Nikhil Kamath, Co-Founder and Chief Investment Officer, Zerodha co-founded his new venture True Beacon in 2019 and launched True Beacon I, the first flagship fund in category-III. True Beacon is an asset management company in Alternate Investment Fund (AIF) space which aims to disrupt the market by adopting a zero upfront fee and only profit-sharing model. In a video interview with Naveen Kumar of Money Today, Kamath shares his fund management experience, investment insights and future strategies. Edited excerpts:
What has been your experience with your new venture into AIF space?
Nikhil Kamath: Its evolution lies in our vision to eliminate middlemen. Take, for instance, if I invest Rs 100 in AIF, at least Rs 1-2 will go to the distributor, another Rs 2 annually to the fund manager coupled with a setup cost and exit load, etc. So each time I invest Rs 100, I am giving only Rs 96 to the fund manager. On top of it, I had to keep giving him Rs 2 annually. So, if I were to keep money with this fund manager for the next 10-20 years, the odds of him outperforming the market benchmark are thin. At True Beacon, we removed the distributor. We deal directly with the client. We don't have any exit load either. It's a completely open-ended fund.
How do you get the confidence that this model will work and will be profitable?
Nikhil Kamath: It has been an opaque industry. A typical CAT-3 AIF will tell your NAV once in a month, and they will do it by virtue of a relationship manager telling you or them sending you an excel sheet with performance. We built a dashboard which shows the performance of the fund on a daily basis. So every day you can log into your own dashboard and see what the fund is doing. If you want, you can withdraw or add money on your own.
At True Beacon, we are not really focussed on making profits. We want to make better the asset management space for ultra HNIs, which has not changed in last 10-20 years. So far as profits are concerned, of course, it will not come in the first two-three years. If there happens a word of mouth publicity of our efficient model, new investors will come and corpus will grow. With significant scale, we'll be able to earn profits.
What Zerodha did to the stock-broking, do you expect True Beacon to do the same to the AIF space?
Nikhil Kamath: Yes. The CAT-3 AIF is our first product. We want to do everything a private bank or asset manager does, but with more efficiency. We are about to launch another product in the CAT-3 AIF space. Then we will launch a CAT-2 AIF. So, we want to be an end-to-end asset management play for an ultra HNI.
Do you expect to disrupt the AIF industry that is into the upfront charges model? Will more players follow you or will they wait to be sure if this model works or not?
Nikhil Kamath: I think they will wait. It'll be hard for the incumbent players to suddenly drop the prices because they have a very sales-heavy model. We don't do marketing campaigns or hire relationship managers. We're truly relying on word of mouth. So, they cannot afford to drop the prices to our level because they still need to have the marketing engine in place.
How do you get the confidence that your strategy will deliver better returns for your investors? What are some unique things that you are doing in the stock selection or trade execution timing?
Nikhil Kamath: Our portfolio is split into two buckets -- 65 per cent of it is into equities. We only invest in Nifty stocks. We don't do midcaps or small-caps. Among 50 Nifty companies, we pick a basket of about 18-22 stocks, that comprises 65 per cent. The balance of 35 per cent of the portfolio is based on mathematics. We run strategies such as mean regression, delta hedging and bare trading to take advantage of volatility in the short-term. A combination of these two buckets, we hope, will give us an alpha over the benchmark Nifty by 6-8 per cent. Our goal is if the Nifty returns 10 per cent, we should earn at least 16-18 per cent.
The remaining 35% portfolio is where your uniqueness lies. Can you elaborate more on that? Is it like going into midcap or small-caps or entirely into derivative or trading?
Nikhil Kamath: The 35 per cent again is large-cap but from the derivative universe. For instance, Infosys and TCS, which are very similar companies in many ways, have a co-relation of 1.2. For every point that the Nifty goes up, Infosys goes up by say 1 point and TCS by 1.2 points. That correlation has been around for the last five to 10 years. We write an algorithm which will place a transaction for this divergence to regress to the mean. If that difference between the two companies becomes from 1 and 1.2 to 1 and 1.4, we'll sell TCS and buy Infosys. We don't take a call on whether the market is going up or down but whether there will be a regression to the mean in a trend, which has existed for many years up until now. And this 35 per cent basket is typically short bias, while the equity basket has a long bias. So it acts as a natural hedge against the 65 per cent portfolio. We try to bring in a USP in both buckets. On the equity bucket, we want to outperform the markets by 2-3 per cent. And on the math-based derivative bucket, we wish for 3-4 per cent. The combination of the two should give us 6-8 per cent outperformance.
Is there some portion being invested in start-ups?
Nikhil Kamath: We are planning a Category 2 AIF, which will be into public and private market in the same proportion. The half of it will be into start-ups and the rest into public markets. But the product is still six months away.
What is the eligibility for the investors in terms of the size of the investment? Are there any other criteria like risk-profiling?
Nikhil Kamath: The regulator mandates that it should be Rs 1 crore, but we typically look for clients with minimum Rs 15 crore. There is no risk profiling because it's a pooled investment vehicle like a mutual fund. So if you come in today, you get 100 units at NAV 102. But if you come in after 10 days, and if you're investor number 10, you get it based on the NAV of that day. So, the risk profile for all the investors coming into this fund is essentially the same.
With a smaller size fund, your strategies may have worked so far. What about the larger AUM as your size grows?
Nikhil Kamath: We have tested it for as high as $2-2.5 billion. So, as long as we are in Rs 15,000 crore level, we shall do fine. These are early days. We only have the first nine months of performance. But luckily, in the nine months, even though our target was to beat the Nifty by 6 to 8 per cent, we did it by about 25 per cent. Including the advisory clients and everything that we have, even our AUM has scaled up to Rs 300 crore-plus. It should take at least two-three years for us to reach a significant scale.
The current mutual fund performers are mostly in the global fund and pharma categories. Isn't that a part of your strategy?
Nikhil Kamath: Ours is totally Nifty stocks. It takes away the commodity and the fixed income aspect of it, but pharma is a big part of our portfolio. Our top three holdings right now are Reliance, Infosys and Cipla.
The impact of pandemic on the economy has been severe, but markets have started going up in a major way. So, what is it that the market is seeing even as the economy is going in the opposite direction?
Nikhil Kamath: The markets are always forward-looking. Market participants are not looking at what is happening now, but what will happen one to three years down the line in terms of demand. After the whole corona cycle, we will still need manufacturing, industry, transport, and all of that. Consumption will pick up again. So, they are discounting what might happen in the next 12 months and choosing to look forward to 24-36 months down the line. Mr Market is not sentimental, right?
Isn't this a situation where investors are left with fewer avenues to generate higher returns and that's why they are compelled to invest in the equity market? Does the fact that liquidity is driving the prices rather than the fundamental value of the stocks add to this?
Nikhil Kamath: I totally agree with you. The biggest factor for the growth of equity market is the mindset of Indians that compels them to keep most of their savings in real estate.
If you take an average Indian household, 70 per cent of their net worth will be typically in real estate - be it a loan on the house or a property that they own. Real estate sector saw a slowdown after a long time. In the last five to seven years, people did not see any yield.
If you talk about the residential vertical of the sector in our country, we're only seeing rental yields of one and a half to two per cent. The value of the underlying asset is not going up and hence people are looking for an opportunity to invest their money in other avenues. So, a lot of the money which was allocated to real estate is now getting rebalanced into equity markets per se.
But I think it's a good trend. If you were to compare household savings and where they're allocated, India would rank at the top spot for investing in real estate. People should have a balanced portfolio with plenty of diversification. My sense is no one should never have more than 50 per cent of their net worth in real estate. People should probably have 50 per cent in real estate, 30 per cent in equity, 10 per cent in gold and 10 per cent in fixed income. This level of diversification will give some kind of a floor when things get really bad. It seems people are becoming aware and are reducing their real estate allocations and increasing their equity component right now.
We saw restrictions, the moratorium on loan repayments and many companies could still be facing cash flow problem, which we may see later on. Isn't there a risk area where the market should wait and watch?
Nikhil Kamath: In terms of how the markets are doing, Nifty50 fell from 12,000 to 8,000 and now is at 10,400 levels. I think the call people are taking right now is not based on whether the markets will go up 20 per cent, 30 per cent, or whatever. They are thinking about allocation of funds in five different asset classes over a five to the 10-year period, and how much exposure they want in equity. And people are rebalancing in equities from real estate based on that. To your point, definitely there will be issues in terms of demand and supply-side issues over the next 12 months, which will affect corporate earnings. But people seem to be discounting that as a short-term phenomenon right now.
What are the sectors you see having high potential in a post-corona world where the investors may see higher returns?
Nikhil Kamath: I think pharma is one of the top picks that we have. There is a big case going on in the world on why supply chains need to hedge the risk they have because most of them have China as a big part of supply chains. Be it the western world or even the Asian ecosystem, both are consuming. For India to make a case that manufacturing has to move from China to India, I think a lot of money has to be spent on infrastructure. There will be significant spending, both by the government and the private industry in the infrastructure space. That's one pocket which will do well, along with pharma. IT sector is another, however, there is a tail risk here because of the US elections. Trump will have to say things which are against outsourcing, anti-immigration and stuff like that. But the IT sector has longer-term contracts. So, you would find that Infosys and similar companies, which get large contracts for five to 10 years, will do much better in times of uncertainty like right now. Therefore, IT, pharma and infra and maybe FMCG and consumption, would be the top sectors.