Our target was to beat the Nifty by 6 to 8%, right now we are beating it by about 25%: Nikhil Kamath

Besides the capital markets stint with Zerodha, Nikhil Kamath co-founded True Beacon in 2019 and launched True Beacon I, the first flagship fund in category 3. 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 Money Today's Naveen Kumar, Nikhil Kamath, Co-Founder and Chief Investment Officer, True Beacon & Zerodha, shares his fund management experience, investment insights and future strategies.

Q. What has been the experience with your new venture into AIF based completely on profit sharing model, which has not been seen in the industry so far?

Nikhil Kamath: I will tell you how it has evolved. If I was investing hundred rupees, I had to give the distributor (commission) who sold me the fund one rupee or two rupees, then I have to give (charges) the fund manager two rupees a year annually. Plus then I had different clauses, like there was a setup cost, there was an exit load, and there was a carry beyond a certain performance. So each time I was investing 100 rupees, I was actually giving the fund manager only 96. And, on top of that every year I had to keep giving him two bucks. Under that model, if I were to keep money with this fund manager for the next 10 years or 20 years, the odds of him making money more than the market, more than the benchmark is very, very difficult. So at True Beacon, we removed the distributor, we don't have any middlemen, we are direct to client only, we don't have any exit loads. You can come in when you want, you can go out when you want, the fund is completely open ended.

Q. Are you confident that this model will be profitable?

Nikhil Kamath: It is an industry which was very opaque up until now. So 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 kind of shows the performance of the fund on a daily basis. So every day you can log into your own dashboard, see what the fund is doing. If you want, withdraw money on your own, if you want to, add capital on your own. All these efficiencies that we thought we could bring into the system are what we worked on. So we were not really focusing on how True Beacon as a company will make profits. We were focusing more on, this is such a bad environment, the asset management space for ultra HNIs, which has not changed for the last 10 or 20 years. We have to do something to make this better. That has been the intention up until now.

But when you talk about the monetary profits that we can earn from it, it might not be in the first year or the first two years, but when people talk about a more efficient model and there is word of mouth and new investors come in and our corpus gains significantly, I think then with significant scale, we'll be able to make a profit as well.

Q. As happened in the stock brokering field with your venture Zerodha, do you expect a similar thing in the AIF space?

Nikhil Kamath: Yeah, so the CAT-3 AIF is just our product number one. So we want to do everything a private bank or asset manager does, but do it more efficiently. Now we are on the verge of launching another product which is 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 guy and not a CAT-3 AIF Fund in isolation, it will only then make sense to us as a company.

Q. I was talking about disruption. Industry is following upfront charges model; will more and more players follow you or will they wait to see whether this model works or not?

Nikhil Kamath: I think they will wait. It'll also be hard for the incumbent players to suddenly drastically drop prices, because they have a very sales-heavy model. Most of the expenses go into relationship managers, ads, marketing campaigns all of that. None of which we're doing in True Beacon and we're relying on word of mouth only. So, I do not think they will be able to afford to drop the fields to our level because they still need to have the marketing engine in place.

Q. Will your strategy deliver a better return for your investors? What are the unique things that you are doing in stock picking or trade execution timing?  

Nikhil Kamath: Our portfolio is split into two buckets. 65% of the portfolio is the equity long only, passive large cap focus bucket. So we only invest in Nifty stocks, we don't do any mid cap, we don't do any small cap companies. In the 50 companies within Nifty, we pick a basket of about 18 to 22 stocks, which is 65%. The balance 35% of the portfolio is a portfolio based on mathematics. We run mean regression strategies, delta hedging, bare trading, all the kind of strategies which take advantage of volatility in the short term. So, a combination of these two buckets, we hope will give us an alpha over the benchmark Nifty by 6 to 8%. So, our target goal is if the Nifty returns 10% this year, we should make 16 to 18% in return.

Q. So, the remaining 35% is where your uniqueness lies, can you elaborate more on that? Is it like going into other caps, like mid-cap, small-cap or entirely into derivative or trading?

Nikhil Kamath: The 35% is again large caps, but it is the derivative universe. For instance, Infosys and TCS, which are very similar companies in many ways, have a correlation of 1.2. For every point that the Nifty goes up, say Infosys goes up 1 point and TCS goes up 1.2 points, and that correlation has been around for the last five or 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 through 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 we take a call whether there will be a regression to the mean in a trend, which has existed for many years up until now.

And this 35% basket is typically short bias, and the equity on the basket is a long bias. So it acts as a natural hedge against the 65% portfolio. So we try to bring in a USP in both buckets. On the equity bucket, we want to outperform the markets by maybe 2 or 3%, on the long only bucket. And on the math-based derivative bucket, we again hope to outperform the market there by 3-4%. So the combination of the two will have 6 to 8% outperformance

Q. Isn't there some portion being invested in start-ups?

Nikhil Kamath: We are planning a Category 2 AIF, which will be half public market and half private market. So one half of that will be startups and the other half will be public markets like this one. But that is still six months away. It has not started yet.

Q. What is the eligibility for the investors, in terms of size of the investment or any other criteria like risk profiling and such?

Nikhil Kamath: The regulator mandates that it should be Rs 1 crore, but we typically look for clients with Rs 15 crore minimum kind of level.  There is no risk profiling because it's a pooled investment vehicle. 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.

Q. With a smaller size fund, some strategies may have worked but as your size grows, will your strategy be replicable to a larger AUM?

Nikhil Kamath:  Yeah, we have tested it for up until two and two and a half billion dollars, I think it is fine. So as long as we're in the Rs 15,000 crore level even, we will be fine. So right now, it's very 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%, right now we are beating the Nifty by about 25%. Including the advisory clients and everything that we have, in the nine months, even the AUM has kind of scaled up to 300 plus now, and it's still very early days. I think it will take two-three years by the time we reach a significant scale.

Q. Mutual funds performers are mostly in the Global Fund category and pharma, isn't that a part of your strategy?

Nikhil Kamath: Ours is totally Nifty stocks only. It kinds of takes away the commodity, the fixed income aspect of it, but pharma is a big part of our portfolio, like our three top holdings right now are Reliance, Infosys and Cipla.

Q. The effect of pandemic on the economy is still not giving confidence that the economy is growing by leaps and bounds, but markets have started going up in a major way. So, what is the market seeing that economy is missing?

Nikhil Kamath: So, the thing with markets and prices is that they are always forward looking. I don't think they are looking at the events or the news coming out today. But they are looking at what will happen one year down the line, three years down the line in terms of demand. Strangely, I think market participants, the way they are thinking of this now is that after the whole Corona cycle we will still need manufacturing, still need industry, transport, all of that. Consumption will pick up again. So I think they're discounting what might happen in the next 12 months and choosing to look forward to what will happen 24-36 months down the line. The markets typically are not very sentimental, right? I mean, they just work based on what the demand for a certain product or a certain industry might be in the future and then they own the company.

Q. Isn't it a situation where investors are left with lesser avenues to generate higher return and that's why they are compelled to come in equity? And that liquidity is driving the prices rather than the fundamental value of the stocks?

Nikhil Kamath: I totally agree with you. I think the biggest factor for equity markets has been that Indians as a community keep most of their savings in real estate. If you take a typical Indian household, 70% of their net worth typically will be in real estate, it will be a loan on the house they own or it'll be in a property that they own. What has happened with the real estate sector is after a long time, in the last, say five to seven years, they have not seen any yield on this. If you talk in terms of residential in our country, we're only giving rental yields of one and half to two percent. And if the value of the underlying asset is not going up, people kind of want to look at other opportunities right now and other avenues to allocate money. So a lot of the money which was allocated to real estate, I think now is getting rebalanced into equity markets per se. But I think it's a good trend. Like if you were to compare household savings and where they're allocated, India would rank one and one of the highest when it comes to real estate. I think people should have a balanced portfolio with plenty of diversification. I typically like to say you should never have more than 50% of your net worth in real estate. We should probably have 50% real estate, 30% equity, 10% gold and 10% fixed income, because this diversification kind of gives you some kind of a floor when things get really bad. People seem to be wising up to that, they are reducing their real estate allocations and increasing their equity component right now.

Q. We saw restrictions, 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: The thing is we (NIFTY 50) fell from 12,000 to 8000, and now we are at 10,400 in terms of how the markets are doing. I think the call right now people are taking is not that whether the markets will go up 20%, 30% or whatever. But it's more about thinking that if I have to be allocated to five different asset classes over a five to ten year period, how much exposure would I want to equity? And people are rebalancing into equities from real estate based on that. To your point, definitely there will be issues in terms of supply side demand side issues over the next 12 months which will affect many corporate earnings, but people seem to be discounting that as a short term phenomenon right now.

Q. What are the sectors you see having high potential in post-Corona world where investors could be looking for higher returns?

Nikhil Kamath: I think pharma is one of the top picks that we have. I think there is a big case going on in the world for 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 which is consuming, or even the Asian ecosystem which is 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. I think there will be significant spending, both by the government and the private industry in the infrastructure space. I think that's one pocket which will do well, along with pharma. I also typically like IT, I mean there is a tail risk here because the US elections, Trump will have to say something which is against outsourcing, anti-immigration and stuff like that because they are due in November. But IT as a sector typically has longer term contracts. So, you would typically find the Infosys, which gets a large contract will have like a five year or ten year contracts and these companies typically do much better in times of uncertainty like right now. So, IT, Pharma and Infra and maybe you can even add FMCG and Consumption to that, would be some of the top sectors that we like.