Idea Exchange: Bust in private equity space imminent. Everybody’s valuation is inflated, says Nikhil Kamath, co-founder, Zerodha & True Beacon

Nikhil Kamath, co-Founder, Zerodha and True Beacon

Nikhil Kamath, co-founder, Zerodha & True Beacon, asserts nobody can predict market trends, says bias behind low trading participation in India, believes cryptocurrencies will see a fightback from authorities, and says the govt appears to have been surprisingly ill-prepared for the second Covid wave. The session was moderated by Principal Correspondent Aashish Aryan.

AASHISH ARYAN: Would you credit the Internet which brought a large number of small retail investors online for the success of platforms such as Zerodha?
Internet trading existed before we (Zerodha) came about. Back in the day, we used platforms such as Sharekhan and ICICI Direct. So we did not really create Internet trading in India. We kind of made it cheaper and more efficient and transparent. The ecosystem of broking, stock market, equity market has been the flavour of the season and we have been talking about it a lot more in the last one year. But you have to remember that it is a very, very small ecosystem. Only about 1.5% or 2% of the population of our country has direct or indirect access to financial markets. Now, that number in the West, say in America, stands at 60-70%. So even though the ecosystem is growing exponentially, and a lot more people are joining it, the base is extremely small. Even if you were to talk in terms of revenue, and in terms of the total number of brokers and companies which cater to this industry, it is a very nominal number.

AASHISH ARYAN: Is a general lack of trust among retail investors the reason for this small base?
One of the things we suffer from is hindsight bias. Unlike countries in the West, where investing is considered to be a good thing to do, in India, if somebody’s kid says that he is a full-time trader, people draw an association with gambling and betting and stuff like that. So, traditionally, it has not been a good career path. We are trying very hard to wash away that image of the broking and trading community in India.

GEORGE MATHEW: Stock markets have come down from their 52-week all-time peak levels recently. Where do the markets stand right now?
The one thing we always tell people is nobody, absolutely nobody knows what will happen in the markets tomorrow. Everybody who is on TV, everybody who is going out there and making wild claims… If any of that were true, that person would be better off sitting at home and buying it himself. So, to call the market with any degree of certainty, especially the future of the market, is impossible.

GEORGE MATHEW: Do you think the rise in bond yields in the US and India will affect the markets?
I think it should. Before you go to yields, I think you have to understand the meaning of currency in a small manner. Back in the day in America, currency was backed by something… They had the gold standard. For every dollar note you took to the Federal Reserve in America, they would give you an equivalent amount of gold. Then they moved from that to the Bretton Woods system, where they said they will not exactly show you how much gold they have but every other country’s currency across the world will maintain a peg to the dollar. The dollar in turn will have a peg with the gold… I think it used to be $1 with some number of ounces, I can’t remember. Then, Bretton Woods went away.

When Richard Nixon was in power, and America had two issues on both ends — they were fighting a war in Vietnam and trying to send somebody to space… this was around 1971, and they really needed money. They said if we have to back whatever we have with some semblance of gold in our Federal Reserve, we won’t have the money required to spend on these expeditions and events. So Nixon said that we will take our country off the gold standard, and that it will be a free trading market. He said that our currency’s value will be based on supply and demand and how people traded internationally. Ever since then, America has been unscrupulously printing money without anything backing it. In the ’90s, they were printing — by printing, I mean printing out of thin air — as much as half a trillion dollars a year.

In the early 2000s, they were printing something like a trillion dollars a year. Last year has been a severe outlier where in one year alone, they have printed four or five trillion dollars a year.

Now, one has to think about supply-demand economics. So much supply for currency with no backing should weaken the currency? It’s a much more complicated story than that… The reason that the dollar maintains an artificial level of stability is because people like us, in India, China, all of us who export a lot of services and goods to America, we benefit disproportionately from having our rupee artificially deleveraged or artificially depreciate… The problem is a lot more stark for China. They export a lot of goods to America and get paid in US dollars. Now they do not carry the dollar back into China, because that would appreciate their own currency. They buy US debt with the money so they don’t have to take it back onshore to China. That, and many other countries behaving like that, has created the dollar that we have today. It’s artificially inflated. It works for many, many key stakeholders and the dollar retains the value that it has today.

All this being said, what they have created by printing excessive money is debt. And last year they were already struggling to service that debt, and were in turn printing more currency to pay that debt… I personally think that someday the chickens will come home to roost… I don’t know if you guys remember this, but George Soros, a very popular fund manager, went after the pound. Till then, nobody thought the British pound could be challenged. But he actually did break its back and he was able to significantly benefit from a large correction in the pound. Something like that will happen to the dollar. Increasing yields will reduce the time before something like this could happen.

PRANAV MUKUL: A company like Zerodha works in a highly regulated market like stock investment. What has your experience been like?
So I am saying this, without being jaded or with any kind of bias… I personally am not too fond of any political party in the country, and I can draw enough criticism and critique on every single one of them… Of all the regulatory institutions in India, the Securities and Exchange Board of India (SEBI) and Reserve Bank of India (RBI) somehow stand out as outliers. I have been dealing with them personally for maybe 15 years now. There is not an iota of corruption… They operate at a level which is far superior than most other facets of our government and government bodies. I think they do an incredibly good job when it comes to regulation. The regulation, in fact, I think has helped us ward away from many of the international crises we have seen in our time, like the banking crisis in 2008, which affected the West. I think we didn’t get hit so badly because of the good job of the regulators… When it comes to regulation, and how well regulated we are, I think, we are not on a par but far superior than the rest. It helps market participants like us, other FinTech companies, brokers and everybody else involved. They are not as erratic as the government; they don’t say one thing today and change it tomorrow and again change it day after tomorrow.

KHUSHBOO NARAYAN: Why is Zerodha not going public? Are disclosures that public firms have to give an issue?
Disclosures are not an issue at all. In fact, we do more, if not as many, disclosures as public companies do right now. Our entire premise has been that we are more transparent than everybody else… From the beginning, we have run a very lean model, wherein we have never taken on debt — we have not taken on a single bank loan or external investor in the last 11 years, even though we have had many opportunities to do so. The reason we work is we do not think like an organisation, we think as investors, and what we can build for the investor communities from the lens of what would have been useful for us.

For example, we have a mutual fund selling platform called Coin. Traditionally, whenever you bought a mutual fund, you paid your distributor 1-2%. Often you did not even realise that you were paying this fee. When we started Coin many years ago, we said that we will wipe out this distributor and we will not charge any fee whatsoever. That 1-2% does not sound like a lot, but when you pay 1-2% in fees for 20 years, that is half your principal. Now, when we did this with Coin, we also said we will keep it absolutely free. Coin has probably sold `20-30,000 crore worth of mutual funds till date and we have had zero revenue coming from that. To retain the ability to make these decisions and not be swayed by external investors who just care about shareholder return is a huge advantage. It makes us very agile and nimble and I think those are the things we hold on to.

SUNNY VERMA: How do you look at the problem of insider trading?
Well, firstly, we deal with a different kind of crowd… But, outside of that, I would say that with the advent of Internet trading, discount broking, accessibility to the stock market, it will be very hard for anybody to do insider trading on the largest of companies in India today. What I always advise investors and retail participants is to stay away from small-cap and penny-cap companies, where generally all these things might happen. Stick to quality names, stick to large-cap, even mid-cap companies. In the last 10 years, I think (insider trading) has gone down exponentially… Now the regulator has many ways in which they can find out and many new tools at their disposal which they use.

AASHISH ARYAN: What are some of the trends and patterns that you have noticed among your investors, say in terms of age, geography or gender?
In a pre-pandemic world, say till last January, the average age of our client used to be between 30 to 33. In the last one year, many younger people have come on the platform, and that number has gone down from 33 to about 30.

In terms of gender dynamics… It is very hard to talk about it publicly. The number of women in the workforce in India is abysmally low. We do worse than countries like Bangladesh. And the number is going down at a pace where now it is under 20%. So only one out of five women in our country is actually part of the formal workforce. Relative to that, about 16% of our clients are women, the balance 84% are men. But I think this is a larger structural issue for the country… It is a very big issue, not just in the FinTech industry, not just in financial ecosystems, but in the country overall.

AASHISH AARYAN: What kind of impact has the recent Covid-19 climate — where the country saw a very high caseload and severe shortage of oxygen and hospital beds, amidst a government struggling to find solutions — had on retail investors?
It is a tough question to answer. The fact that I have to think so much before talking or criticising anything that is going on, is worrying for the future of our country. That aside, I would say, it (the situation) is terrible. We are very active socially and we do a lot of work with the government in Karnataka and governments in other states… We have about 10 ambulances going around in Bengaluru. Because there is so much demand, these ambulance owners are asking for Rs 25-30,000 to transfer bodies to the crematorium. Nobody has Rs 30,000 in a slum in Bengaluru to send a dead body to the crematorium. Then, when they go to the crematorium, they have to wait in line with the body for hours on end. This is just horrible… The fact that we could not model for the scenario, that we did not build capacity and systems as we watched this happen in the rest of the world, was very silly.

I don’t know how else to describe it.

PRANAV MUKUL: Is there a plan to monetise the data that Zerodha has collected so far through its services?
Our crowd, our ecosystem is the full-time trader. We are more of a platform for professionals and people who trade many times a day, and we charge them Rs 20 per transaction. We have been profitable from the very beginning. Even though that Rs 20 does not sound like a lot, when you have like 10 million times that Rs 20 happening on a daily basis, that becomes a significant number. So the scale is humongous… We probably do like $15 billion of turnover a day. One in every six transactions which happens in the country, happens on our platform. So at that scale, that nominal fee kind of makes sense. So, this is not like a data game. We are not trying to be Google or Amazon. We are in many ways traditional brokers who have put technology first.

PRANAV MUKUL: What is your opinion on cryptocurrency?
The need for something like bitcoin is there. Now, if all governments across the world continuously print currency, currency will get devalued at some point. So to have a currency with a definite number — where no new currency can ever be created or old currency be destroyed — I see the use case for that… If a situation like Zimbabwe or countries where inflation is in the tens of thousands of percentage points, comes up, then bitcoin becomes a lot more relevant. In a country where bread today costs Rs 50 a pound, and tomorrow it costs Rs 500 a pound… but if it costs one bitcoin today and one bitcoin tomorrow, people will opt for bitcoins. From that point of view, I see why bitcoin is becoming popular today and why cryptocurrencies and blockchain technology is doing well.

On the flip side, I think cryptocurrencies are taking away power from governments. At the end of the day, the American Central Bank, the RBI will say, ‘We don’t regulate, we have no control, there is no KYC on bitcoins.’ So the powers of a central bank or government to regulate or monitor are severely curtailed. So they will fight back. The last battle may be in a way has been won by cryptocurrencies. The next battle will be when the central banks and governments fight back against cryptocurrency… Cryptocurrency is totally anonymous. That might be a big threat to cryptocurrencies themselves.

ROSHUN POVAIAH: We have seen 11 new unicorns in the last year. How sustainable are these valuations?
For all the companies, the valuations are inflated. It absolutely makes no sense. I think a bust in the private equity space is imminent. To a large extent this has been brought about by access to very cheap capital across the world… I think this is a bubble if ever there was any. Everybody’s valuation is over inflated, including ours. I don’t even know why we are valued at what we are. But the correction will happen at some point.

AASHISH ARYAN: Despite the Indian government’s push for local products, not many start-ups have succeeded…
This could seem overtly critical, but we have done very little innovation as a country. Indian start-ups have been good, in many or most cases, at copying the innovation that happened in America or in different pockets of the world, albeit with a lag of five to 10 years… Right now, the ecosystem is like that. It’s very frothy.

ANANT GOENKA: Nandan Nilekani had said that in America when digital exploded, they created monopolies. In India, at least in the FinTech world, we democratised data and allowed many people to coexist. Do you agree with that?
I would say so… What he has done with payments and UPI has to a large extent democratised that ecosystem. … I will give you an example. Back in the day, before Aadhaar, if I had to open an account… you needed to have a physical presence in all the tiny tier-two, tier-three towns, which in turn would have led me to charge five times more than I charge right now for the product to remain feasible. I think a lot of this has democratised the ecosystem in such a way that we, sitting in Bengaluru — two kids with not too much capital — can think of starting a company like this. The same applies to two kids sitting somewhere else today. Now, I saw the new policy recommendations… The changes will be interesting to see. But I think all of these changes have led to increased democratisation.

ANANT GOENKA: Post-liberalisation, the Indian businesses that did well were the ones that did well in spite of the government and not because of it. But in the digital world globally, if you don’t have the hand of government behind you, you can’t seem to get very far. Is that the case in India?
I personally subscribe to the laissez-faire school of thought. I feel lesser involvement from the government and more freeing up of the ecosystem will go a long way in democratising and growing the business ecosystem, than the government trying to govern which direction what goes in.

ANANT GOENKA: Companies such as Tesla or Coinbase have much higher valuation than their traditional peers. Do you see that happening in India? Would this be possible without the backing of the government?
Coinbase, at least, has a revenue component. They are on track to make $2 billion — they had $1.7 billion in revenue this year. (So a higher valuation is) justified to a certain extent. Tesla is a moonshot. But we are not looking at it as a moonshot. We are expecting that cars by 2030 or 2040 will all be electric and Tesla will have a market share in that. We are valuing the company like the event has already occurred. In my hypothesis, I think that is flawed. The odds of that happening, even if they are very high, I don’t think the valuation for Tesla is justified.

Do the people of the country wait until the government does something about climate change?… I would assume that even if the government did not interfere and we saw people dying in floods, and if we were to draw a conclusion that that is happening because of climate change, we would be organically incentivised to buy an electric car. Can the government expedite that process? Yes, they can… The government can come in and play a significant role and expedite it because, in the end, the government has more access to information and knows better than the people of the country about what is happening across the world. But it can also be the opposite — the government can be very short-sighted in their view and focus on increasing the GDP.