Tuesday, May 24, 2022
outlook business

"I stick with the Nifty as I feel governance is still a big issue in India"

Alternative Investment Fund True Beacon's CIO on why he does not invest in mid-caps and his investing approach

"There are old traders and there are bold traders, but there are very few old, bold traders,” goes a market saying attributed to legendary systems trader Ed Seykota. If Nikhil Kamath stays the course, he will end up amongst the few old bold traders. At 34, he is far from old but he has had a long innings in the market having started at the age of 17. Along the way, he also co-founded Zerodha with elder brother Nithin. The duo now wants to replicate the same success in wealth management through alternative investment fund True Beacon. With assets under management of Rs.4 billion, it has set its sights much higher with plans to raise a billion-dollar fund that would invest in Indian equities. In this Outlook Business interview with Editor N Mahalakshmi, Nikhil who doubles up as CIO at True Beacon talks about his investing journey and current market outlook.

As you reflect on your investing journey, how has your strategy evolved?
I started trading about 17 years ago, when I was 17 years old. In the very beginning, it was randomly buying something because it looked nice, based on a little bit of fundamental analysis or liking for a particular sector. It was then followed by technical analysis for four-five years where I would look at chart patterns, try to mix that with fundamentals and arrive at trades.

That was followed by quantitative for a few years, algorithmic that gave advantages with co-relation, mean regression strategy, and that was followed by watching sentiment, what promoters are doing, geopolitical issues and money flow across the globe.

Now, I think it is a combination of everything. Sometimes, it is a combination of two or three of these different methods, sometimes it is one in isolation, but I don't think I stick to one particular method anymore. I would call myself a cyclical investor who tries to take advantage of cycles in the market, sometimes these are short, sometimes these are long.

What is your stock screening process? How do you go about identifying stocks?
I stick to the Nifty as I don't like buying mid-cap companies, so my universe is small. I only have 50 companies to pick from. I choose sectors I like and then try to figure out companies that could do well. I stay with the Nifty as I feel governance is still a big issue in India. At least with the Nifty, you do not have to worry about that. 

What is the average holding period in your portfolio? How much profit comes through active trading and how much through buy & hold?
Active trading is the hedge component which is about 30%, passive is typically longer term. In India, if you actively trade derivatives, you are paying 42% tax. If passive, you are paying 10% if you hold for about 12 months. Typically, a vast majority of the portfolio is held for at least 12 months but if something cyclically changes about the sector, I will hold it for three-four years. 

Which sectors do you avoid? Is it to do with valuation or the characteristics of the sector?
I don't like the public sector because of regulation. You don't know how things will change tomorrow, so I avoid them. I also don't like stocks which are very closely linked to global commodities, say steel or cement. Commodity trends are set globally, and we specialize in India, so we stay away from it.

We also stay away from companies which are expensive. Whatever is the flavour of the season, we typically do not buy. Two years ago, NBFCs were very expensive including Bajaj Finance and Bajaj Finserv. So, we try not to enter those companies and pick modestly valued companies with reasonable book value and little debt.

After the Budget, there is optimism about power stocks and public sector banks. Does the recent price action change your opinion at all?
I think not just in India but across the world, we are getting to the point where renewables are becoming competitive from a price standpoint.  I think today solar power costs maybe 10-15% more than thermal power and wind may be 20-25% more. The problem is in transmission more than generation. We lose as much as 40-50 % of the power generated during transmission and I think a lot of money has been spent there to improve the infrastructure.

There is another issue. Private solar power and wind power plants have to sell through the public platform and at one particular rate. They can’t freely sell power to the private sector. That has to change to really incentivize people to come in and put money in renewable power.

When you invest in renewables, the biggest risk you face is technology itself evolving so rapidly that you end up destroying capital. Do you think these companies can create value over the long term?
I look at government power consumption data. I think it is a better metric of measuring how well the economy is doing than GDP because in GDP there are a lot of moving parts. But, when you look at actual power consumption, you tend to see what the industry is doing. I think there is plenty of scope here, because the size of the industry will probably grow 5x in 30- 40 years. Immaterial of the money that has come in and will continue to come in, a lot will change and it will open up many opportunities.

Are you now bullish on public sector banks?
Not bullish, but less bearish than many other companies because of their valuation. Even after the post-Budget run up, I think there is value out there. Then again, we are 1.3 billion people, about 40 million-50 million file income tax. Maybe 1.5-2 % pay reasonable amounts of income tax. This number has to go up unless we start de-growing and do terribly as a country. This tax paying population from 2-3% has to go up significantly and when that happens, I think more people will need access to the banking sector.

I personally hope that farming which is exempted from taxes right now will be under the tax net, especially for the wealthier farmers. When more and more farmers and rural communities come on the formal banking platform, the demand and use case for banking will be tremendous. So, public sector banks have an opportunity to grow over time.

What kind of bets have made you money? If you were to pick your top trades in the recent past, what would they be?
Reliance has made some money. Then, a couple of years ago when the whistle-blower news came, Infosys had dropped significantly. That’s when I went long Infosys and short TCS in the same proportion. These two companies have been co-related for a long time. Infosys traditionally was more expensive but at that point, TCS became a lot more expensive. Buying Infosys and shorting TCS when the co-relation diverged significantly was a good trade.

As for Reliance, we are in an economy where large is getting larger and proximity to power plays a huge part. I think Reliance ticks all those buckets. They are the largest, they are close to the government, and they probably will continue to do well as long as the incumbent government is in power. And, the whole opportunity of getting data to rural parts of the country is also excellent.

How were you positioned last March before the lockdown? Were you surprised by the pullback thereafter?
We got lucky as our hedges were linked to the economy slowing down, it had nothing do with Covid. The economy was slowing down much before the lockdown. On the contrary, the lockdown has helped more than it has taken away, because of pent up demand or whatever. We were hedged significantly pre-lockdown, in February and March we had about 70% hedges and when the correction happened, we did quite well.

The market fell 20-30%. we were only down between 7-10% so that really helped. On the flip side, when the market rallied, we underperformed a little bit. What we are trying to achieve is a risk profile when the market goes up 10%, we are typically up 6% or 6.5% but when the market goes down 10% then we are down 3.5-4%. We are always playing the arbitrage between a stronger company doing well versus a weaker company doing badly.

We are still not sure. We did not think that the market would recover in the manner that they had and we didn't exit our hedges. During February and March, we were about 70% hedged and as time progressed and the fundamentals became a little bit more reasonable, we started bringing down the amount of hedging from 70 to 60 to 50. We continue to be 50% hedged. While we did get alpha when the market corrected, we also lost alpha when the market went up. But, by virtue of being more hedged when the correction happened, net-net we are up.

Let’s talk about some of the worst trades you have done.
Buying stuff which is the flavour of the season has generally turned out badly for me. It happens in public equity, and it happens in private equity as well. If I were to give you an example of the private market, every SaaS company out there right now is the flavour of the season. They are getting ridiculous valuation. A company with million dollars in revenue is now valued at $100 million. People entering the SaaS industry right now probably will regret it 10 years down the line because they bought it at a high.

In terms of the equity market, pharma & IT had the attribute during the pandemic. But I like those sectors because they will not hit you badly in a correction. They are good places to hide. But not real estate which has seen a significant spurt of late. I don't think adding a significant corpus to real estate right now is very prudent and that is something I would avoid.

Why so?
I have always believed it has been overpriced in India, especially residential real estate. If an illiquid asset class yields annual rental return of 2.5%, which is half the inflation rate or the risk-free rate in the country, I don't see the sense. We buy real estate because we have been sold this idea, when we are growing up, that as a man you have to have a wife and a kid and a house to feel settled. Practically and mathematically, it makes a lot more sense to rent today than to buy considering you pay 2.5% of the price of the property and you don't have to put that money upfront.

Promoters of real estate companies have been making this argument for a long time that land is finite, and demand will continue to go up because of urbanisation. I contradict that by saying urbanisation in the manner that it happened in China might not necessarily be replicated in India.

When you look at the population, we always thought that it will grow, and India will have two billion people at some point. If you look at the replenishment rate, every couple has to give birth to 2.2 kids for the population to remain constant. In the latest census, in the first 17 states where they measured the birth rate, it had fallen to about 2.17. So, the whole narrative of rising population no longer holds good.

What variables are you watching now to confirm a change in sentiment?
From a one-year perspective may be not, but if you look from a three-month perspective, consumption has picked up. The number of promoters saying they are doing better than pre-pandemic has gone up progressively in the past two or three months. Whether it will sustain, none of them know.

I think by September we would probably know if this short-term spurt in consumption continues or we go back to the trend prevailing pre-pandemic where we were slowing down as an economy. I personally would bet on the pre-pandemic trend versus the chaos of the past three months.

That turning out to be the case, would your hedges increase from 50 to 70?
The current momentum has made it hard to hedge at 70%. We will be around 50, but there is a case for equities as countries have been printing money and devaluing their currency. If you take America for example, they were printing about $0.5 trillion/year between 1980 to 2000, from 2000 to 2019 they were printing about $1 trillion/year. In 2020 they printed about $4 trillion-5 trillion.

So, a lot of that money will flow into equity. That in turn, might again boost the market. If they print another $4 trillion-5 trillion next year, I will make a case for buying physical gold and storing it in a vault somewhere. I think gold will be a decent hedge against the dollar.