Private Market investing can catapult you to success with Nithin Kamath

Private market investing is simple: invest in a business and expand it over time, with the goal of either selling it for a profit or taking it public. The advantages of private investments are well known today, and investors — particularly those with patience, vision, and a desire to build long-term riches — should consider them.“If you don't invest in private markets, you probably will miss the opportunity of a lifetime” , says Nithin Kamath, Co-founder & CEO, Zerodha - India's biggest stock market brokerage.According to Nithin, the biggest challenge for public market investors when switching, is to shift their goals from “profit” to ”growth”. Nithin believes that for people who are looking for sustainable growth and yielding competitive returns, the larger opportunities actually lie in the private markets today.In this conversation on “The Private Market Show”, Nithin and Shanti draw out the comparisons between Private and Public Markets and how “Time” is a big factor to consider when choosing how to allocate your assets.Tune in here - http://bit.ly/The_Private_Market_Show_EP_1Read the full conversation below!The Private Market Show | Episode 1 | Public Market vs Private Market | Nithin KamathShantiThanks for taking the time, really wonderful to have you on the series. Over the last few years, you built India's largest stock market brokerage that has been digital-first. And today, of course, you are ahead of many of the larger players. So you are kind of very different in how you've approached the market. And, we have heard a lot about your podcasts and seen that this has started from a personal pain. So, talk about your journey and then we'll kind of take this forward. Nithin I've been trading the markets from when I was 16 or 17. This was like the late nineties. Back when I started, it was mostly trading the markets. When I say trading, it was day trading. Every once in a while, when I suddenly got access to some capital, I would buy some stocks for the long term. In 2009, we had this whole opportunity to go after being a brokerage firm that we didn't have as traders. The plan when we started was he continues trading and I go give this a shot at building a brokerage firm. And if it doesn't work out in one or two years, I get back to trading. When we started Zerodha, it wasn't really meant to be what it is today. It was really meant to be an active brokerage, like a brokerage firm for very active day traders and futures and options traders. In Zerodha, there've been a bunch of things that we did that worked out very well for us. The first tipping point was Kailash joining us as our CTO. He's a co-founder, but he doesn't like to be called one. So that was in 2013 and around him, we started building in-house products. The other thing that we've done very well is, right from day one we've been extremely transparent in a very opaque industry. We had just one pricing model right from day one till now. In 2015, we did a small growth-hack as people call it. We went zero brokerage in equity investing, which was, if you buy a stock and you hold it for overnight, we don't charge any commissions.In 2016, Aadhar happened as a result of demonetization. We decided that we are not going to go solve all problems but we partner with startups and build niche platforms. We call this initiative ‘RainMatter’. Today, it has a bunch of really cool startups that are built on top of us. Then, we built ‘Coin’, the largest direct mutual fund platform in the country. We are three and a half million customers. We are around 15% of the exchange retail volumes today. And, luckily, we somehow were able to build all of this without raising external capital.

Team Zerodha - The Public Market disruptors

Shanti If you look at investing in general, there are some pillars. One is risk return. The second is portfolio, and the third is access. Everybody says high risk, high reward, right? So you cannot divorce those from each other. And I personally think it is a myth that in public markets people think is lower risk, and there are smaller returns. Like non-linear returns can only come from startups. But I do believe that there is still risk in public markets. When you pick up a portfolio or when you pick up your best performing stock in public markets and if you look at your best founders who have invested in private markets, can you spend a little bit time trying to draw out the analogy in terms of evaluating each of that?Nithin Firstly, you need to figure out what cycle the industry is at. Broadly, you need to understand if the country is growing or not. We all are in stock markets because we all believe that India is going to continue growing. And so that kind of ticks the box. It then comes down to identifying industries that you think are going to outperform. You kind of boil down to a bunch of industries and then within the industries you find your best stocks. Now your best stocks, at the end of the day, comes down to how good probably the promoters are. Shanti You're looking at macro, then you're looking at industry - the vertical, and then you're looking at team. And this is exactly how people look at private markets - where they say, ‘I want to look at market size’. I see investing is actually based on a fundamental principle of macro, domain and team but the weightage to each of it could differ between a public market and the private market.Nithin I think the problem with Indian markets unlike the US is that you cannot list in India unless you are profitable. In India, the first thing public market investors look for is the price to earnings ratio and if you are a company with no earnings then that makes no sense. So, I don't think in private markets you can use profitability as a metric, at least right now. It's about saying that India is growing so fast and there are opportunities for all these companies to suddenly become large and turn profitable. In this current cycle where money is so easily available, it's just bound to happen that startups will go chase growth versus chasing profitability. But for people who are looking at returns, the large opportunities lie in the private markets today. In public markets, some of the brands that I would aspire to own that I don't own today is Ola, Swiggy, Paytm. And I know, unfortunately, the day they list on the exchange, they'll probably have been juiced out. All the value is created when the company went from say $1 Mn in valuation to $10 Bn in valuation. And, they will list in the market at a $10 Bn valuation. And, the guys who were in the zero to $10 Mn phase were looking at growth while valuing a company and not really profitability. I think that's a big change. Me and Nikhil keep talking about it. So every time conversation comes, because he does only public market investment he sees profit and I look for growth. I think that is a big shift a public market investor has to look at, otherwise you'll never be able to invest in private markets. But if you don't invest in private markets, you probably will miss the opportunity of a lifetime because all the growth and value today probably gets created in private markets.Shanti You know that a lot of people understand that value is getting created in private markets and wealth is probably getting unlocked in public markets. This brings me to the next question on access. And, this is unfortunately the good or the bad part of private markets. Somebody said on YouTube, “there is insider information in public markets which is illegal stuff. But in private markets, it's all about insider information.” So you as an investor, when you started your first investment in startups in 2015, how did you get access? Nithin I think what worked out well for us is that by 2015, we had already spent five years on Zerodha. There was a little bit of brand build for the business. 90% of our business or investments in private markets are around our core competency, which is, businesses are solving problems that we understand. The first person who came to us came for the core competence and not for capital. That's how it mostly began. If you look through our journey, we've always tried to help the startup in some way or the other. And then, that word of mouth there also has kicked in. So today, if anyone's building anything around savings or investing, they reach out to us before they go anywhere else. And because people understand the value that we bring and it's not money. In today's world, there's so much capital available for good folks that if you're trying to go compete in terms of capital, you'll never be able to get access. It has to come down to saying, “Can I, as an investor, bring something to the table that you don't already have.” I think that's what people should focus on when they're starting. They should invest in industries and businesses which they understand. Otherwise there's so much liquidity today, I don't really see why a startup would take money from an angel. When a guy is starting off values in sort of 5 million raises 2 million. Five years or 10 years back where you could invest in a startup at a million and lesser valuation as a seed, and the change is evident today as there is capital available.ShantiGood founders still want smart money. So they want money which can help them grow because I actually think entrepreneurship is difficult. And on top of that, you won't want to make it more difficult by having investors who don't understand your space, who don't understand your business and create a lot more problems for you as you move forward.Nithin I've not been able to make a single investment till date just by looking at the pitch deck. I have invested in founders that I know who have started something which I don't understand. But this is because I have known them for a long period of time. And it doesn't matter what you're doing because I'm betting on the founder and not on the industry. Personally, I think it's quite tough to invest into a pitch deck. A lot of these decks have a positive bias to them automatically. If I have to start a business, my deck will automatically look a lot more rosier than probably it is. I think people should stick to investing into industries that they understand really well. Shanti How do you then create portfolio diversification? I think that inherent bias could also come in. If you're from industry, you will be very cynical about what will not work because you have not seen it work for so long. So disruptions happening, if you are from the same industry sometimes has a higher likelihood for failure, because you just won't believe that that could work. Most of my investments that have done well were on foundersNithin But then I'm guessing that that realisation came through after knowing the founder for a while, right? It's very tough to have one meeting and be able to gauge a founder, right as in you, you have to kind of see through, like, good and bad times to figure out how this founder is. I look at it as maybe two to 5% of my capital is allocated to private markets, right? I think the best odds of this working is when you understand what you're investing in, then it's actually a lot of fun as well. And otherwise, if you invest in something, you know, like, say, if I were to invest in, like edtech, I have no clue how it works. Now, I wouldn't even be interested in following up with what's happening with the industry or what is like, but if there's something happening in my industry, then I every time I'm working, I'm also anytime an opportunity comes for a startup I'm invested in I suddenly remember, I connect that person, so that the founder, then you know, appreciate the fact that you just helped me connect, make this connection or connect the dots, etc. Nithin The best way to evaluate companies is by speaking to the customers. If there is customer love, I think it's worth taking. And, a three year old startup, if he doesn't have a customer love it, you should. You shouldn't even bother, right as in if you can't find some customers who love the product, I mean, then there's a problem. And but, but but things like Ola, Swiggy, all of these guys had a lot of customer love. Shanti So that brings me to my next question - ROI and exits. If you look at the private market, maybe your exit horizons are five to eight years, but if you want to make a good return in the public market, people still say buy stock, forget it for three years. Right? How can we kind of define the correlation on reward losses in public markets versus private markets?"There is no concept called timing the public market. The only way to make money is buy a stock, wait for it to grow and sit through the growth. I think private markets actually almost have an edge there."Nithin I was asking Nikhil this question. He has been killing this in the last 10-12 years. And, he's been doing better as the capital has increased. Usually people start underperforming as capital increases. But Nikhil one has been doing it opposite. And there was this whole debate saying, when you hold a lot of stocks, say 10 crores of a very illiquid company on the stock exchange, which means I can't sell it very easily, right. So even though the stock is trading in the market, I can't sell 10 crores of stocks immediately and then buy it back almost at the same time. My question to him was, “do you think this illiquidity actually is the reason for higher ROI?” Not being able to just get in and get out, is it really the reason why you think you perform better? I personally think it is just that ability to buy and sell a stock any time is good for you. But I think, you know, as a stockbroker, I shouldn't be saying that, but I think it's actually, you know, not that very good. Right. Now, this illiquidity actually means that people sit through their decision, right, as in the sense, they're not very impulsive, they're not triggered. There's one small piece of news that comes in the newspaper, you're not going to sell your private holdings because it's not easy to sell it. But if you were a public market investor, you could sell all your mutual fund holdings. Donald Trump lost for example, right? Then tomorrow morning, you realise that the world just went ahead, I can't really go back and buy the stock now because I've already sold it. And money is made by sitting tight, money is not made by actively buying and selling. It's an illusion, people have that in public markets, you can somehow time the markets, there is no concept called timing the market. The only way to make money is buy a stock, wait for it to grow and sit through the growth. I think private markets actually almost have an edge there. What if we were trading in the Indian stock markets? Would you actually sat through, you know, 10 years, when this company went from 0 million to 1 million to 10 billion, you know, what, if at 100 million, because the toughest thing to do in the stock markets and all public markets is to sit on a stock? For example, Tesla, you know, went from, say, 200, to say $2,000, right? Yes. But who's who can sit on that growth as in when it goes from 200 to 400, you want to get out right? As in because you're like, dude, I just did percent in one month, I should maybe get out and buy back again. Then it goes to 600. And it goes to 800? No, I mean, it's extremely tough. So yeah, so I personally think this illiquidity of private markets is actually a bonus, and not, you know, it's not, I mean, of course, you have to be in a good investment. But, I mean, if you assume, you know, you have invested in 10 private stocks, and you know, one of these is going to hit a great outcome. You want to sit in the stock through the whole journey, you don't want to just get in and get out. I think private markets in that way give you that opportunity almost accidentally, right, not by choice, you know, it's almost by force. I don't really think too much of this. It's not easy to exit a private investment. I think people should look at it almost as an advantage versus a disadvantage.Shanti It is a myth that public markets have liquidity and private markets don't have liquidity. Of course, the definition changes for employees of public markets, right? Because now you hold a stock, and you can go sell the stock whenever you want. Right. So that is a little different from making an investment into private and public.Nithin It's a little different way of thinking about this but like I know that all the private investments I've done, I'm gonna sit through it, and I hope one of them has a billion dollar outcome.Shanti Grand slam winner, right? That is the power law equation, which plays out in private markets, but does that similar model play out in public markets?Nithin It's extremely tough to call the outliers that are going to outperform. It's almost impossible, right? The only strategy is to diversify. And, hope that one of your 10 stocks does this mega move. There is no way you can put 100% in that one stock. I mean, unless you're, you know, some Lord Brahma comes and blesses us. I think that's a mistake most retail make. I wouldn't even say retail, even I see a lot of HNIs do it - they go very concentrated in a few stocks or a few companies, and it's just taking too much risk. You know, I think I think the first thing everyone should do is to diversify. When I say that my private investments are concentrated in FinTech, but that is just between 2 to 5% of my portfolio. 95% is in public markets, and it is diversified. People have to think of risk before they think of reward. And, and risk really can be covered in this world only by diversifying. That's really the foundation of investing.Shanti Yeah, so basically, you're saying that the foundation of investing is diversification. And then waiting for exits, and not being hurried and not trying. So basically, time and diversification, are the two parameters in investing, whether it's private markets or public.Nithin And the thing about this time, like I said, private investors have an edge which is they are forced to sit on time. In my investing career, I've sold stocks for random reasons. And then the stock has done 100 times. In around 2002 or 2003, I wanted to do GMAT. The fees was INR 25,000. And one of the IPOs that I had invested in was Indiabulls. I sold INR 30,000 of that stock and I paid for my GMAT fees which I never took and for the other INR 5000, I went and partied with my friends. That was essentially an INR 2-4 cr. My GMAT cost me INR 2 cr. But would I have sat through the whole journey? I don't think so. But today, a private investment that I have done, will I sit through it? I most likely will. I can't just get up in the morning and just sell it. As soon as I think I think like I said, you can look at a glass half full or half empty."People think traders are gambling. But I think, you know, if you have a process, you follow a bunch of rules. I don't think it's gambling."Shanti I can see a lot more analogy now between private and public markets. I think the biggest myth, like the four pillar myth is very similar to the fundamentals of investing and then how you kind of apply it to both the markets. How much of startup investing you think is gambling, versus like the lack of understanding and going ahead and putting in money? How does that behaviour correlate to public market behaviour?Nithin I come from a very kind of a middle class background, and I'm from a Brahmin family and I'm the first businessman in the family. Zerodha is just the last 10 year journey and before that I used to be an active trader. People think traders are gambling. I have this theory around why people look at trading stocks as gambling. And one of the reasons is because your results are instant. I personally think of it almost like, for example, say I went to college I didn't study, right. I'm essentially gambling my life, right? The problem there is that I won't get to know the results immediately. I'll get to know 10 years from now when my friend in college is holding you know, earning a lot more salary than I am? But in stock markets, it's all of that as an everything is there's no grey, everything is black and white. You invest and in the next second, you know if you're right or wrong. There isn't really waiting for 10 years to figure out if you're right or wrong and that whole instant result almost makes it seem like gambling. So you can gamble with everything in life, you can gamble their education or their relationships with what course you decide to do in your life or what job you select or what stock you buy. I might sound conflicted, because this is the business I've been doing for most of my life and when people say I'm gambling as a dude, we gamble with everything in our lives. That's how I look at it. I think there are a bunch of rules to follow in everything that we do in life, right? And there are rules around trading, there are rules around investing, right? Going to college and not studying is gambling right?If you don't follow these fundamental rules of investing, right, which is your portfolio diversification or not going against the trend of like not the big problem with most people in the markets is that public markets is where people go against the trend. And they like to buy stocks, which are falling, and they like oxygen going up, right? If you take all your money and go one stock, you're gambling, right? Because, you know, you've again, broken the most fundamental rule of investing, which is diversification, right? Yes. And so you can do it in public markets, you can do it in private markets, right? I mean, I can take all the money I have and find this one startup on your platform, and go and say, dude, you know what, I believe in you, so take this money. Yes. Was that gambling? No, there are no two ways about it. Right. And so yes, I think I think I mean, that's how I think about gambling. I think as long as you follow, you know, I mean, you spend some time, effort, and you follow some kind of a process, a bunch of rules to decide, and have you invest? I mean, I don't think it's gambling.But you know, in life, it's all about the right place at the right time. So there's always luck in everything, right? So it's not just, you know, you just don't get lucky in gambling, you have to get lucky in every single thing in life, and investing as well. So I don't think you can run away from that. But yes, but yeah, but I think, you know, if you have a process, you follow a bunch of rules. I don't think it's gambling.ShantiThis was wonderful. For me, it kind of reinforces that we have to go back to talking about fundamentals of investing, rather, and not talk about public versus private markets, right, because I think the foundation stays the same. It is still money, you're investing. I think in India, the challenge is that we don't have technology startups today listing an IPO right, because of the requirements. The kinds of companies available in public markets today are not the kind of companies which will create value in the next 10 years in India. I think that is why that integration of allocation becomes more important. Nithin One of the biggest challenges we have is: Usually stock markets participation increases when people can get an opportunity to invest in brands that they aspire to own. Right? I don't see one single brand that a 20 to 30 year old in India will aspire to own listed on the exchange. HDFC is a great band but do I, as a 25 year old really aspire to own HDFC Bank? You know, it is, again, the reason the markets have expanded so much over the last 10 years, is because of Netflix and Facebook and Amazon and its companies which like Tesla. People love these brands, and they have an opportunity to kind of be part of them - it's almost like owning the brand. Right?Shanti So just closing this session within just a trivia which nobody knows about you.Nithin In the context of the current conversation, right, I think so back in 2007, eight, you know, I tried to take a programming course, I, you know, by the realisation was that, you know, what, technologists are going to be the x men of tomorrow. I mean, that was that was a given. And then I said, you know, what, I need to be one, then I realised I have no intellectual capabilities to sit into the hands of an aide and learn programming, then, you know, the whole idea came that if I'm not one, I have to be a friend of one. Right? And so whatever little money You know, I started making I started investing, or giving it as lending loans, whatever I to people who understand tech, right. And so one such investment was in was a company called Sensible in 2012, where the startup idea didn't fly. But Kailash who heads our tech was one of the co-founders of sensible, right. So I went on my x men. So I think it's a given that technologists are going to rule the world. So for people now, it's almost like an access to be around such technologists when you invest privately into these companies, right.Check out how Revenue Based Financing is the asset class for the Smart Investor.Check out the best practices to manage your cap table efficiently.