Hedge funds and VC firms both occupy a niche place in the investment landscape that can provide investors with a powerful perspective on achieving alpha.
With markets so competitive, both hedge funds and venture capital firms have evolved to employ unique strategies to try to beat the market. But you don’t have to run a hedge fund or VC firm to use the same approach to investing.
Today, I want to walk you through the key differences between the two types of enterprises and the strategies that you can adopt to improve your returns.
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What is the difference between a VC and a hedge fund?
There are a number of key differences between a VC company and a hedge fund, including asset focus, risk profiles, time horizons, ownership structures, funding sources, ultimate investment goals, and liquidity for investors. Let’s break each down:
Asset Focus Hedge Fund vs VC Company
Hedge funds are generally a lot more flexible in the types of investments that they can make, sometimes investing in stocks, bonds, options, mortgage backed securities, futures, credit default swaps, etc. By contrast, venture capital firms (ie. VC firms) only invest in new companies. They typically purchase stock in newly created startups and may get options on top of the share ownership.
While hedge funds can make large investments in individual companies to gain majority ownership, they usually have much smaller stakes. VC firms, on the other hand, often take large positions in individual companies.
Risk Profile in Hedge Funds vs VC Companies Can Be Quite Different
While some say that hedge funds are more risky, it really depends on the particular strategies being employed. Since hedge funds can take a much wider range of approaches to investing, and fund’s risk profile could be a lot more or less risky than a VC’s approach.
For example, take a hedge fund that only goes long great companies that it buys at very cheap prices relative to fair value and then diversifies heavily. This would be a pretty low risk fund. A fund that only makes short bets on micro cap companies, on the other hand, would be pretty high risk and certainly much higher than any VC fund.
A VC fund does take on a lot of risk on each individual bet because it’s not at all certain that any investment it makes will work out rather than go to zero. But, VC investors often make dozens of bets to spread the risk.
Time Horizons Between VCs vs Hedge Funds Vary
While both hedge fund managers and VC investors can take a long term approach to their investments, VCs do so almost by default, while hedge funds can deploy a number of different strategies that are short term in nature – such as merger arb.
Ownership is Qualitatively Different in VCs vs Hedge Funds
Venture firms often take large stakes in companies and gain board seats so they can exercise some control over the company. While Hedge funds can do this as well, they typically make much smaller investments over more securities and do not exercise control of the company they invested in.
Funding Sources are Slightly Different Between Hedge Funds and VCs
Hedge funds typically bring in capital from wealthy investors, and there are SEC rules governing who can invest. In the US, only accredited investors can invest in hedge funds. To qualify, the investor must have an annual income exceeding $200,000 (or $300,000 joint with a spouse) for the past two years, with an expectation of the same going forward, or a net worth over $1 million (excluding primary residence).
VC firms get their funding from limited partners, typically wealthy individuals, endowments, or pension funds, for specific investment circles. The fund will run for a certain length of time with the objective of making a number of early investments in successful companies.
The Investment Goal Differs Between Hedge Funds and VC Companies
Hedge funds are geared towards making a great absolute return (capital gains plus dividends) for their investors each and every year. On the other hand, VC funds aim to make great early investments and then to cash in by selling their shares during an IPO.
Liquidity is Much Better in a Hedge Fund vs a VC Fund
When it comes to taking your money out, hedge funds provide far more liquidity than VC funds. Actually, this is a major drawback for hedge fund managers, since investors typically want to exit the fund just as bargains are surfacing, and plow money into a fund when markets are overheated.
By contrast, VC funds provide very little liquidity to investors, and payouts are usually only made after a company goes public.
Do VC Managers Invest Their Own Money?
Yes, VC managers do invest their own money. The exact amount they invest can differ from manager to manager, but they generally eat their own cooking. This incentive is a powerful way to convince others to place some money with the fund.
What is the Downside of VC Funding?
There are a number of downsides to VC funding for new companies, but generally, the problems come down to VC funds imposing managerial control, making leadership changes, and requiring the firm’s top management to pivot in directions different than initially intended.
Remember that when a company gains VC funding, it loses some control over its strategic and operating freedom because venture capitalists gain board seats and can exercise significant control over the major decisions the company makes. While before funding, the founders would make every key decision, after funding they have to consult with their financial backers, and those backers can force the firm to make different decisions.
Is Berkshire Hathaway a hedge fund?
No. Next question, please.
More seriously, Berkshire is a corporation run by Warren Buffett. Buffett used to run a hedge fund, known as the Buffett Partnership, but this was in the 1950s and 1960s. He purchased Berkshire Hathaway via his partnership, but later dissolved his partnership, preferring to use Berkshire as his main investment vehicle.
Who is the Biggest Hedge Fund in the World?
The biggest hedge fund in the world is Bridgewater Associates, run by Ray Dalio. In early 2025, the fund managed about $154 billion USD.
The larger the funds get, the lower their returns tend to be because it is harder to find anomalies in the stock market. They have to shift to making more macro forecasts which can be a crapshoot in terms of returns.
How to Invest Like a Hedge Fund or VC
Both hedge funds and VCs provide some great frameworks to invest by.
Hedge Funds are typically focused on hedging strategies (ok, at least they used to be), which involves shorting something and going long something else. While this can be ok if you know what you’re doing, I think the real opportunity is in the special situations that many funds capitalize on.
Two that seem the best bet are activism and spin off investing. Hedge Fund managers often pester management at companies to make big changes to unlock value for shareholders. They focus in on an undervalued firm and then draw up a plan and a list of demands for management. If management take them up on those plans, investors can come out ahead. If they don’t, hedge fund managers can battle management using proxy filings and public pressure, which could bring attention to the low priced shares.
By tracking successful activists, you can get in on an attractive company before the price rises and then let the activist work for you.
Spin offs are probably the most practical special situation that an individual investor can pursue to achieve great returns. The idea is to scan the upcoming deals to find situations where the company is undervalued and then buy it after it’s spun off. You need to select well, though, because not all spin offs are money-makers.
It’s also possible to employ the same sort of strategies that VCs follow, but you need to do so in a very particular way because startups are typically off limits for small investors. What I like to do is to find great managers who run public companies and have the habit of making large purchases in tiny upstarts. If the manager has a great track record and he buys startups and folds them into his public company, then you are effectively investing in a publicly traded VC firm.
How do you find great opportunities such as these?
That’s the catch. It’s hard, and you can spend hours each week just scanning the interwebs for ideas.
That’s why I recommend that you sign up for our free Morning Brew newsletter. Each month, we’ll send you each and every deal we come across, which will save you a lot of time and effort trying to find them yourself.
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