KEY POINTS:
For a lot of New Zealand investors hedge funds are those mysterious international players we see piling into local stocks and playing the odds on the success of a takeover play.
For example, The Warehouse share register almost certainly contains arbitrage hedge funds which have invested on the
basis that a bidding war will send the price soaring if both Foodstuffs and Woolworths get clearance from the Commerce Commission next week.
Those sort of plays have given hedge funds a slightly glamorous reputation as high-risk players.
But really the opposite is true, says David Copley, who is setting up a local hedge fund company, in partnership with London-based Trafalgar Capital.
"There is a much wider gamut of funds which we haven't seen here," he says. "The basic misconception is that they are riskier forms of investment."
But by taking long and short positions or by investing in counter-balancing industry sectors, hedge funds aim to deliver positive returns with less volatility.
"The aim is to generate positive returns irrespective of the market," Copley says.
"We don't care about indexes."
The other form of hedging well known in New Zealand is currency and commodities hedging. Funds which invest in these markets tend to use more leveraging, Copley says. But it is another misconception that all hedge funds are leveraged to the hilt.
The joint venture company, to be called Trafalgar Copley, will focus on Australasian markets and will invest only in equity and debt markets.
The first fund already has capital committed from international investors and is due to be closed off on April 30.
The fund will use mainly a "long and short equity strategy", says Copley, who cut his teeth in the hedge fund division at UBS in New York.
But a range of hedging mechanisms are available to hedge funds.
These include investing in companies with offsetting characteristics.
A theoretical example would be buying airline stocks and offsetting with oil company stocks. How heavily the fund weighted its investment to one or the other would depend on whether it expected oil to rise or fall.
But by investing to some degree in both, the fund is able to set its own level of risk.
Trafalgar Copley will first identify companies which fit its strategy and then determine whether to invest directly in stock or in bonds or capital notes issued by the company.