He Manages ₹80,000 CRORES With This Investment Mantra Ft. Prashant Khemka | KwK #138

It's over ₹80,000 crore.

In 2000, Sensex should cross...

The real earnings are the earnings above the cost of capital; everything else is just the cost of capital.

I have seen, I have experience. From '98 to 2006, I was managing money in the US. The whole dot-com bubble, I had the opportunity to experience...

Good, good. Thank you, Kushal. Thanks for having me here.

So globally, if you look at domestic clients and offshore combined, and we have an India strategy as well as a global emerging market strategy where we invest in about 25 countries, from Mexico to South Korea. So combined, it's over ₹80,000 crore, mainly India is the biggest piece of it.

Certainly. So in June 1985, I first came across, stumbled across something like the stock market. That's how it started. Obviously, I was born into a middle-class family, but in our neighborhood, all the people, my friends, were quite wealthy. So whatever gadgets there were — say a video player, at that time a color TV, video, even a black and white TV — before that, we wouldn't have one at home. So we'd go to the neighbor's house to watch India-Pakistan matches. I remember watching most of Amitabh's movies through the balcony door of our landlord's house. So as long as they didn't switch on the AC, they kept the door open; when they switched on the AC, the domestic staff would come and close the balcony door, and the movie would remain unfinished. So I always had it in mind that I too should earn money. And mom and dad, my parents, also encouraged me a lot. My dad had a good store, our garment store, where I also spent a lot of time, but he always encouraged me to do something big, set up a factory, this and that. Only then... My dad used to invest in the stock market, but he felt that only uneducated, rustic people invested in the stock market.

So what happened in 1985? After 1984, obviously a major event happened at the end of '84 — the assassination of Indira Gandhi — so there was quite a bit of panic at that time. But '85 was a year for a variety of reasons: the market was up 100%. To this day, if you look at calendar-year performance, '85 is the best year for a calendar year. So like retail investors, I also got sucked in. And what happened — all the family's money, whatever savings my father had, my grandfather's, from my great-grandfather's time, whatever small savings there were, were always invested in the share market. So there were quite odd lots too — two shares, five shares, ten shares — stuck in IPOs, many shares, something like 150 companies.

So in June, on June 20, 1985, my great-grandmother passed away. So the ritual that was followed back then was 12 days — all members of the extended family would get together at a place in Andheri and only talk about the share market. Nobody talked about grandmother or grandfather; they only talked about how they were making a killing in the share market. So I got very excited. At that time I was about twelve and a half years old, and I was reading the book 'Think and Grow Rich' by Napoleon Hill. So I said, these people are talking about four times, ten times in Locomotive, ten times in Century and Nestle, and all this was not quite understandable to me — how could so much money multiply like this? I said, I have ₹5,000 saved from all the Diwalis. I have always been quite familiar with the log table since the second grade, so I calculated that with ₹5,000 I could become a crorepati in 11 years, and being a crorepati was a very big deal in those days — that's what our landlord and neighbors were at that time. So that excitement gave me an interest. From then on, every morning — earlier it was the newspaper, it wasn't my alarm clock, I didn't wake up like that — but as soon as the newspaper came, grandfather would put the newspaper on my face: Mumbai Samachar, in which all the stock prices came. As soon as the newspaper arrived, I would get up, look at all the stock prices, look at the prices in my portfolio, and so on. That's how my interest in the share market developed first, and then on top of that... Obviously there was no internet then; Mumbai Samachar was the only real newspaper that had any coverage of the stock market. Then, around that same time, a year or two before or after, Dalal Street Journal started, its first publication, so I read that. Whatever I could get my hands on — I read a lot of annual reports, because we had shares in a hundred-odd companies, and even if you have just one share, the annual report does come to your home. So grandfather would encourage me: 'Read the annual report and tell me what it's written.' And that's how the journey started.

See, first of all, in '85, it was my father's and grandfather's portfolio that I knew about. They had those printed certificates, thick files of certificates, and I would keep looking at them. Whatever needed to be done with them, they let me do it. But obviously, at the age of 13-14 — although grandfather always encouraged me, my father was always against the share market. It was ingrained in my father's mind that the share market was for uneducated people, because he was actually a college dropout. He'd say, 'Anyone can do the share market; go study and do something, don't spend time on this.' But still, by reading and so on, I would tell grandfather and father that this one is good, that one is bad. Now, they didn't understand anything anyway, so if I said anything confidently about stocks, they slowly started feeling that maybe he knows something, he keeps reading here and there. So first, they'd have me sell their shares and buy something new. As silly as it started with, you know, in Mumbai Samachar on the second page, bottom right-hand side, there used to be a box of 12-month high and 12-month low. So the start was like that: whatever was at the 12-month high, sell it; whatever was at the 12-month low, buy it. In Century Textiles, I made a big mistake — it went up five, ten times while doing that. Even now I hear from my dad sometimes, 'You had me sell it; Century became so cheap.' That's how it happened.

My own, what I finally started, was at some sub-broker's clerk's place — I started it secretly from my father. The first one I remember there is Bliss GVS, which is now Bliss GVS; earlier it was called Bliss Chemicals. It was one of the first shares; its IPO had just happened around that time. Back then, an application was for ₹5,000, so that's where it started, and IPO applications from then on. And in our family too, from my great-grandfather's time, IPO applications were always skewed in favor of retail investors. Even today there's some skew favoring retail investors in IPOs; at that time it was much more skewed, and the pricing of the IPO was determined by some government agency, so they would conservatively underprice it. I applied to many all over the world over many years at that time. So like that — Bliss GVS, then Cochin Refinery was one that came around the same time, Vinyl Chemicals came much later, in '90. So I applied to quite a few IPOs. And from the market too, one of the earliest ones I remember reading about in the Street Journal and buying was Polaroid. Half these companies probably don't exist today, but Digital Equipment was one of the earliest ones. But that was also, I think, in the '90s, the investment I made. So getting IPO allotment was quite easy then; it was better for retail investors. As of today, it has become quite difficult. Earlier, what was it — everyone did it. We were a family of five, but we'd submit 50 applications, meaning we had accounts in different banks, so you'd apply according to each bank account. Now, one name became mine — say Prashant Khemka; one became Prashant Kumar Khemka; one became Prashant Rajendra Khemka; one became Khemka Prashant Rajendra. So father had opened bank accounts in all these different names, and he would also apply in the children's names, even in newborns' names. Got it? So if you apply for 50 applications rather than one — if you apply for 50 applications of ₹100, ₹500, ₹500 each — say you block ₹25,000, your allocation would be a lot higher than a single application of ₹25,000. The allotment status that was published in the newspaper back then was at every level — meaning an application of ₹100, you had to do it in multiples of 100. So you applied for 100, how many shares did you get? Applied for 200, how many did you get? Applied for 300, how many did you get? The ratio at ₹100 was the most preferential.

Yes, that was more or less wiped out. First of all, the money was borrowed — I had borrowed from everyone at home. My father wouldn't lend me money, but grandfather, aunt, uncle, maternal uncle, mother — I borrowed from everyone. I wouldn't tell them I needed money; I'd say my friend's father needed it and I'd pass it on through my friend. And I'd offer such a high interest rate — 3% per month — and it didn't seem like much because the market could double every year, so they didn't inquire much. Even if they knew it was Prashant taking it in his friend's name, they'd still give it. So I did that. The majority of that ₹1 lakh was mine anyway. I also had two friends with me who had each borrowed ₹1 lakh from their fathers. It was a bull market, so all the fathers gave the money, and they would present it to my father in front of him: 'Prashant has been investing in the share market for many years and is very good at it.' So their fathers also gave the money. We opened an account called Trinity Ventures at the DCB Bank in Andheri, and with that ₹3 lakh account, I was running it to invest in the share market. It was a very concentrated portfolio, in which one stock alone was worth more than 50% — I won't name it; it is still a highly successful company today as well — but more than ₹50 lakh was in a single company. Now, at that time, physical certificates came, and around that time, in '91-'92, demat hadn't happened yet, so sometimes fake certificates would also arrive — fake certificates — and our biggest investment got stuck with fake certificates. There is a resolution mechanism, but because of the scam that happened, it became more complicated. Many brokers were no longer around after the scam; they had bigger troubles to deal with, and ultimately that investment was written off entirely. And all three friends had borrowed money, so obviously our equity, our net worth, was completely wiped out. ₹3 lakh was a significant amount at that time — think of it in today's terms, it's been 32-33 years, this is about '91-'92, so even '92 is over 32 years ago; today it would be worth crores of rupees.

No, see — fund management, it's not a principal position agency. My friends, obviously, they had borrowed from their own fathers, all three from family members. In the end, my father bailed me out. My father, whoever's money I had taken, first I kept paying back the interest by borrowing again and again, but ultimately my father had to step in and give the money to everyone. So all of it was borrowed from within the family — as I said, from grandfather, from aunt — so he took money from dad and gave it to all of them. Then my dad also had a similar story when he started investing, but he made a very big loss in the stock markets, and after that he decided that the share market was not for him.

No, certainly. See, big losses — in every bull run there's a big profit, and in every bear market there's a big loss. In '92, the entire amount was borrowed money; maybe ₹5,000-₹10,000 of it was my own, because my father had given me 100 shares of Tata Chemicals in 12th standard, which were worth ₹12,000 at the time, because I got admission to a government college — Sardar Patel — for engineering, while my friend had to go to a private college. So my father gave me that ₹12,000 as a ratio of the fee difference, and that was the money, plus a little more. The rest — even that ₹3 lakh we had leveraged, we had borrowed on top of borrowing. So our equity was very low, single-digit percent maybe, and that was wiped out. Then over time, obviously, I did some work, got some money, I also got pocket money from home, and I kept investing whatever money I had, and I kept taking loans again too. In the 2000 bull run also, that was the first time I became a millionaire — a dollar millionaire and a rupee crorepati, if you will — but again I was quite heavily indebted at that time, so in the 2000 crash I didn't get wiped out again, but it was a massive loss because of leverage.

Stopped the leverage, meaning I stopped taking loans. Yes, I stopped taking loans, and then it was more like: invest only as much as you have in equity. And that was a lesson learned after making mistakes twice, in '92 and in 2000, because there was no money — how would you invest a material amount? By 2000 I had money, but the greed was greater: with your own money you can't earn that much, so take leverage. If in '92 my equity was single-digit percent, in 2000 my formula was 30% equity, 70% debt, which proved to be too high once the bubble burst. Got it?

So it's always been in equity. I'd say it is in the mid-to-high 90s. The little bit that is working capital — even in the company, at White Oak, the working capital portion is separate; the rest is in all our funds. As a policy, everyone in our team cannot invest in single securities or outside equity funds as of today, at least. So whatever money there is, it's in the company's funds.

Certainly. So if I go to the origins again, it's family-related. As I said, we had a shop where grandfather, father, and I — all three of us — would be there many times during the high season, the summer season. And right next to it is a very popular market in Andheri, Nado Market, where the store was. I saw many people there: the neighboring shops would go from one to two, two to three shops; we had one shop. So I also used to tell dad and grandfather, 'Let's expand too, buy the shop next door and expand.' So they would tell me: look, at that time — this is probably late '80s, early '90s — the price of a shop, I don't remember exactly, but say a shop would cost ₹10 lakh, and you'd have to stock it with goods, working capital, so the total cost would be ₹20 lakh. Now on ₹20 lakh, at that time — in our community, the Marwari community, Kutchi community, maybe it was less in the Kutchi community — but in ours, there was a system of two months' interest. Within the community, you can lend at 2% and you can borrow at 2%, pretty much. Or even if grandfather and dad had lent at 2%, the opportunity cost became 2% a year, roughly 25% — so on ₹20 lakh, 25% means ₹5 lakh became the opportunity cost. So they'd say to me: 'Show me a business plan where, by expanding the shop and taking the one next door, you can earn more than ₹5 lakh, and we will consider it.' So since then it has been in my mind: the real earnings are the earnings above the cost of capital; everything else is just the cost of capital — you can earn that even without doing anything. So this Okho-FinCo model is inspired from there: first, out of the income — because you invested ₹20 lakh and earned ₹3 lakh a year, that ₹3 lakh is not earnings; it's a ₹3 lakh loss, in a way, according to my dad.

So in this Okho-FinCo framework, take any company in India — take company ABC, say. First, the investment in plant and machinery and working capital — just like the shop and working capital investment — whatever investment there is in plant and machinery and working capital, we park it in a deemed subsidiary called FinCo, and we assign the revenue to Okho. From that, we pay a deemed cost of capital for plant and machinery and a deemed cost of capital for working capital finance.

So, again, if I take the shop example: if my father had money, he would buy a ₹10 lakh shop and put ₹10 lakh into working capital as well. So directly it doesn't seem like any cost to them, because the shop was bought with household money and the goods were also bought with household money — so no direct cost. But the deemed cost of capital is that on that ₹10 lakh you take ₹2.5 lakh as an opportunity cost, a deemed cost, and on the working capital also ₹2.5 lakh. The shop is an appreciating asset, so you don't depreciate it; in the true sense you should give the benefit of appreciation, but my father wouldn't take that into account — he'd just take the money. Now, if you're setting up a factory, then obviously there will be depreciation in the factory. It's like a car: if you buy a car, there's a lease payment in which there's a financing cost plus an amortization amount. So if we're evaluating a company here that has a factory, the equivalent lease amount — in which FinCo, by design, would be structured to earn only the cost of capital. If today the post-tax cost of capital is 11%, we'd keep a deemed cost of payment from Okho to FinCo such that FinCo earns an 11% post-tax return. So by design, FinCo earns cost of capital — return on capital equals cost of capital. So by first principles, growth becomes immaterial: whether it grows 50% or 5%, its value is one-time invested capital, because you are earning only the cost of capital. And then Okho, after paying this cost, if it has excess return — or after paying this cost and paying tax to the government, if some cash flow remains, that is excess return on invested capital, but it has already paid the cost of capital. Now FinCo's multiple is very low, but it is one-time invested capital, and if your discount rate is 11%, then 1 divided by 11% will be a nine-times multiple business. But Okho can be worth 20, 30, 40, 50, 60 times cash flow — its excess ROIC after paying cost of capital.

So today, if I take the Sensex — obviously I'm explaining this briefly, so it's a bit complicated — but what do you get from this? You get the composition of the enterprise value, the DCF value: how much is FinCo's value, which is just dumb capital, and how much value comes from excess ROIC in the business. Many companies — even if you look at consumer goods — some dairy company might have only 1% in FinCo and 99% in Okho; a food products company might have 1% in FinCo and 99% in Okho, because the entire business is driven by excess ROIC. Yet another company may have only 40% and 60% might come from FinCo and only 40% from Okho. So the high-multiple component is very low in the second case; it's very high in the first case. So you get the split of the enterprise value, and then if you rearrange this, the price-to-excess-ROIC multiple — by substituting in this same equation and computing — you'll get the company's price-to-excess-ROIC multiple. Because if the market cap is, say, ₹50,000 crore, and by your calculation you get that ₹10,000 crore is the cost between plant, machinery, and working capital, then ₹40,000 crore is the market value, the market ascribing value to Okho. If you divide that — say, against ₹40,000 crore, if there's ₹800 crore of excess ROIC cash flow, Okho's cash flow after paying cost of capital and paying tax to the government — then 40,000 divided by 800 gives a price-to-excess-ROIC multiple of 50. 40,000 divided by 800 is 50 as the excess ROIC multiple; its P/E multiple could be 30, 40, 35, somewhere in that range, depending on the case. If you do this for all companies in the Sensex, then the Sensex's price-to-excess-ROIC multiple today comes to 40, while its P/E multiple is 20.

See, if you want to do a rough calculation, not a detailed one, what you can do is add the company's net block and net working capital. In this case it should be ₹10,000 crore. Okay, it may not be exact — sometimes it might be ₹8,000, sometimes ₹12,000, because many adjustments are needed. But for a rough calculation — for many years I used to do rough calculations only, later I formalized it — so that ₹10,000 crore is done. So you get Okho's value as ₹40,000 crore. Now similarly, to calculate the excess ROIC cash flow, you can also do a rough calculation: take EBIT, check what the net working capital is and what the working capital is — you've already done that for the first part — and on top of that, first, if 11% is the discount rate, to gross it up to pre-tax you divide it by (1 minus the tax rate). So if you take a tax rate of 25-27% plus cess, that 11% will convert into 15-16%, something like that.

Generally we take 11% post-tax, so pre-tax it comes to about 16%. Now, on that ₹10,000 crore of net block plus this, at 16% — so ₹1,600 crore is the cost of capital, only the financing element. Correct? Then net working capital, which is a depreciable asset — obviously, if you're going to do it properly, like our team does, you have to calculate based on what the asset mix is, what the economic life is, the remaining economic life. But as a rough handle, if say it's a cement plant, you take 20 years, 25 — again it will depend on the actual life — but say you take 20-25 years of life, then the net block, you divide it by 20 again as a simplistic... or you can take depreciation as a proxy, while it wouldn't be accurate, but if you take depreciation — say the net block is ₹8,000 crore, so ₹8,000 crore divided by 20, take another 5% — how much would that be on ₹8,000 crore? Maybe ₹400 crore. So ₹400 plus ₹1,600 — subtract ₹2,000 crore from EBITDA. Okay? And then apply tax on it, and whatever remains — that is the ROIC, excess ROIC free cash.

So see, the first example I gave, of the food products company — there's a company where 1% is in FinCo and 99%, call it 100%, is in Okho, for ease of illustration. So for the one whose 100% is in Okho, its P/E multiple is the same as its price-to-excess-ROIC multiple. And when you say 100% is in Okho, it means it doesn't need any working capital or plant and machinery at all. Why? Because it outsources all of that — manufacturing. They are only a marketing company and an R&D company, let's say. And working capital isn't needed because their position in the market is so good — a cash-and-carry model: first you pay cash, later you take the goods. And employees have to be paid after a month, so even if there's a little receivable or something, they pay employees later. So FinCo is almost zero, and there are many business models like that. Or globally, my favorite companies, Moody's and S&P — theirs is negative FinCo: they take the money first, before issuing the rating, and pay employees later, and bonuses at year-end, right? So you can even have negative FinCo in some companies — meaning receivables came first, payables later. Yes, meaning payables are standing and there are no receivables at all.

Some companies — those are obviously very rare, which have an extremely strong market position. So this food products company — take a food products company whose 100% of the value is in Okho. Suppose both the Okho multiple and the P/E multiple are at 50 times. We look at its P/E multiple — 50 times. Now there's another food products company whose P/E multiple — I said 60% of the value is in FinCo, only 40% is in Okho. Not going into detailed calculation now, but quite very likely its P/E multiple will appear to be 20-22 times. But if you go to see the excess ROIC multiple, the Okho multiple, it will be 70-80 times. Suppose for a minute we take those numbers: that 80-times excess-ROIC multiple, P/E multiple 20 times. Now if you just go by P/E multiple, it will seem: look, the market multiple is 20, the Sensex's; this first company's P/E multiple is at 50, two and a half times the market — very expensive. Better than this is the similar-line food products company, which has only a 22-times multiple, and it is growing just as fast — growth would be similar, or the growth could be faster than the first company, the second one's maybe a bit, but for ease of comparison let's say growth is similar, earnings growth is similar. So I would buy at 22 times rather than at 50 times, right? Whereas if you look at the price-to-excess-ROIC multiple, the first company is at 50 times, the market is at 40. Yes, it is at a premium, but it is a superior business in terms of quality of...

Sustainability of that excess return, you have to assess whether it is superior or not, indeed all the attributes that in the first place make that excess return come — it is not easy to earn excess returns over a long period of time. So the reasons for excess returns — whether those reasons are sustainable — you have to assess that. If it is sustainable, then a 50 times excess return multiple, 40 compared to market, is not too high a premium to pay. But the second company, which is at 22 times P/E, is actually at 80 times multiple on ROE, so then 50 times is actually more attractively valued. Got it? Even though the P/E multiple is roughly two and a half times at 50 times compared to 22 times of the other company, and if in this case the P/E-ROIC multiple, if instead of 50 it were 30-35, it would be even more attractive, and it would be more attractive. Yes, got it? Very, very helpful.

See, debt — I think of as a symptom. It is not the root cause, so we don't have generally... Basically, the team believes in the first principle of valuation, and the most fundamental principle of valuation, which is that the value of any business is the present value of future cash flows. This FICO framework that we discussed — it is an enhancement of that first principle, which is a DCF link. Value of any business is present value of future cash flows. Everything else that you use are thumb rules of... and to varying degrees they have their own shortcomings.

But they are easier. Today, if a retail investor has to compute free cash flow, it is not that easy for them. And what is a normalized free cash flow — computing that is quite difficult because of the volatility in working capital, you know better than anyone else. So in this, what is there — these are thumb rules, P/E multiples and all that. Now, not investing in a company with debt is also a thumb rule, which is not completely misplaced, but is not, in our assessment, 100% fully logical.

Let me explain with an example. I cannot take the names of individual companies, but you can — I hope — in food products companies, you have understood which companies you can take as representative. Similarly, if I talk about leverage — for any company, when would debt or equity dilution be a great thing to do for a company, and when would it be a bad business model? A bad business model — so if your growth is higher than your ROE, then you have to either raise or dilute equity to raise more capital. Basically, you need more capital if your growth year after year — not one given year — if your growth year after year is higher than ROE.

Now you know many businesses in the market, financial companies as well as non-financial companies. By the way, all financial companies are leveraged companies, right? On the balance sheet there is debt — a finance company de facto, the lending companies. So unless you make the... because many people make exceptions, right? For financial companies, debt is okay. But if you think about it — if debt is okay for a financial company, if debt is okay in one business, then maybe it is okay in other businesses also. We just have to understand the root logic behind why debt is good or bad.

So if debt is okay in financial companies, and there are some financial companies — you would know some very large, others small — where return on equity, the growth has been higher for very long. And by growth you mean the new growth, top line growth, loan growth, top line growth — so that is much higher than ROE. So okay, in case of financials we are talking of top line, but in case of any standard company — to correct myself — growth of cash flows is what we are talking about. Cash flow growth is... is higher, not cash flow growth. Let me correct myself.

And if you understand — suppose return on equity is 20%, you have invested 100, and let's take banking itself — your capital is 100 crore and your net profit is 20 crore, so 20 crore is 20% ROE. Now suppose you have to grow by 30 crore, meaning growth from 100 to 130, right? For a second, assume zero debt — your income is only 20 crore, you can only lend 20 crore next year, so you can only go from 100 to 120. If you have to go to 130, you will have to take a 10 crore loan from other banks and depositors, or dilute equity, right? So suppose you take a 10 crore loan, and now your net worth is 120, your total asset base is 130, correct?

Now next year, suppose again you have 40% growth — on 130 that's 40%, meaning you need a book of 180 crore. But your income is only 20, ROE 20% on 120 net worth, so only 24 additional came in — organically you can only do 144. If you have to do 180, you have to take another 36 crore loan, right? So your loan keeps increasing like this. And obviously, because in the banking sector there is this thing — what do they call it — debt-to-equity ratio that is desirable. So you can't just keep on leveraging, that's why you dilute equity beyond a certain debt-to-equity.

And if it is an operating company — suppose it's a power plant, a telecom company, or in different industries there is a certain debt-to-equity that is, you know, a desirable level. So if you want your investment growth to be higher than your return on equity — how much the growth of your capital base is higher — to answer your question — than the growth in your earnings and return on... sorry, return on equity — if your growth of investment is higher, investment capital is higher, then you have to borrow to make that additional investment in capital and dilute equity.

Now this is good if your return on equity is higher than your cost of capital. If cost of capital is, say, 10 and return on equity is 20 and growth is 30, there is no better business model than that. I will want the company to lever up as much as they can, you know, obviously staying within some cyclical... so it doesn't go completely to zero, but to the extent that is, you know, bearable leverage. But if your return on equity is 5 and cost of capital is 10, then growth is actually harmful, unless obviously in such a scenario also it's not any given year of growth, but it is present value of future cash flows again.

So it may be in this second example also where I gave 5% is return on capital and return on equity, and 10% is return on cost of capital, and you may be growing for several years at 20-30%. In telecom business it happened like that — as long as eventually light at the end of the tunnel is there, you can't do it sustainably for decades this way. But if there are many business models where in initial years you would have high losses and very low profits, so the return on equity would be negative and lower than cost of capital, and your growth is hyper growth, and for those like all the new-age businesses — now that's the example — but many of them would turn out to be highly successful because eventually they would end up... those that end up earning — not everyone ends up, but those that would end up earning ROEs that are far higher than their cost of capital, then it will be debt worth taking at this time.

So obviously new-age businesses, they don't take debt, they dilute equity, but basically raising capital because growth is higher than return on equity. And if a business has ROE which is more than the cost of capital and the growth is also higher than both these numbers...

It doesn't have to be below, but yes, there is a certain prudent number for each industry. In the case of banks, leverage is 8 to 10 times, okay? Debt-to-equity ratio. For NBFCs it depends on what kind of NBFC — if it is housing finance, then there, because the asset is so secure and it is secured lending and one of the highest quality assets, so the debt-to-equity ratio can be higher. If you are doing unsecured assets, credit cards and other forms of personal loans and all, then what is a prudent level of debt-to-equity would be lower, right? Similarly for utilities there is a certain prudent level of debt-to-equity. In certain — like in new-age companies — because the volatility of the operating environment is so high that zero debt is desirable. So any extra capital that you need, you better do through equity raise, even at the cost of getting diluted in a business that you may seem to believe to have a lot of upside. But still, that may be... debt may prove to be the death knell for companies where the operating environment is highly volatile and cyclical and unpredictable, which is usually the case with new-age companies, right? Where operating environment is not a time-tested, competing environment is always evolving.

Suppose you generate power — at a certain price, obviously there too we have seen over the last 15-20 years it is a far more uncertain business model than what was believed 15 years ago or so. Where the business operationally is more unpredictable, there the optimal level of debt would be lower.

So certainly I can't talk about individual companies, as you know, but we've always been open to every company by design. And in fact, mistakes that I've made over the career — investing decades — are among the largest mistakes are those of omission. Mistakes of omission, where at different times I might have led myself to believe that a certain industry is not good, a certain set of segment of market is, you know, not investable, and kind of ignore them, write them off.

Yes, money can be made in every sector, in every segment of market. So sectors — obviously like financials, consumer, these are all there. When I say segment of market, it can be anything — like large cap, mid cap, small cap. It can be private sector, PSU sector — those are two different segments. It can be new-age companies and traditional old economy companies. In every segment there is money, and one should not shut down. And as I said, I've made this mistake and learned more than a couple of times over my investing life, and now I have resolved not to make it again — is to never shut down segments of market.

New-age companies — I have seen, I have experienced. In fact, '98 to 2006 I was managing money in the US, the whole dot-com bubble I had the opportunity to experience. Invested in day one in my US portfolio companies, missed also — like I didn't understand there — and that's also been a great learning. And that...

business model sound over time, cash flows will be generated, right? So we don't ignore new-age companies at all. In fact, we believe it is an advantage because a lot of people ignore — many people ignore that sector, saying we won't touch it because it's loss-making, a lot of companies would fail. So many people ignore it. So any segment of the market where a lot of people are ignoring, it may be a more inefficient segment, so there you may expect to find very special opportunities. So we evaluate every opportunity — in fact, in new-age we evaluate with great care.

See, I don't know which fact sheet, which year and which time fact sheet, but it may not be way off the mark. Because roughly if I look, yes, 25-30% in financials, suppose you take, roughly 15%, 12-1% suppose in technology, so that becomes 40 already. And consumer... consumer discretionary or consumer staples might have been added, perhaps, because these four segments — financials, tech — including if you count new-age companies in tech, it will be even more. But let's say 15% both combined, so tech. And then if you include healthcare and cons... so these four segments — you are right — have been segments where we have over time probably two-thirds or more of the portfolio has been invested in these four segments.

But if you look at the benchmark also, these four segments are roughly more than half. The benchmark also has 25-30% financials and the rest 10-10-6 or so, if you add up it will be above 50. But yes, our allocation is higher because in these segments we find a lot many more alpha-generating opportunities, and for a variety of reasons. But if you keep financials aside once, the other three segments and healthcare — in these sectors there are a large number of mid-cap and small-cap companies. Where there are a large number of companies, there are a lot many more things and ideas to evaluate. And because they are mid and small cap, there is greater inefficiency in those segments of the market, so you can find more opportunities with very large upside potential.

Whereas if you look at a sector like energy, which is a larger sector in the benchmark than healthcare and some of the other sectors — but energy, even if it is 10-12% in the benchmark, there are only a handful of companies, a dozen companies at most, mainly large caps. So there is not much inefficiency in that segment of the market. You can't find a company where you see 100-50% upside — even if you are wrong, at least you should see 100-50% upside. Whereas in these sectors where there are lots of mid and small cap companies — and these are not the only four sectors, but there are like industrials, chemicals, and many other segments of the market where there are quite a few small cap, mid cap companies — there usually our allocation is higher.

So not from a top-down view that small caps would outperform large caps, but there you find more inefficiently priced companies — basically there, meaning the opportunity to find undervalued companies, alpha-generating opportunities are more.

Very good. So first, I assume that ₹80,000 is pending — too high an amount to spend if you are earning ₹12 lakh. In my calculation I have actually assumed tax also. On ₹12 lakh, how much tax would it be? 20-25%? So ₹8 lakh is still left. Meaning out of ₹12 lakh, 25% — so out of ₹75,000, if you are only saving ₹20,000, you are saving very little. Okay, so first advice would be to save more. Okay. Second, you are 21 years of age — if you are... again, every individual has their own risk appetite, and you have to invest according to your risk appetite.

And risk appetite also may be dependent and linked to your familiarity with the asset class. So like mine has always been familiarity with the equity class, so I don't mind — in fact I feel very uncomfortable if 100% is not invested in equity, because my belief since day one has always been that equities deliver highest returns over a long period of time. In the interim it can be volatile, but in the interim I don't mind the volatility because I am concerned with the end goal. And every year — obviously at 21 years, and the individual is not a full-time investor because he is earning — his income is coming anyway. So if I take the example of, let's say, when I was 21 I was not earning, but let's say when I was in the high 20s and I was on job — so around 30 or 31 in the US when I was working, money would come in the bank, and first thing next morning I would be at the bank counter to wire the money back to India to get invested in the equity market.

I used to live in Boston, State Street's own bank was where I worked, so the bank tellers knew — 'who are you sending money to every day?' Every month's last day, money — here I am investing in the equity market. So entire, you know, in fact expenses also would run on credit card, revolving credit. Sending all the money immediately — because if I was even one or two days late in sending the money, I feel like, you know, those two days' return was missed in the market. And the return expectation in the market — and when I was younger the expectation was even higher, so 25-30% return was the expectation in the market. In the bank in the US, you don't even get one or two percent, so the entire 25-30 years' loss was there. If you compute it daily, what the daily loss is, that also was coming to something like, you know, five-six basis points per day. And converted into rupee terms, you know, would be a sizable amount. So if even one paisa was left lying in the bank and not deployed in the market...

If the risk appetite towards the market is low, then someone may feel uncomfortable investing 100% of money. So an individual should determine what is the right... Sleep at night is very important. If investing 100% doesn't let you sleep at night comfortably because of the volatility, then reduce it. Wherever you get good sleep — if you keep money in completely safe investments, cash and fixed deposit, you sleep. But you should realize that sleep has a cost. Many times if you understand the cost, you won't be able to sleep, right? Because in fixed income or fixed deposit if you keep money in banks, today how much — 6% or so is what you get, which after tax becomes 4 and a quarter or so, which is less than inflation. So in nominal terms you are making money — pre-tax 6%, post also 4 and a quarter — but you are not beating inflation, so in real terms you are losing money.

It's not just in India — worldwide. It's not that in India you get less in banks. Worldwide this phenomenon is... it's like an unwritten law of investing, understand this. That's why in places like Japan, Switzerland, Sweden, where inflation is very low — when it is very low, interest rates become negative, because the bank will charge you money to keep your money secure, and you can't earn in a risk-free manner. In my assessment, returns after tax that would cover your inflation cost — and so in real terms you lose money. And once you understand that, you must understand that, and then decide what asset allocation to do.

So if you ask me, given the situation that you described — 21 years of age — if the youngster has the whole life ahead of him to earn, yes, you have to plan for contingencies. Have you taken insurance or not — that is also an important factor. And I always encourage everyone that, you know, certain types of insurance may make sense. A lot of insurance doesn't make sense, but certain times make more sense and you should take it. But that is a basic — if you have done that, then, you know, at that age...

Because your net worth — the way I would calculate it is net worth is like if I suppose 25-30 years, whatever it is, my next 30-40 years of earning life — in life anything can happen, but you assume a certain base case — so the present value of those earnings. So you will already find that 90% of your net worth — maybe 98-99% at 21 years of age — anyway is the present value of your future earnings capability and the savings from that. So what you are saving today, ₹20,000 a month, a year suppose ₹2.4 lakh — that is anyway less than 1% of your net worth, if you will. So instead of being extra cautious in that, I would say find the... and I am obviously tilting more towards where my bias is, that one should invest in equity market and mutual funds.

Mutual funds obviously — see, if a person is doing it full-time, at which this person is not, because he is working, she is working — somewhere it is better to give it to professional managers and let them manage the money rather than throwing darts. The stock market is one thing where no license is required for anyone to invest, and everyone follows a bit, reads a bit, and considers themselves an expert. Because, you know, when there is a bullish environment, as it has been for the last five years, in that environment usually retail investors perform better than fund managers. Usually when a sharp crisis comes, some type — then fund managers... I am always saying this typically, not for every investor this would not be true. Typically if a sharp crisis comes, retail investors get badly hurt, while fund managers might hold up better. And when you combine the bull and the bear market, you can argue one-on-one that both are similar. I have a bias that maybe at least on a risk-adjusted basis a professional manager might do better.

So if someone is not doing it full-time, or at least not giving enough amount of time to identification... still you can do it. But ultimately, you know, if you think seriously about your financial health, then it's better to take a financial advisor's advice and a professional fund manager's fund management capabilities can be leveraged.