual audit. A manager with at least 100 million dollars in listed US equities and certain options files Form 13F within 45 days of each quarter end, and the form excludes short positions entirely. A long/short fund's 13F therefore shows half the portfolio, six weeks late. Our guide to reading 13F and 13D filings explains how far that data can be pushed.
With no prospectus, investors check the fund themselves through hedge fund due diligence: operational reviews, audited statements, service provider calls and background checks on the manager.
Taxes: Form 1099-DIV against Schedule K-1
A mutual fund is taxed as a regulated investment company. To keep that status it must distribute at least 90% of its investment company taxable income each year under section 852 of the tax code, and in practice it distributes almost all realized gains as well. Shareholders receive a Form 1099-DIV. The catch is that you can owe tax on capital gains distributions in a year when you sold nothing and the fund's price fell.
Most US hedge funds are limited partnerships, which pay no tax at the fund level. Each investor receives a Schedule K-1 showing a share of the fund's income, gains, losses and deductions, split by type. Short-term trading gains are taxed at ordinary income rates. A calendar-year partnership's return is due on March 15, and it can take an automatic six-month extension with Form 7004. Funds that use it send K-1s after the April 15 individual deadline, so their investors file for an extension too.
Benchmarks, absolute returns and the 2025 numbers
A US large-cap mutual fund is measured against the S&P 500. If the index falls 20% and the fund falls 15%, the manager has done the job. A hedge fund is usually expected to make money in most years regardless of the index, which is why many hold short positions that cost them in rising markets.
In 2025 both groups trailed the index. The S&P 500 returned 17.9% including dividends. The HFRI Fund Weighted Composite, which averages thousands of hedge funds, returned 12.6% net of fees, its best year since 2009. And 79% of active US large-cap mutual funds underperformed the S&P 500.
Over ten years, Warren Buffett's bet between an S&P 500 index fund and five funds of hedge funds ended with the index fund compounding at 8.5% a year and the funds of funds at between 0.3% and 6.5%. The funds of funds did lose less in 2008. The long record for active mutual funds is covered in our article on active vs passive investing, and index averages for hedge funds carry survivorship bias because funds that close stop reporting.
Hedge fund strategies inside a mutual fund
Fund companies also package long/short equity, managed futures, merger arbitrage and multi-strategy approaches into ordinary mutual funds and ETFs, usually called liquid alternatives. Anyone can buy them, they redeem daily, and they charge a single expense ratio with no performance fee.
They still operate under the 1940 Act. The 300% coverage rule, the derivatives value-at-risk limit and the 15% illiquidity cap all apply, so the leverage and illiquid positions that drive some hedge fund returns are off the table. More than 250 liquid alternative funds have merged or closed since 2014, leaving about 160.
Interval funds and non-traded BDCs sit between the two worlds, with lower minimums and quarterly liquidity. They are the main retail route into private credit.
Choosing between a hedge fund and a mutual fund
For most people the question never arises, because they do not meet the eligibility tests. For those who do:
- If the money might be needed within a year or two, a lock-up and a quarterly gate can keep it out of reach.
- If the goal is broad stock market exposure, an index mutual fund delivered it for 0.05% a year in 2025, and the hedge fund composite trailed it that year.
- If the goal is a return stream that behaves differently from stocks, some hedge fund strategies provide one, and a few liquid alternative funds approximate it with daily liquidity.
- If the goal is a specific star manager, the fund may be closed. Renaissance Technologies' Medallion fund bought out its last outside investors in 2005, as covered in our list of hedge fund books.
This article is general information, not investment advice.
Working at a hedge fund vs a mutual fund
A mutual fund manager runs large, diversified, benchmarked portfolios and is paid mostly from the steady management fee, so teams are bigger, hours are more predictable and turnover is lower. A hedge fund's income swings with the incentive fee, so pay swings too, and a bad year can end a career.
Pay figures are estimates, and the most detailed public ones come from the career site Mergers & Inquisitions. At large asset managers it puts post-MBA analysts at roughly 250,000 to 350,000 dollars in total compensation and portfolio managers at about 1 to 1.5 million dollars. It puts hedge fund analysts at 200,000 to 600,000 dollars, with an upper end that is rarely reached at a mutual fund.
Mutual funds hire graduates directly through structured analyst programs and MBA recruiting. Most hedge funds want two to four years of experience in investment banking, equity research or asset management first. Exits differ too: mutual fund analysts often move to pensions, endowments and family offices, while hedge fund analysts move to private equity, family offices or a fund of their own. Our guide on how to become a hedge fund manager covers the routes in, and what a hedge fund is covers the basics this article assumes.
Frequently asked questions
Is a hedge fund riskier than a mutual fund?
Usually, because the law caps what a mutual fund can do and leaves a hedge fund free. A mutual fund must keep at least 300% asset coverage on bank borrowing, hold no more than 15% of net assets in illiquid investments and pay redemptions within seven days. A hedge fund can borrow far more, concentrate, hold assets with no market price and lock up capital for a year or longer. Some hedge fund strategies are built to be less volatile than the stock market, so the answer depends on the specific fund.
Are hedge funds regulated by the SEC?
Yes, through their managers. The fund itself uses an exemption from the Investment Company Act, but a US manager with more than 150 million dollars in private fund assets generally registers with the SEC as an investment adviser, files Form ADV, reports confidentially on Form PF and is subject to anti-fraud rules and examinations. Mutual funds are regulated at both levels: the fund registers under the Investment Company Act and its adviser registers under the Advisers Act.
Can a non-accredited investor put money in a hedge fund?
Rarely. Rule 506(b) of Regulation D allows up to 35 non-accredited but financially sophisticated purchasers in a private offering, but it triggers heavier disclosure duties, so most funds refuse them. Funds that rely on section 3(c)(7) can only accept qualified purchasers. The practical route for a non-accredited investor is a registered fund that runs a hedge fund style strategy, such as a liquid alternative mutual fund or an interval fund.
What is the minimum investment for a hedge fund compared with a mutual fund?
No law sets a minimum for either. Each fund chooses its own. Mutual fund minimums are commonly between zero and a few thousand dollars, and Vanguard's Admiral shares generally require 3,000 dollars. Hedge fund minimums are set in the offering documents and commonly run into six or seven figures. The eligibility tests are the stricter gate: 1 million dollars of net worth to be accredited, and 1.4 million dollars with the adviser or 2.7 million dollars of net worth to be charged a performance fee.