Hedge Fund vs Private Equity: 6 Key Differences

Detailing the main differences between private equity and hedge funds in terms of structure, liquidity and methodology, as well as cases where leadership optimisation is key.

By: Leadership Dynamics team


4 mins

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While a private equity fund invests in companies, and works to ensure their success for a profitable sale, hedge funds will invest in just about anything that offers a high return. Their flexibility allows for multiple types of hedge fund, but there are some key differences across all types.

This article will give you an understanding of the main differences between the two investment vehicles, but also delve into the how and why private equity firms create value for their portfolio companies, and when hedge funds get involved in value creation and leadership optimisation in distressed private equity investing.


  • The 6 key differences

  • What is distressed private equity?

  • Hedge funds and loan-to-own

  • How to ensure value creation from leadership

The 6 key differences

1. Time

Private equity: Private equity funds invest in companies, either buying wholly or obtaining a controlling stake, over a defined period of time – usually 3-5 years – and only see a return when they sell a company on.

Since their investments are a long-term commitment, private-equity firms have an interest in improving and maintaining sustainable, long-term performance of their portfolio companies.

Hedge funds: Hedge funds use pooled funds from limited partner investors to make investments that will offer the maximum return as quickly as possible. Their investment guidelines do not restrict them to one type of investment, so they are more flexible in what they invest.

2. Risk

Private equity: Private equity funds have a varying degree of risk, depending on the business model of the portfolio company. For example, a business services business has an inherently lower risk than a healthcare company.

Hedge funds: Since these focus on short-term investments for maximum returns, the risk is naturally higher. However, they will use diversified investments to "hedge" against the risky investments (hence the name!).

3. Liquidity

Private equity: Private equity firms invest directly in companies, which makes them a highly illiquid investment as the money is locked up until exit – normally a minimum of three years. Limited partner investors must wait until a sale to see a return.

Hedge funds: Hedge fundshave high liquidity due to their investments' short-term nature and wide variety of assets, including public equities, debt, bonds and other securities. Hedge funds are able to offer investors the right to withdraw capital at short notice.

4. Structure

Private equity: Private equity investments are closed-ended, which means new investments cannot be added after the initial window and there are restrictions on transferability for a defined period of time.

Hedge funds: Hedge funds, on the other hand, are open-ended, so have few if any restrictions on transferability. Investors can add or redeem shares at any time.

5. ESG and impact investing

Private equity: Private equity impact investing, ESG investing and other kinds of sustainable investing have become more and more popular as more limited partners prefer to make a difference at the same time as maximising returns. Funds will identify a company and either qualify or disqualify it as a potential investment depending on their environmental and social impact or their level of governance.

For more on ESG and impact investing in private equity, see our article ESG Investing in Private Equity: Benefits and Challenges.

Hedge funds: While private equity impact investing is about value creation so that they can help the portfolio company to make even more of a difference, hedge funds are primarily silent investors who do not usually have any involvement in value creation. However, they do use negative screening to exclude investments that are in environmental or socially irresponsible companies or sectors. And they can use positive screening to search for investments in companies that operate a good ESG policy.

6. Value creation

Private equity: Gone are the days when private equity firms could buy a company, sit on it and sell it a few years later for a profit; high competition means that's not enough anymore. Not only must investors work with their portfolio companies to increase its financial performance; they must ensure it can provide a sustainable return or else buyers will not be interested.

The value of a company is dependent on using investment wisely to lean on various value creation levers, such as internationalisation, M&A, operational efficiency and digitisation. However, the most important of all value creation levers is leadership. A solid management team is essential to executing the strategies that align with the value creation plan.

Hedge funds: Hedge funds do not usually concern themselves with value creation as they have no involvement in the running of a portfolio company. Except, that is, for hedge funds in the distressed private equity business. This is where a hedge fund manager's experience in distressed debt trading comes to the fore.

What is distressed private equity?

Distressed private equity is the kind of private equity that employs some of the hedge fund skillset. It's a hybrid model between the classic buy-out model of private equity and hedge funds' distressed debt trading strategies.

Distressed debt trading is short-term trading of a troubled company's debt. Hedge fund investors evaluate the liquidation, breakup or restructuring value of the debt, and sell it on when it reaches a higher value. But there is no control over the performance of the business, it's simple trading.

In times of recession, the distressed market grows, and distressed investing and private equity becomes more prevalent as companies enter troubled times and need help turning themselves around.

A private equity firm that specialises in distressed investments will buy equity in the troubled business rather than debt, restructure the business and then help turn it around. Hedge funds usually buy debt and wait for the company to turn itself around, or use a trigger event to swap the debt for equity.

Hedge funds and loan-to-own

Since hedge funds are not restricted to the type of assets they invest in, they are able to do the same, and many are therefore becoming owners of businesses that they need to succeed.

Some hedge funds operate a loan-to-own strategy in the distressed market. This means they buy some or all of a company's debt, and then make a debt-for-equity swap (usually triggered by a default or bankruptcy) to gain a controlling stake in the business.

In this case, it's in the fund's interest to help the company back on its feet and so they must ensure the leadership team is up to the job.

How to ensure value creation from leadership

How can private equity companies and hedge funds who own equity build leadership teams that are effective enough to see a return from the investment?

Start by assessing individual leaders on the team, so you can build a picture of their competencies, experience and behaviours.

Aim for diversity and balance

Assessing individuals is just the first step to building a team, it's knowing how they work together that determines their success as a team. When assessing executives, look for a balance between competencies, experience andbehaviours.

A team that over-indexes on the same types of experience and behaviours can lead to a lack of creativity and innovation, and can lead to group-think. Without alternative views, leadership teams fall into complacency and an "us vs them" approach to management, which damages company culture.

The key is diversity, especially cognitive diversity. Having people withdifferent ways of thinking on a team leads to better problem solving, and better performance. So when assessing individuals on the team, identifying those behaviours that complement each other.

The importance of behaviours

While personality is static, behaviour is dynamic. Assessing behaviours goes beyond the CV and deeper than an interview. When an assessment of performance history is combined with behavioural analysis, you can more accurately predict whether or not someone is likely to behave how they say they will. Behaviours tell you what a person is likely to do in a given situation, no matter their experience. So while personality shows you "who they are", behaviours tell us "how they act".

To learn more about how these behaviours work together, take our PACE test for free, and you will get a detailed analysis of your own behavioural profile.

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