Opinions

Pension funds trying to change the world — is it justified?

by Sandeep Kumar

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Simply put, a pension fund or a pension pot is basically a pot of money that provides retirement income. So, when you and I retire, we’re going to need to live off the money. We might have saved up but right now when we are working, we can invest money into our retirement and that is where a pension fund comes in. It is a large sum of money that is being invested in order to pay you and me when we retire.

Pension funds often pool huge sums of money to be invested in capital markets like the stock and bond markets, in order to produce profit (returns). It represents an institutional investor that invests substantial sums of money in both private and public corporations. The primary purpose of a pension fund is to ensure that there will be enough money to cover employees’ pensions after they retire in the future.

The rise of pension funds

The “unseen revolution” altering corporate ownership in the United States is now evident to all, fifteen years after it was first documented. Around one-tenth of the equity capital of America’s publicly owned corporations is held by the 20 largest pension plans (13 of which are pensions of state, municipal, or nonprofit employees). In total, institutional investors — most notably pension funds — own over 40% of the common stock of the country’s large (and many medium) corporations. Public employee pension funds, which are the largest and fastest expanding, are no longer willing to be passive investors. They are increasingly demanding a say in the companies in which they invest, such as veto power over board appointments, executive salaries, and key corporate charter elements. Pension funds also control over 40% of the medium- and long-term debt of the country’s larger corporations, which is still widely disregarded. As a result, these institutions have become both the largest lenders and owners of corporate America. For years, finance texts have highlighted that the lender’s power is equal to, if not greater than, that of the owner.

One of the most dramatic power swings in economic history is the rise of pension funds as dominant owners and lenders. General Motors developed the first modern pension fund in 1950. Pension funds now have $2.5 trillion in assets, split about evenly between common stocks and fixed-income instruments, after four decades. These assets will continue to increase aggressively for at least another ten years, according to demographics. In the 1990s, unless there is a prolonged depression, pension funds will have to invest $100 billion to $200 billion in new resources per year.

Source: Financial Stability Board

 

 

 

Types of pension funds and its difference

There are two key types of pension funds. The first type is Defined contribution and the second type is Defined benefit.

Regardless of how well the fund performs, a defined benefit fund distributes a fixed income to the recipient. The employee contributes a set amount to the fund. These donations are invested prudently by the fund managers. They must outperform inflation while not losing the principal. The fund management must make a sufficient return on investment to cover the benefits. Any gap must be covered by the employer. It’s similar to an insurance company’s annuity. In this instance, the employer acts as the insurance company, bearing all of the risks if the market falls. Because of this risk, several firms have discontinued offering these policies.

In a defined contribution plan, the employee’s rewards are determined by the performance of the fund. 401(k)s are the most common of them. If the fund’s value falls, the employer is not required to pay out defined benefits. The employee assumes all of the risks.

The most significant distinction between a defined benefit and a defined contribution plan is the risk shift. The defined benefit is being rolled out because it is old school. Defined contribution on the other hand is around for the most part today. Most employers, companies, and individuals are likely to be on defined contribution pension schemes.

Country-wise comparison of pension funds

Globally, the quality of pension systems accessible to workers varies substantially. According to the Mercer CFA Institute Global Pension Index 2020, the Netherlands has the best system, whereas the United States is nowhere near the top.

· Netherlands: Its retirement income system is based on a flat-rate public pension and a semi-mandatory occupational pension tied to wages and collective bargaining agreements. The majority of employees in the Netherlands are members of these occupational plans, which are defined-benefit plans that are industry-wide. Earnings are based on an average over a lifetime.

· Denmark: Denmark features a public basic pension system, an income-related supplementary pension benefit, a fully funded defined-contribution plan, and required occupational pension plans.

· Israel: The retirement income system in Israel is made up of a universal state pension as well as private pensions with the mandatory employee and employer payments. Annuities are typically paid via the private pension system.

How pension fund diversifies its investments

By shifting their concentration to other assets, pension funds can protect themselves from a stock market meltdown. Most pension funds have typically sought growth by investing in shares, but with global stock market valuations so high, the short-term outlook appears dismal. Alternative assets, such as private credit, private equity, and real assets, may outperform a standard growth portfolio on a risk-adjusted basis.

Investors are shifting their focus to alternative credit investments in search of yield due to low bond rates and scheme demographics. As contributions fall, a growing number of schemes become cash flow negative, putting an emphasis on income-generating assets while requiring forced sales of growth assets.

Because interest rates on traditional assets like gilts and investment-grade bonds are so low, trustees are looking into alternative credit markets like high yield, private lending, royalties, and long-term leasing.

 

Performance of pension funds during the financial crisis

  • The funds’ investment performance all suffered in the early aftermath of the pandemic’s outbreak. Their returns, on the other hand, have fared “significantly better” than they did during the global financial crisis when they fell far short of their standards.
  • The funds’ ability to withstand shock was aided by the swift and unprecedented monetary and fiscal support provided in response to the rapid spread of Covid-19. However, improvements in the asset class mix and risk management capabilities of the funds also contributed to the funds’ ability to withstand shock.
  • Since the financial crisis, pension funds have extended their exposure to alternative asset classes such as private equity, infrastructure, and real estate, which has helped to mitigate the risk of their public assets.
  • In addition, the robust liquidity positions of pension funds have helped to protect them from market volatility.
  • During the market upheaval in the first half of 2020, these funds had minor liquidity stress, in contrast to the previous financial crisis. We feel that since then, advances in risk management governance mechanisms have been effective in protecting funds from market volatility.

Source: OECD website

 

How pension fund tackles inflation?

Inflation protection refers to assets that tend to appreciate in value when inflation rises. Inflation-adjusted bonds (such as TIPS), commodities, currencies, and interest-rate derivatives are examples of these. Although the use of inflation-adjusted bonds is frequently justifiable, some have expressed worry about the greater allocation of pension fund assets in commodities, currencies, or derivatives due to the additional idiosyncratic risk they represent.

Liability matching, sometimes known as “immunisation,” is an investing technique that compares the timing of predicted future expenses to the timing of future asset sales and revenue streams. The method has gained traction among pension fund managers, who use it to reduce the risk of a portfolio’s liquidation by matching asset sales, interest, and dividend payments to planned pension payments. This is in contrast to simpler techniques that aim to maximise return regardless of when withdrawals are made.

To supplement social security payments, pensioners living off the income from their portfolios, for example, rely on secure and consistent payments. A matching strategy would entail buying stocks strategically in order to receive dividends and interest at regular periods. A matching strategy should ideally be in place well before the retirement years begin. To ensure that its benefit commitments are met, a pension fund would use a similar technique.

Pension fund driving sustainable investing

Pension funds might be a powerful force in persuading businesses to embrace ESG goals such as tackling climate change and increasing employment justice. However, they must balance these objectives with their fiduciary responsibility to protect their members’ retirement savings. They must also overcome obstacles in the United States, such as gaps in ESG adoption measurements and misunderstanding about government restrictions on such investments. According to the paper, total assets managed by U.S. institutional investors using ESG principles have increased significantly over the last 15 years, reaching $6.2 trillion in 2020, with public pension funds accounting for more than half of that (54%). Climate change and war risks in terrorist or repressive regimes have recently risen to the top of investors’ concerns, followed by tobacco usage, corporate governance, and sustainable natural resource and agriculture practices. Investors’ appetites for ESG principles, on the other hand, oscillate between extremes.

According to the Wall Street Journal, ESG fund investors are moving their focus from growth to value companies, while other institutional investors are “lining up trillions of dollars to support a shift away from fossil fuels.”

Conservative risk measures

Pension funds make guarantees to their members, ensuring that they will be able to retire with a particular level of income in the future. This means they must be risk-averse while simultaneously generating sufficient returns to cover the guarantees. As a result, together with blue-chip stocks, fixed-income instruments make up a large portion of pension portfolios. Pension funds are increasingly looking for additional returns in real estate and alternative asset classes, albeit these assets still make up a modest portion of their overall portfolios.

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This article has been co-authored by Sayan Maitra and Yogesh Lakhotiawho are in the Research and Insights team of Torre Capital.

Paytm: What you need to know about the Indian Payments Solution Giant, and the would-be Billion Dollar IPO

by Sandeep Kumar

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Paytm or Payment through mobile is India’s leading payment processing, commerce, and digital wallet application. It’s a brand of the parent company One97 Communications and was launched by Vijay Sharma in 2010. The app allows you to carry out various transactions from paying your local vendor to paying your electricity bill and much more. It started as an online payment and recharge service and transformed into a virtual and marketplace bank model providing several services like mobile banking, recharge, online marketplace, etc. Paytm has catered to more than 250 million users in the last 8 years. It has the capacity of handling more than 5000 transactions per second.

Snapshot

How does Paytm make money and its revenue stream?

Paytm was initially launched as a bill payment and mobile recharge platform, later it introduced several other services on its platform and came up with the concept of Paytm Wallet, Payments Bank, and online marketplace.

 

Cost structure

Paytm serves a large number of users, which is why it is so cost-driven. Its platform and customer acquisition account for the majority of its costs. This is a common expense faced by many organizations around the world where the cost of acquiring new customers is very substantial. The amount of money spent on this process is more than the returns earned.

 

Valuation and funding history

Global peer comparison

The story so far

According to data released by the National Payment Corporation of India (NCPI) number of digital payments per capita currently is 22.42 per month. The cumulative value of transactions made through payment gateways stood at INR 29.5 Tn ($40 Bn). Also, the payments sector has the highest number of fintech startups. According to IBEF Digital payments in India are expected to increase over three-folds to INR7092 Tn ($100.61 Tn) by 2025 on account of government policies. Mobile payments will drive around 3.5%of total digital payments of INR7092 Tn (US$ 100.61 Tn) by the financial year 2025, up from the current one percent.

Market scenario

India had always been a cash-obsessed economy and now it’s one of the leading countries adopting technology and digitization across its industries. The digital payment market, though adolescent is exciting. Both the public and private sectors are going through rapid digital transformation driven by the increasing use of mobile internet and progressive regulatory policies. The sector has been evolving since demonetization and the pandemic has accelerated the digital shift. A coming couple of years will witness a completely new way of how money moves within the Indian economy.

Impact of e-commerce

The growth of e-commerce along with the emergence of digital wallets played the role of catalyst for digital payments. The e-commerce payments market historically dominated by cash is evolving to meet the demands of its increasingly smartphone-led online shopping culture, with cards and digital wallets rising in prominence. Cards are the most commonly used online payment method despite the fact that credit card penetration per capita is 0.02 and debit card penetration is 0.64. Digital wallet is the fastest growing method and accounts for more than a quarter of all e-commerce payments. To lure the consumers, the digital wallets doled out lucrative offers and cashback to get consumers on board using the payment channel.

Market competition

The market is a highly competitive one with that the NCPI of India has set out new guidelines for digital payment apps limiting their share in the overall volume of transactions on the unified payment interface at 30%. The UPI segment is dominated by PhonePe and Google Pay who have a combined share of more than 80%. The digital wallet segment is completely dominated by Paytm with close to 50% market share. Paytm has taken an integrated route by adding multiple services in its portfolio such as lending, Insurtech, Weathtech, payments bank along with EDC terminals, gateway aggregator & e-commerce. Similarly, PhonePe is offering Insurtech and Weathtech, and Google Pay will be entering into lending and Insurtech.

Value propositions

Paytm offers a variety of services some of the prominent offerings are recharge, top-ups, tickets, hotels and etc. It then diversified into new services like the digital wallet with a match-making model. The two customer groups of the company are the individual account holders that deposit money in the wallet and the merchants who accept the payment. To increase the attractiveness and adoption of various new lines of services targeting the two customer bases were started:

Value creation

Companies are benefitted from the ability to receive a wide range of digital payment methods, both online and in-store. Along with the more traditional ways like debit and credit cards, this also includes a few nascent innovations such as QR codes, Paytm’s own digital wallet service, and United Payments Interface.

Future plans, innovations, and alliances

Paytm is en route to becoming a full-stack financial services provider. Setting up the digital bank and venturing into Weathtech and Insurtech, the company has entered into quite a few key strategic partnerships. To forward their Insurtech plan the company acquired Raheja QBE General Insurance Company, a provider of general insurance plans. Paytm also strengthened up its credit offerings by tying up with SBI Cards to provide contactless credit cards. Paytm Payments Bank was proactive in entering into a partnership with ride-hailing companies like Ola and Uber. This will empower more than 1 lakh driver-partners to conveniently use Paytm FASTags and seamlessly commute across the country, according to Paytm.

Digital gold

Owing to the digitization of the Indian gold market in recent times, Paytm has collaborated with MMTC-PAMP (a well-known gold refiner), to provide a safe platform for its users to purchase, sell and store digital gold. Paytm claims to facilitate the purchase of 99.99% pure gold for as low as Re.1 and store them at an insured vault for no cost.

Conclusion

A mobile wallet’s value proposition includes not only the payment services but also the value-added services that can be provided in a mobile-enabled environment. In a fast-changing and extremely competitive world, no one wants to be left behind in the fight for customer acquisition. Paytm has evolved rapidly and has earned a name for itself in the Indian financial and business sectors. The fact that it grew from a small startup to a massive corporation in such a short period of time demonstrates the further opportunities for growth in the digital space and how innovation is being used effectively in India.

This article has been co-authored by Ayush Dugar and Pranav Agarwal, who is in the Research and Insights team of Torre Capital.

 

“All that glitters is not gold” — Growing valuation bubble of Indian start-ups

by Sandeep Kumar

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 The valuation game

The Venture Capital valuation is a simple game, but never an easy one. While there is little to learn, to play it perfectly takes years, if not decades of experience under the belt.

So how do the VCs arrive at that valuation figure? Market Opportunity? Product Market Fit? Strong Founder Team? Disruptive Product Offering? Extensive Network Economics?

Nah.

Capital invested divided by the stake diluted. That’s it!

The VC chooses the amount of capital he is ready to deploy and the stake he wants to have in the company. Of course, the wish is to part with the least capital for the most stake. Now coming up with these two numbers, the capital chunk to invest and the amount of stake to buy, this is where experience comes in.

The winning bet in your portfolio

Most VCs have personal favorite ranges which they are comfortable with. Some VCs may like to hold only a few concentrated bets while others may want to deploy small amounts into numerous startups. The premise is the same. Each VC wishes to hold at least one winner in its portfolio, the winning bet that ‘returns the fund’.

This gets us to staging. The valuations do nothing to the VC portfolio, except increase the unrealized returns section, which, as the name suggests, are ‘unrealized’ and don’t mean anything unless the company makes an exit from that valuation.

But what if the company is not yet ready for an IPO or a buyout?

The VCs of course know this. Hence when they get together to finance a startup at some stage, let’s say series A, they are offering just enough money to take the startup to the next funding stage. This continues until the IPO or buyout.

Nowhere do the VCs use the DCF or any other model to find a fair value of the shares of the startup. Startup valuation is not a valuation game, it’s a pricing game. It is not about finding a startup trading at a lower than its fair value price and hoping the market corrects itself, the game is about finding another buyer who will be ready to pay higher. All this has nothing to do with cash flows generated from the assets held by the startup, adjusted for the underlying risks of all sorts (DCF basically). All these valuations are nothing more than exhaust fumes as suggested by Fred Wilson, an NYC based VC:

“Early-stage valuations aren’t valuations. They are the exhaust fumes of negotiation about two things — the amount raised and the amount of dilution.”

The information asymmetry

Now let’s take a look at what we have: You are a VC that is trying to get a stake in some startup. What do you do to get an idea of how much you should pay? You don’t have DCF or any other model to help. So, you look at what similar companies have been valued at. With new business models operating in diverse geographies, you realize that it is hard to say how you can define a similar company. Let’s say you came up with food delivery as one category. Despite the difference in the business models, one can hardly cobble together a list of 4–5 startups in the Indian space.

So, the VC game is plagued with opaque, inconsistent deal information. While the figures the VC arrives at are most probably wrong and have nothing to do with reality, they have nothing to worry about as long as they are able to find someone who’s ready to buy at a higher price from them.

The Indian startups in numbers

The past few years have been a gala time for the Indian startups who have managed to secure funding unabated despite the pandemic and its blues.

Startups in India managed to raise $7.8 Bn until April itself. This is a significant number almost 70% of the total $12.1 Bn raised in 2020 and more than 50% of $14.2 billion raised in 2019.

The average funding size has increased to $25.21 Mn, up from $14.94 Mn in 2020. There have been 402 funding rounds until April itself, against 1,114 deals in 2020 and 1,036 in 2019.

Overvaluation and the global landscape

The push towards absurd overvaluations has been a result of the negative interest rate environment. Post the GFC, there was heavy lending and even more borrowing. So much so that people had to pay up money just so that they could lend money. Of course, this led people to look for alternative avenues to park their money and generate juicy returns. The baseless optimism and hollow belief in spotting the next Bezos, Zuck, or Musk have led to an audacious amount of money flowing in, creating completely senseless valuations, having no roots in reality.

Tesla, more than $13 Bn in debt at the end of last year, recently had a market capitalization of $160 Bn, greater than General Motors and Ford combined. At the IPO price, Square was valued at close to $3 Bn, which is 50% below the $6 Bn valuations for which it had raised money from private investors a year before. Uber which in accounting terms stands at around 5x times its revenues, is also grossly overvalued as it is nowhere close to being the leader in the driverless car’s space. WeWork tried to go for a $47 Bn listing but ended up getting corrected to $8 Bn.

The WeWork fiasco was dubbed as a wake-up call in a Morgan Stanley report stating that the days of ‘’ were over.

Unicorns were considered rare. Today, however, the United States has a herd of more than 100 of them, with 100 more outside the US. Each worth a billion dollars or more.

Will history repeat itself?

Let’s talk about the Indian scenario and the startups which we believe are overvalued and most likely to come back to their intrinsic value as and when the markets correct themselves.

1. Byju’s: World’s most valuable Ed-Tech Company

Byju’s operates an online learning platform. It also creates a mobile app for pupils that offers a variety of learning activities. Exam preparation classes are also available. Original material, watch-and-learn movies, rich animations, and interactive simulations are all available to users on the site. The firm is having an EV/Revenue multiple of 17x.

It is the only major player in the Ed-Tech space in India, which has led the company to raise multiple rounds of funding and leading to an enormous increase in valuation. Knowledge in today’s world is free, however, Byju’s creates unique content with animation and the product often seems to be overpriced. In recent times there were a number of instances on various social media platforms where people questioned the pressure on the sales team and how Byju’s is so concerned about their sales when they try to push their offering in the market.

In the long run, the expected return from Byju’s is questionable. Below is the chart of the revenue and valuation of Byju’s over the last five years.

2. Cred — The borrower’s messiah

Losses in billions of dollars are nothing new for hyper-funded companies, especially when they’re chasing size and consumers at any cost. CRED’s metrics tell a tale in and of itself. CRED has made a profit of $71,000 in its second year of operation. CRED hasn’t been able to monetize its user base in FY20, despite acquiring a large customer base with a high propensity to spend and consume.

While the two-year-old company’s sales remained low, its total expenditure increased by more than 5.9 times to $52 Mn in FY20, compared to $9 Mn in FY19. The greatest cost center for the financial firm was advertisement and marketing, which accounted for 47.6% of total expenditure. From $3 Mn in FY19, such costs increased by 9.3 times to$25 Mn. During the fiscal year that ended in March 2020, CRED spent Rs 726.7 to earn a single rupee of operating revenue. CRED’s yearly loss in FY20 was INR 360.3 Crore, up 5.9 times from the $8 Mn it lost in FY19. The current cash burn is difficult to sustain, with an appalling EBITDA margin of -1979.5% in FY20, and the company will have to focus on its collections.

Despite registering astronomical losses it has attained a unicorn status by raising its valuation to $2.2 Bn in 2021. It is worth noting that the company is founded and led by Kunal Shah who is a known name in the start-up world for founding and leading numerous companies which may be an explanation behind the astronomical valuation of Cred. The graph below shows the valuation and losses of Cred over the years.

3. CarDekho — India’s leading car search venture

CarDekho helps users buy cars along with expert reviews, detailed specs, and prices, comparisons as well as videos and pictures of all car brands and models available in India. It has recently acquired an auto marketplace, Carmudi (Philippines) in late 2019 to expand business in Southeast Asia. GirnarSoft, the parent company of Jaipur-based automobile-related services behemoth CarDekho, has seen its losses increase by 155% to $45 Mn in FY2020. This comes after the company’s losses had already increased by 39% in the previous year.

Despite that CarDekho has managed to raise its valuation. Last year, Cars24, a CarDekho competitor, increased its consolidated revenue to $418 Mn and achieved unicorn valuation, and has a much lower EV/Revenue multiple. Let us now see the EV/Revenue Multiple of the peers in this game through the table below.

As per the last reported revenue and valuation figures.

We can infer from the table that CarDekho has a huge EV/Revenue multiple which signifies that the valuation of the firm is increasing at a much faster rate with respect to the revenue that the company generates, leading to overvaluation of the company. The graph below shows the valuation and revenue of CarDekho.

4. Unacademy

Unacademy is a Bangalore-based educational technology startup in India. Unacademy lessons are available in the form of Live Classes, which are both free and available on a subscription basis. Unacademy earned $12 Mn in revenue but spent $53 Mn, resulting in a loss of INR 300 crore. Employee benefits accounted for 23.7% of the edtech start-up’s costs, while other expenses accounted for 75%.

While 2020 brought plenty of development, the corporation would need to significantly increase its expenditures to reverse the losses it had in the fiscal year 2020, which ends on March 31, 2020. Unacademy’s revenue in FY21 is estimated to be over $55 Mn. It’s worth $3 Bn or approximately 35 times the expected income. The graph shows the valuation and loss of BharatPe.

5. BharatPe

When we talk about e-commerce giants, PayTm, Amazon, and Flipkart all wanted payments to take place within their own closed networks. BharatPe’s goal was to achieve what all the large brands were afraid to do: simplify things for retailers by adopting a standardized interoperable QR code. It allowed shops, street food vendors, and tea vendors to accept payments using any UPI app (PhonePe, Google Pay, PayTM, and so on) without having to download the apps. It was a simple and cost-effective approach with an added layer of security. The payment system’s complexity was reduced by a factor of ten by combining multiple UPI apps into a single sticker.

BharatPe was able to achieve early success by keeping things simple. BharatPe’s product strategy is based on making things simple for merchants, and the company uses P2M transactions as a springboard for future services. Because BharatPe does not charge merchants a setup or transaction fee, its fundamental feature money collection using QR codes is essentially a loss-maker for the company. It must spend a large amount of money to manage the servers that process millions of transactions every day. However, this provides BharatPe access to merchants who are passionate about their products and eagerly accept their offers. Despite having no visible revenue stream and without even earning a penny, the valuation of the company is increasing, and currently, it stands at $900 Mn, very close to the unicorn status. The graph shows the valuation and revenue of BharatPe.

The apprehensive loop of growing valuations

The indications are all too familiar. With large markets, illustrious founders, rapid growth, and top early-stage VCs on your side, you have a good chance of raising the next big round, even if you don’t yet have unicorn status (the desired billion-dollar value). And when major acquisitions are made for unproven companies, and valuations double or triple in a matter of months, it begs the question: are we in a bubble? This is always a challenge because most people only realize they were in an economic bubble after it has burst in the past.

Rich valuation multiples have also spread from the typical suspects — consumer internet companies — to enterprise software providers. This is a first. SoftBank, for example, invested in Mindtickle last year, valuing it at $500 Mn based on estimated revenue of $20 Mn — $25 Mn. Even SaaS companies in the United States, including Slack, Zoom, Snowflake, and Cloudflare, have gone public in recent years with great success. Sentiment in India often comes straight from the United States, particularly in related industries and from funds that invest in both nations, including several of India’s leading venture capital firms. Startup valuations are also affected by how publicly traded firms trade if retail investors are ready to pay high prices for loss-making companies, whether banks financing a share issue can find enough at a given price, and so on. There isn’t a single bubble across the board. Because of the vast quantity of money available in the market, investors are willing to pay a premium for good business. But that should be done judiciously.

Investors beware

For the first time in years, it’s possible to claim that private markets are more logical than public markets. If stock markets are the yardstick, select pricey companies may not be overvalued. A closer examination of what constitutes a bubble, as well as what Indian entrepreneurs are doing, reveals a more complete picture. Growth investing has been positive in industries that have recovered quickly from the epidemic, and there has been a lot of interest in a few market leaders. At such levels, one would expect some amount of rationalization. Investors must evaluate the prospects and the future road map of a company before investing. As more investments flow into a company without a proper business model or less revenue, it results in overvaluation creating a bubble. Investors can lose a colossal sum by not choosing the right company.

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This article has been co-authored by Sayan Mitra and  , who is in the Research and Insights team of Torre Capital.

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Pension funds trying to change the world — is it justified?

by Sandeep Kumar

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Simply put, a pension fund or a pension pot is basically a pot of money that provides retirement income. So, when you and I retire, we’re going to need to live off the money. We might have saved up but right now when we are working, we can invest money into our retirement and that is where a pension fund comes in. It is a large sum of money that is being invested in order to pay you and me when we retire.

Pension funds often pool huge sums of money to be invested in capital markets like the stock and bond markets, in order to produce profit (returns). It represents an institutional investor that invests substantial sums of money in both private and public corporations. The primary purpose of a pension fund is to ensure that there will be enough money to cover employees’ pensions after they retire in the future.

The rise of pension funds

The “unseen revolution” altering corporate ownership in the United States is now evident to all, fifteen years after it was first documented. Around one-tenth of the equity capital of America’s publicly owned corporations is held by the 20 largest pension plans (13 of which are pensions of state, municipal, or nonprofit employees). In total, institutional investors — most notably pension funds — own over 40% of the common stock of the country’s large (and many medium) corporations. Public employee pension funds, which are the largest and fastest expanding, are no longer willing to be passive investors. They are increasingly demanding a say in the companies in which they invest, such as veto power over board appointments, executive salaries, and key corporate charter elements. Pension funds also control over 40% of the medium- and long-term debt of the country’s larger corporations, which is still widely disregarded. As a result, these institutions have become both the largest lenders and owners of corporate America. For years, finance texts have highlighted that the lender’s power is equal to, if not greater than, that of the owner.

One of the most dramatic power swings in economic history is the rise of pension funds as dominant owners and lenders. General Motors developed the first modern pension fund in 1950. Pension funds now have $2.5 trillion in assets, split about evenly between common stocks and fixed-income instruments, after four decades. These assets will continue to increase aggressively for at least another ten years, according to demographics. In the 1990s, unless there is a prolonged depression, pension funds will have to invest $100 billion to $200 billion in new resources per year.

Source: Financial Stability Board

 

 

 

Types of pension funds and its difference

There are two key types of pension funds. The first type is Defined contribution and the second type is Defined benefit.

Regardless of how well the fund performs, a defined benefit fund distributes a fixed income to the recipient. The employee contributes a set amount to the fund. These donations are invested prudently by the fund managers. They must outperform inflation while not losing the principal. The fund management must make a sufficient return on investment to cover the benefits. Any gap must be covered by the employer. It’s similar to an insurance company’s annuity. In this instance, the employer acts as the insurance company, bearing all of the risks if the market falls. Because of this risk, several firms have discontinued offering these policies.

In a defined contribution plan, the employee’s rewards are determined by the performance of the fund. 401(k)s are the most common of them. If the fund’s value falls, the employer is not required to pay out defined benefits. The employee assumes all of the risks.

The most significant distinction between a defined benefit and a defined contribution plan is the risk shift. The defined benefit is being rolled out because it is old school. Defined contribution on the other hand is around for the most part today. Most employers, companies, and individuals are likely to be on defined contribution pension schemes.

Country-wise comparison of pension funds

Globally, the quality of pension systems accessible to workers varies substantially. According to the Mercer CFA Institute Global Pension Index 2020, the Netherlands has the best system, whereas the United States is nowhere near the top.

· Netherlands: Its retirement income system is based on a flat-rate public pension and a semi-mandatory occupational pension tied to wages and collective bargaining agreements. The majority of employees in the Netherlands are members of these occupational plans, which are defined-benefit plans that are industry-wide. Earnings are based on an average over a lifetime.

· Denmark: Denmark features a public basic pension system, an income-related supplementary pension benefit, a fully funded defined-contribution plan, and required occupational pension plans.

· Israel: The retirement income system in Israel is made up of a universal state pension as well as private pensions with the mandatory employee and employer payments. Annuities are typically paid via the private pension system.

How pension fund diversifies its investments

By shifting their concentration to other assets, pension funds can protect themselves from a stock market meltdown. Most pension funds have typically sought growth by investing in shares, but with global stock market valuations so high, the short-term outlook appears dismal. Alternative assets, such as private credit, private equity, and real assets, may outperform a standard growth portfolio on a risk-adjusted basis.

Investors are shifting their focus to alternative credit investments in search of yield due to low bond rates and scheme demographics. As contributions fall, a growing number of schemes become cash flow negative, putting an emphasis on income-generating assets while requiring forced sales of growth assets.

Because interest rates on traditional assets like gilts and investment-grade bonds are so low, trustees are looking into alternative credit markets like high yield, private lending, royalties, and long-term leasing.

 

Performance of pension funds during the financial crisis

  • The funds’ investment performance all suffered in the early aftermath of the pandemic’s outbreak. Their returns, on the other hand, have fared “significantly better” than they did during the global financial crisis when they fell far short of their standards.
  • The funds’ ability to withstand shock was aided by the swift and unprecedented monetary and fiscal support provided in response to the rapid spread of Covid-19. However, improvements in the asset class mix and risk management capabilities of the funds also contributed to the funds’ ability to withstand shock.
  • Since the financial crisis, pension funds have extended their exposure to alternative asset classes such as private equity, infrastructure, and real estate, which has helped to mitigate the risk of their public assets.
  • In addition, the robust liquidity positions of pension funds have helped to protect them from market volatility.
  • During the market upheaval in the first half of 2020, these funds had minor liquidity stress, in contrast to the previous financial crisis. We feel that since then, advances in risk management governance mechanisms have been effective in protecting funds from market volatility.

Source: OECD website

 

How pension fund tackles inflation?

Inflation protection refers to assets that tend to appreciate in value when inflation rises. Inflation-adjusted bonds (such as TIPS), commodities, currencies, and interest-rate derivatives are examples of these. Although the use of inflation-adjusted bonds is frequently justifiable, some have expressed worry about the greater allocation of pension fund assets in commodities, currencies, or derivatives due to the additional idiosyncratic risk they represent.

Liability matching, sometimes known as “immunisation,” is an investing technique that compares the timing of predicted future expenses to the timing of future asset sales and revenue streams. The method has gained traction among pension fund managers, who use it to reduce the risk of a portfolio’s liquidation by matching asset sales, interest, and dividend payments to planned pension payments. This is in contrast to simpler techniques that aim to maximise return regardless of when withdrawals are made.

To supplement social security payments, pensioners living off the income from their portfolios, for example, rely on secure and consistent payments. A matching strategy would entail buying stocks strategically in order to receive dividends and interest at regular periods. A matching strategy should ideally be in place well before the retirement years begin. To ensure that its benefit commitments are met, a pension fund would use a similar technique.

Pension fund driving sustainable investing

Pension funds might be a powerful force in persuading businesses to embrace ESG goals such as tackling climate change and increasing employment justice. However, they must balance these objectives with their fiduciary responsibility to protect their members’ retirement savings. They must also overcome obstacles in the United States, such as gaps in ESG adoption measurements and misunderstanding about government restrictions on such investments. According to the paper, total assets managed by U.S. institutional investors using ESG principles have increased significantly over the last 15 years, reaching $6.2 trillion in 2020, with public pension funds accounting for more than half of that (54%). Climate change and war risks in terrorist or repressive regimes have recently risen to the top of investors’ concerns, followed by tobacco usage, corporate governance, and sustainable natural resource and agriculture practices. Investors’ appetites for ESG principles, on the other hand, oscillate between extremes.

According to the Wall Street Journal, ESG fund investors are moving their focus from growth to value companies, while other institutional investors are “lining up trillions of dollars to support a shift away from fossil fuels.”

Conservative risk measures

Pension funds make guarantees to their members, ensuring that they will be able to retire with a particular level of income in the future. This means they must be risk-averse while simultaneously generating sufficient returns to cover the guarantees. As a result, together with blue-chip stocks, fixed-income instruments make up a large portion of pension portfolios. Pension funds are increasingly looking for additional returns in real estate and alternative asset classes, albeit these assets still make up a modest portion of their overall portfolios.

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This article has been co-authored by Sayan Maitra and Yogesh Lakhotiawho are in the Research and Insights team of Torre Capital.

DiDi Chuxing IPO: The race to dominate the global ride-hailing pool besides stiff competition

by Sandeep Kumar

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DiDi Chuxing is a Chinese ride-hailing company headquartered in Beijing that was founded in 2012 by Cheng Wei. DiDi is China’s largest ride-hailing provider, with nearly 600 Mn riders and tens of millions of drivers. Didi Chuxing has the advantage of being a domestic player who is familiar with China and its clients. In China, the company’s app allows users to request trips from automobiles and taxis, as well as chauffeur services, minibusses, and ride-sharing services. If the IPO is successful, the company’s valuation could range between $70 Bn and $100 Bn. DiDi Chuxing, which is backed by SoftBank, plans to raise $1.5 Bn in debt financing through a revolving loan facility prior to its IPO. At a time when the Chinese government is cracking down on technology companies, Uber’s Chinese counterpart DiDi Chuxing may have filed for an IPO under the radar. Goldman Sachs and Morgan Stanley have been chosen to lead the company’s initial public offering (IPO).

Snapshot

  • Headquarters: Beijing, China
  • Founded: 2012
  • Notable Investors: SoftBank, Alibaba Capital Partners, and Ant Group.
  • Capital Raised: $24.9 Bn
  • Latest Valuation: $62 Bn
  • Exchange: NYSE
  • Ticker Symbol: DIDI
  • Founder: Cheng Wei

Cementing the position with its industry-leading services

DiDi-Chuxing allocates calls from customers within 3 kilometers, though this boundary is being widened now. However, DiDi-Chuxing recently added a destination basic allocation system in which DiDi drivers can announce a destination and escaping location. The DiDi-Chuxing allocating systems have two modes: selection mode, which began in July 2018, allows the DiDi driver to choose the destination, including long-distance; and allocation mode, which allocates calls to DiDi drivers nearby.

DiDi-Chuxing usually assigns DiDi-X to veterans and DiDi-pool to new drivers. Customers of DiDi use payment methods such as Wechat-Pay, AliPay, DiDi-Pay, and others. When paying for any DiDi-Chuxing usage, DiDi customers can change their payment methods. When a customer sends a DiDi-Chuxing car-sharing fee, the fee is transferred from the customer to DiDi. If the customer did not pay, he must pay the fee before using DiDi-Chuxing again. In the case of long-distance driving in Beijing, the DiDi system raises the fee by up to 30% to compensate the DiDi driver for financial loss.

In the case of DiDi-Premier, there are discrepancies between the announced payment amount in advance and the actual payment amount after driving. These two amounts, however, differed by only a few cents. Even though the customer’s money is directly allocated to the driver’s bank account, the money may be paid a little late after driving. Actual payment takes place two days after the customer’s payment, or one-time weekly payment is made.

Currently, DiDi-Premier is charged a distance fee, a low-speed fee, and a long-distance fee. DiDi-Luxury also receives a long-distance basic fee and a fast call allocation fee. Because of weak government regulations and medium-level public transportation conditions, DiDi-Chuxing has a 3 km base call allocation system, with a trend toward increasing the allocation distance from more than 3 km up to 10 km in the case of DiDi-Luxury.

Ride-Hailing App’s concentrated Revenue Model

The majority of the company’s revenue comes from its private ride-hailing app. DiDi-X drivers received 80% of the revenue paid to DiDi-Chuxing by the customer. DiDi drivers can drive the DiDi car for 12 hours per day, which is calculated based on the DiDi operating time.

DiDi-Premier drivers earn 74% of the revenue. DiDi-Premier fees are 20% higher than DiDi-X fees, and DiDi-Premier drivers earn 20% more than DiDi-X drivers. DiDi-Luxury is five times more expensive than DiDi-X and three times more expensive than DiDi-Premier. DiDi-Chuxing pays DiDi-owned luxury car drivers 10,000 yuan per month in one-time and weekly payments. The fee for DiDi-Pool is 10% less than the fee for DiDi-X. If customers pay with Alipay, Alipay provides a small incentive to the drivers as part of an Alipay promotion in DiDi-Chuxing. If a DiDi driver cancels the allocation more than four times, the driver must pay DiDi-Chuxing a fee.

What is important is that the revenue of DiDi drivers is more than twice the minimum salary of university-graduated manpower under the weakness of China’s taxi industry and the automotive industry with the support of the Chinese government with limited regulatory power. The Chinese government regards DiDi-Chuxing as a kind of revenue-increasing engine for the people.

DiDi’s Business Timeline

 

A dominant strategic player in the Chinese Market with uncertain longevity

DiDi Chuxing has risen to the top of the online car-hailing market after merging with and acquiring Uber China. After driving Uber out of China in 2016, DiDi Chuxing quickly dominated the country’s massive ride-sharing market – but its position is far from secure, as more powerful rivals emerge to challenge its dominance. According to PwC, China’s shared travel market will reach $564 Bn by 2030, with a 32% annual growth rate. Many businesses have been drawn in by the massive shared travel dividend. China’s online car-hailing market exhibits a high level of market competition. Many players are still active, in addition to the dominant DiDi Chuxing. There is still room for a taxi-hailing market worth $100 Bn. The national average ride-hailing success rate is around 75%, and 25% of online ride-hailing demand remains unmet. This provides a lot of incentive for new entrants like Gaode Taxi, Meituan Taxi, Ruqi Travel, and other public online ride-hailing platforms.

DiDi Chuxing has approximately 554.7 Million orders, while the order volume of more than ten travel platforms such as T3 Travel, Cao Cao Travel, Wanshun Car-hailing, Xiangdao Travel, and Meituan Travel is less than 90 Mn, according to the calculation of the internal parameters of online car-hailing. As can be seen, DiDi Chuxing’s order volume far outnumbers that of other ride-hailing platforms. DiDi Chuxing, on the other hand, cannot sit back and relax. The company’s continued loss of market share has also planted a slew of hidden dangers for it. DiDi Chuxing’s market share accounted for 95% of the scale of online ride-hailing around 2016. Later, due to security incidents, DiDi Chuxing’s ride-hailing business was forced to go offline in the second half of 2018, and its market share also fell to 90%; according to calculations, DiDi Chuxing’s market share is only about 85% today.

How does DiDi fair over different regions and their market leaders?

 Source: PitchBook 

 Chinese Ride-Sharing Giant on the way to profitability 

DiDi Chuxing is dubbed “China’s Uber,” yet it really outperforms Uber and other competitors in the Chinese market. DiDi Chuxing, or DiDi, is a Chinese ride-hailing startup that has amassed over 550 Mn users and 31 Mn drivers since its launch nine years ago. DiDi claims to have a 99% market share in China’s taxi-hailing business and an 87% market share in private auto hailing, according to its own data. In comparison to Uber China’s 45 cities, it has a presence in over 400 cities across the country.

The company’s primary ride-hailing business is lucrative, and it has rebounded since the coronavirus outbreak in China, its home market. The corporation has 14 international markets, including Australia, Japan, Latin America, and Mexico, in addition to China. The business is more than just automobiles and cabs. DiDi also includes bus services and a chauffeur booking option, which might be beneficial if you’ve had too much to drink and need a designated driver to take both the car and the driver home.

DiDi’s financial performance is difficult to quantify because it is a privately held firm. In 2018, Chinese news outlets claimed losses of $1.6 Bn. While its primary ride-hailing company charged an average of 19% in commissions, overall expenses, which included tax payments and driver bonuses, were 21%, implying a 2% loss each journey. This pattern may be traced all the way back to the beginning.

Concerns Regarding the company

  • Massive expansion and competitive pressure: DiDi’s rapid expansion in China was fuelled by its fierce competition with Uber and lax government rules regarding ride-hailing services. DiDi created an army of drivers, which it bolstered with massive driver subsidies, allowing it to outrun Uber’s operations.
  • Regulation which limits driver’s work regions: China, unlike the United States, has rules that limit where residents can work. DiDi drivers from rural areas, in particular, are not allowed to work in larger cities unless they live there. Residency licenses come in a variety of levels, and cities vary in how aggressively they enforce them. However, many are tightening their belts. Many large cities are experiencing a driver shortage as a result of this, as many drivers do not want to risk paying fines for working where they do not live. It has also compelled DiDi to delete a large number of its drivers from its own app.
  • DiDi’s predicament is hardly exceptional: Regardless of size, all ride-sharing companies must choose between responsible expansion and safety. The murders that were reported exposed significant flaws in the DiDi app and its protocols. One major flaw was the company’s decision to outsource its passenger assistance system, which was chastised for failing to act on a previous complaint against one of the alleged murderers. Keeping an in-house customer support team would definitely strengthen the entire safety system, but it is a step that would have a negative influence on the company’s bottom line, which is already far from profitable.

Valuation analysis of the company

 Source: PitchBook 

Market sentiments surrounding the IPO

DiDi Chuxing is planning an initial public offering, with a capitalization of $60 Bn. Although no official date has been set, the company anticipates going public in the first half of 2021. When it comes to ride-hailing, you may only be familiar with Uber Technologies Inc. and Lyft Inc. DiDi, on the other hand, is one of the most well-known ride-hailing companies in the world. Even yet, the recent failures of ride-hailing IPOs are worth noting. Following their IPOs, both Uber and Lyft saw their stock prices plummet, trading as low as 70% below their IPO prices. DiDi, on the other hand, may have something the other businesses don’t.

DiDi has a 17.5% ownership in Uber, and DiDi has invested $1 Bn in Uber, so DiDi is essentially the Chinese Uber. But there’s a lot more to it. DiDi joined Kuaidi in 2015 to build a smartphone-based transportation services behemoth. Taxis, privately owned cars, carpooling, and buses would be summoned by users. This is in stark contrast to the Uber and Lyft models, which rely solely on scooters.

According to the sources, DiDi Chuxing chose New York because of a more predictable listing pace, the existence of comparable peers such as Uber Technologies Inc. and Lyft Inc., and a larger capital pool. The decision comes as the US Securities and Exchange Commission pushes forward with a plan to delist international companies from US stock exchanges if they fail to meet US auditing criteria.

But even if DiDi was restricted to China alone, there would still be a case for the company. It serves a nation of 2 Billion people and has plenty of institutional backing. Tech investment giant and Uber-backer SoftBank Group Corp backs DiDi. Alibaba Group Holding Ltd. and Tencent Holdings ADR also back the company. Before its IPO, DiDi still expects to have another funding round to boost the valuation. Some of its shares are still trading below its 2017 peak valuation of $56 Bn.

Extensive product expansion and the road ahead

DiDi Chuxing, a Chinese app-based ride-hailing business, has unveiled a new three-year strategy for steady and sustainable growth. DiDi’s three-year plan, dubbed “0188,” moves away from its “all-in-safety” approach and toward longer-term safety capacity building and user value creation. The number 0 represents safety as a top concern, while the other three numbers represent DiDi’s strategy aims.

As of the beginning of 2020, DiDi has completed over 1 Bn international journeys. DiDi prioritizes its platform for integrated four-wheeler (ride-hailing, taxi, designated driving, and hitch) and two-wheeler (bike and e-bike) and public transportation solutions, as well as it’s subsidiary Xiaoju Automobile Solutions, autonomous driving, fintech services, and smart transportation businesses.

A customer-centric car leasing business has been unveiled by DiDi and its long-time partner BAIC, as well as a consortium of automotive industry enterprises and Chinese state-owned institutions. “In the next three years, the companies hope to have a fleet of 100,000 cars available for lease,” according to the agreement.

Should you invest?

The majority of initial public offerings (IPOs) are volatile at first. You have a large influx of early investors who buy into the hoopla and then fade away. As a result, many IPOs experience a drop in the period following the IPO. We’ve already listed Uber and Lyft, but we can think of a few more. JFrog Ltd. (NASDAQ: FROG) has dropped 33% since its first public offering in October. Snowflake Inc. (NYSE: SNOW), the largest software IPO in history, dropped 40% after rising 61% in the months afterward. This is how most initial public offerings (IPOs) go, which is why we constantly advise against investing in them immediately. You might want to get in as quickly as possible in some circumstances. But, in most cases, it’s better to wait for the euphoria to settle down and see whether the stock can return to a stable state i.e. the actual value. You should also be wary of the company’s particular industry.

It’s difficult to be positive about a ride-hailing service, using Uber and Lyft as examples. But, as we already stated, DiDi’s case may be different. As both Uber and Lyft have been embroiled in a price war across the United States, which has caused their stock prices to plummet.

DiDi has the advantage of having China almost entirely to themselves, as well as having infiltrated overseas markets. A user base seven times that of what many consider the industry’s biggest brand (Uber) might have a significant impact on DiDi’s stock performance following its IPO. As a result, the stock is more likely to be a buy than Uber or Lyft. However, because Uber is a shareholder, DiDi’s success might put money in Uber’s pocket, giving Uber an even bigger advantage in its struggle with Lyft. If you want to purchase Didi stock, it is advisable to get it at the right price

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This article has been co-authored by Sayan Mitra and Yogesh Lakhotia, who is in the Research and Insights team of Torre Capital.

Asset allocation for new age investing: The key to reaching a higher financial altitude

by Sandeep Kumar

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Perhaps you keep telling yourself that you’ll invest when you have more money or that you’ll do it “someday.” Or perhaps you’re concerned that the markets are now fragile, so you’re sitting on the side-lines, waiting for a “better time” to invest. Alternatively, you may believe that you must become a hard-core specialist before you can accomplish anything with your money that approaches investing.

But here’s the thing: delaying it may cost you more than you realise. Experts estimate that 40% of people have lost money due to procrastination. If you wait to invest, you may miss out on some extremely significant financial advantages. In the long term, the sooner you put your money to work, the better off you’ll be.

Long-term economic growth forecasts are crucial for global investors. Equity prices are based on forecasts of future earnings, which are in turn based on forecasts of future economic activity. This dynamic implies that the same variables that drive economic growth will also boost equity values in the long run. Similarly, the predicted long-run real income growth rate is a crucial predictor of the economy’s average real interest rate level, and thus the level of real returns in general. The link between actual and prospective growth (i.e., the degree of slack in the economy) is a fundamental driver of fixed-income returns in the short run.

Asset Allocation: An inevitable step for successful investments

The asset allocation that is appropriate for you at any particular stage in your life is mostly determined by your time horizon and risk tolerance.

  • Risk ToleranceRisk tolerance refers to your readiness to risk losing some or all of your initial investment in exchange for higher prospective returns. An aggressive investor, or one who is willing to take on a high level of risk, is more inclined to risk losing money in order to achieve greater outcomes. A cautious investor, or one who has a limited risk tolerance, prefers investments that will allow him or her to keep their original investment. Conservative investors preserve a “bird in the hand,” while adventurous investors pursue “two in the bush,” as the classic phrase goes.
  • Time Horizon – Your time horizon refers to how many months, years, or decades you intend to invest to reach a specific financial goal. Because he or she can wait out slow economic cycles and the inevitable ups and downs of our markets, an investor with a longer time horizon may feel more comfortable taking on a riskier, or more volatile, investment. Because he or she has a shorter time horizon, an investor saving for a teenager’s college education will likely take on less risk.

Letting go of traditional investments

Traditional investments like FDs already have seen starving interest rates. It will not be unrealistic to assume that soon there will be a time when instead of the bank paying interest on FDs the investors will have to pay the bank to keep their FD being in negative interest rates. Similarly, Mutual funds in maximum cases fail to give a hefty return, the way it is presumed. If we talk about stocks majority of the investors tend to lose money as the act of investing in stocks, bonds, etc. is driven by human psychology and not by numbers. Often investors tend to ignore macroeconomic factors like GDP, Unemployment, etc. We profoundly find investors to have an attitude of going with the flow resulting in over-valuation of a stock and at the end when the bubble bursts there are only tears.

Let’s say if you did run the numbers very carefully but the hardest fact to digest is that the stock market prices don’t only depend on the company’s performance. As we have discussed a number of times that macroeconomic factors are not in the control of any individual investor.  Let us take a glance at the returns that the traditional asset classes have generated through a graph.

Traditional investments were the investors’ favourite since they appeared to provide security and comfort. However, they have a significant and generally noticed secondary effect: a tiny increase in wealth. The rate at which prices rise is referred to as inflation. According to the most recent estimates, India’s inflation rate is around 5% – 6%. This indicates that money loses 5% – 6% of its worth each year. After accounting for inflation, a 4.5% after-tax return on traditional assets will result in negative real returns.The falling interest regime that on for the last few years, drove quite a few of these investors towards Mutual Funds which still fails to provide an optimum return for investors.Following the recent market downturns, interest rate reduction, and the resulting impact on fixed deposit rates, many investors are now questioning if traditional investments are still a smart investment option.

Alternative asset classes for investments an opportunistic future

Alternative assets are less traditional and more unexpected investment options. Alternative asset classes include commodities, real estate, NFT (Digital Art), venture capital, private equity.

  1. Alternative Investments
  • Venture Funds: It is money put into start-ups and small enterprises that have the potential to grow over time. It is a high-risk, high-reward investment that is often made by relatively wealthy people. Even more intriguing is the fact that most traditional venture capital funds are limited partnerships. This means that the money can only be invested once by the fund managers. They must refund the principle and gains to the venture capital fund’s investors if they make an investment and leave for a 3 to 4x return.
  • Private Equity Funds: It is made up of investments made privately and not publicly traded. These investments are made directly into private enterprises by investors. Typically, this funding is raised to fund innovative technology or acquisitions. Success in the private equity markets necessitates a high level of risk tolerance and the capacity to deal with significant illiquidity.
  • Unicorns: Unicorns were formerly depicted by ancient Greeks and Romans as being very quick and light on their hooves, with a horn treasured by merchants and investors. It’s a description that may also be used to today’s unicorn businesses. Investing in unicorns makes sense given low interest rates, continuous technological advancements, and new regulatory benefits. However, there is a contradiction to investing in unicorns: the availability of private equity makes them less likely to go public, yet their aversion to public markets makes their shares difficult to come by.

We have the expertise you need and the service that you deserve at Torre Capital, a VC-funded Singapore-based Financial Technology company. We are creating a fully digital Wealthtech to connect family offices and HNI investors with global opportunities, including alternative assets like Private Equity, Venture Capital, Real Estate Funds, and Hedge Funds.The table below consists of some of the PE/VC Funds with their IRR and Fund size.

  1. Real Estate

Commercial and residential properties, as well as REITs, are all examples of real estate. Real estate consists of land and anything permanently attached to it. REITs, or real estate investment trusts, are businesses that own and operate income-producing real properties. REITs provide investors with the chance to invest in real estate as a kind of financial stability. Transacting in REITs is substantially less expensive and time-consuming than transacting on properties. REITs make a lot more sense as an investing vehicle. Second, it provides investors with a new asset class outside of traditional stock, debt, cash, and gold, so helping to diversify risk. The returns generated by REITs are depicted in the graph below.

Collectibles / NFTs

NFTs are digital works of art that exist on the blockchain network and can take a variety of forms. Memes, video clips, images, music, and even tweets are some of the most popular forms of digital art. When you buy these tokens, just like any other investment, there’s always the possibility of your money growing in value. These digital treasures are non-fungible, which means they can’t be replaced. At the moment, blockchain technology is generating a lot of buzz. Some predict the technology will have the same impact on consumer behaviour as the Internet did. Now let us come to the prime question that is how much to invest in NFTs?

Honestly answering these NFTs (especially Digital Art) revolves around the concept that beauty lies in the eyes of the beholder. Hence when you buy something unique and the other person sees the same value in it and the demand increases the prices also shoot up. It will be wise to say that an investor can always explore this option with extra wealth.

 

  1. Cryptocurrencies

In the last five years (ending 31 December 2020), the S&P 500 index of large-cap US equities has compounded at an annualized growth rate of 14.5% (in USD, net dividends reinvested); over the same time period, the price of bitcoin in USD has compounded at an annualized growth rate of 131.5%. Now if we consider Etherium it also has given a hefty return of 500% in 1 Year. If this still feels normal, then let’s talk about some astronomical figures like in the case of Dogecoin or Meme coin as it was named earlier has given a return of around 20000% in a year.

Apologies if you felt a minor heart attack after seeing these return figures.

It is also very important to note that the market is highly volatile and very unprecedented due to a lack of regulation. We are not unaware of the current scenario of Bitcoin and the way Elon Musk is affecting the market sentiments and indirectly controlling the prices, even the astronomical values that Dogecoin gave was also due to the SNL tweet by Elon Musk. You might still be wondering if you should invest in cryptocurrency or not!If we consider simple lottery tickets where nearly 1 lac people buy the tickets and the probability of winning the competition is 1/100000. Now If I ask you do you put all your savings to buy lottery tickets? The obvious answer is No. The reason it is has no backing and the uncertainty is infinite. We just intend to justify the psychology behind the investment by bringing in the example of a lottery. You should invest your money in crypto according to your risk appetite. The graph below shows the returns generated by Bitcoin and Ethereum.

  1. Digital Gold

Buying physical gold certainly has its downsides. There are issues of identifying its legitimacy and purity, then there are problems of safekeeping and storage. One more issue is that we are in the midst of a pandemic. It is not quite ideal to go out to gold dealers or jewellery stores. Digital gold, on the other hand, can be bought online and is stored in insured vaults by the seller on behalf of the customer. All you require is Internet/mobile banking and you can invest in gold digitally anytime, anywhere. You can take physical delivery of the gold at your doorstep. You can invest an amount as low as Re.1. Digital Gold can be used as collateral for online loans. Digital Gold is genuine and the purity is 24K, 99.5% for SafeGold and 999.9 in the case of MMTC PAMP purchases.

Your purchase is stored safely and is also 100% insured. You can exchange digital gold for physical jewellery or gold coins and bullion.Trading volumes of digital gold in India totalled four to five tonnes last year in India and have proved to be a new way of investing in gold. Let us take a glance at the returns that the gold market has generated through a graph.

The magic wand of diversification to minimize risk

Diversification is the process of dispersing money among several investments in order to lessen risk. You may be able to limit your losses and lessen investment return variations by selecting the correct set of investments without losing too much potential gain.

Furthermore, asset allocation is critical since it has a significant impact on whether you will reach your financial objectives. Your investments may not produce a significant enough return to fulfil your goal if you don’t include enough risk in your portfolio. For example, most financial experts believe that if you’re saving for a long-term goal like retirement or college, you’ll need to incorporate at least some stock or stock mutual funds in your portfolio. However, if you take on too much risk in your portfolio, the money you need to achieve your goal may not be available when you need it. For a short-term aim, such as saving for a family’s summer vacation, a portfolio strongly weighted in stocks or stock mutual funds would be improper. You may feel comfortable building your asset allocation model if you know your time horizon and risk tolerance, as well as if you have some investment expertise.

The art of rebalancing

Rebalancing is the process of returning your portfolio to its original asset allocation balance. This is crucial since some of your investments may drift away from your investment objectives over time. Some of your investments will increase at a higher rate than others. Rebalancing your portfolio ensures that one or more asset categories are not overemphasised, and it returns your portfolio to a reasonable level of risk. Let’s say you’ve determined that alternative investments account for 70% of your portfolio. Alternative investments, on the other hand, now account for 90% of your portfolio, thanks to a recent spike in returns. To re-establish your original asset allocation mix, you’ll need to sell some of your stock assets or buy investments from an under-weighted asset category.

Your portfolio can be rebalanced based on the calendar or your investments. Investors should rebalance their portfolios on a regular basis, such as every six or twelve months, according to several financial gurus. The advantage of this strategy is that it uses a calendar to notify you when it’s time to rebalance.

Others advise rebalancing only when an asset class’s relative weight grows or lowers by more than a particular percentage that you’ve determined ahead of time. The benefit of this approach is that your investments will alert you when it’s time to rebalance. Rebalancing, in either instance, works best when done on a somewhat occasional basis.

Never put all your eggs in one basket

Many people are hesitant to invest because they are afraid of losing money. A novice investor’s first question is frequently, “What if I lose everything?” While all investing has some risk, the fear of losing “everything” is unfounded if you choose wisely where to invest your “eggs.” A well-diversified portfolio should have two degrees of diversification: between asset categories and within asset categories. You’ll need to spread out your assets within each asset group, in addition to arranging your investments across stocks, bonds, cash equivalents, and maybe additional asset categories. Naturally, when you add more investments to your portfolio, you’ll incur higher fees and expenses, lowering your investment returns. As a result, while considering how to diversify your portfolio, you’ll need to factor in these fees.The idea is to find investments in parts of each asset class that may perform differently depending on market conditions. So Happy Investing!

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This article has been co-authored by Sayan Mitra and Ayush Dugar, who is in the Research and Insights team of Torre Capital.

The Fault in our Doge

by Sandeep Kumar

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– And why it won’t go to the stars; or the moon; or practically anywhere for its sake

Among the deluge of cryptocurrencies popping up every day, Dogecoin has had the most gala ride in the past few months. The cryptocurrency, which features the ‘Shiba Inus’ dog as its mascot, gained its market cap from $1 Bn in early January to $80 Bn in May. January and May, of the same year! That is insane!

So a basic primer first for all those who don’t know what Dogecoin is.

Dogecoin: Something that started as just a meme.

Dogecoin is basically like Bitcoin (it actually is a fork of Litecoin, which is heavily adopted from Bitcoin) and like most cryptocurrencies, it enables peer-to-peer transactions on a decentralized network. The difference between the two? Bitcoin was a revolutionary technology, the original proof of work concept, based on a blockchain. Many called it the ‘disruptor of the internet’, some considered it a challenge to the global financial system, yet others considered it to be a shift of power from evil global forces to the next-door Joe and6 Jane. Bitcoin was the money of the future.

Dogecoin is just dogecoin, a digital coin, with the picture of a dog on it!

The Dogecoin has been around for much much longer than most think. It was started in 2013 by two engineers, Billy Markus from IBM and Jackson Palmer from Adobe. In their meeting they decided to combine the two phenomena that had taken the world by storm: Bitcoin and Doge, and out came the Dogecoin. Because this is what the guys do when they meet, they build random, open-source, meme-based, cryptocurrency.

The Initial Claim to Fame

The idea was to make an alternative to Bitcoin due to the massive profiteers that had gotten into mining it. Bitcoin, launched in 2008, had failed to achieve what it set out to venture. Dogecoin was expected to change that.

How?

Well, Bitcoin was limited in number, only around 21 million of those can be mined ever. Dogecoin, on the other hand, 10,000 of them can be mined every minute.

The Dogecoin was a hit amongst the crypto geeks. It was mostly used to tip online content creators due to the high speed of transactions, nominal denominations, and low cost of transaction compared to other cryptos like Bitcoin. It was dubbed as a ‘tipcoin’. It is claimed that the trading volume even surpassed the heavyweight Bitcoin for a brief period. In 2017, it crossed the $2 Bn market cap figure, after raising 50,000, USD for a Jamaican bobsled team, raising 30,000, USD for clean water in Kenya, and sponsoring a Nascar. All of this before crashing.

The Dogecoin went unnoticed for years, the original subreddit that had catapulted it to fame silenced, the founders of the coin left, and the code wasn’t even updated.

It was in March 2020 when the Doge had its moment. Serial entrepreneur and influencer Elon Musk threw his support behind Dogecoin and the community, claiming it was ‘inevitable’ and could be ‘the currency at Mars’. He was joined by several others such as Carole Baskin, a big cat rights activist, singer Gene Simmons, bodybuilder Kai Greene, former adult star Mia Khalifa, American rap star Snoop Dogg, etc.

Even with all the love and support that Dogecoin has been getting, let us walk you through the potential faults that hinder its acceptance as a currency of any form.

Founder’s Exit

The Dogecoin is a meme coin, not meant to be taken seriously. Even its founders didn’t. So much so that they abandoned the project long ago. Today merely three part-time developers manage the codebase. This has led to absolutely no tech development taking place in the Dogecoin code base since 2015.

While some view this in the ‘do not take it seriously’ vein, a poorly maintained codebase makes the Dogecoin susceptible to be dislodged by more up-to-date and modern coins. The Dogecoin may be left behind and simply replaced by some other memecoin that catches people’s fancy.

Cyber Attacks, Security Breaches, and Frauds

Due to very little codebase maintenance, Dogecoin has been hacked previously. The Doge Vault was infiltrated and close to 280 million Dogecoin, worth $55k then ($196 Mn today) were stolen along with the credit card information of hundreds of users. While the community almost immediately pooled resources to recover the stolen Doge under the banner, the official statement read this:

“It is believed the attacker gained access to the node on which Doge Vault’s virtual machines were stored, providing them with full access to our systems. It is likely our database was also exposed containing user account information; passwords were stored using a strong one-way hashing algorithm. All private keys for addresses are presumed compromised; please do not transfer any funds to Doge Vault addresses.

If you like to use Dogecoin, you should change your online account passwords and make sure to check your credit card statements frequently for fraudulent or unauthorized purchases. But let’s be serious here; we kind of hope you aren’t investing serious capital into this pseudo-currency. (emphasis added)

That is the official statement.

In 2014 a crypto exchange called Moolah was set up in the UK to handle Dogecoin by Alex Green. Many new doge holders jumped the wagon, while Green continued using the ‘tipcoin’ to make hefty tips. He even sold shares of the exchange as Dogecoins. It wasn’t long before Moolah was shut down, and Green disappeared with the money, who was later found to be Ryan Kennedy, a serial scammer, and rapist.

And not just dogecoin, but even with other cryptocurrencies, several unregulated exchanges spring up one day and take off the next, leaving investors high and dry.

Pump and Dump

Cryptocurrencies aren’t really of any use except mindless trading. The volumes are meager and regulators are absent. This makes them a ripe target for pump and dumps by pumping rings which have existed since the very inception of cryptos.

When the Reddit user /r/wallstreetbets successfully managed to pump the Gamestop stock, the crypto pump rings saw this as the moment that they had been waiting for for years. They saw a gullible audience, that didn’t really know what it was doing, to follow them thinking that they would make a blow against the big guys and have fun doing so.

Needless to say, most stories ended on a bitter note, with several of these gullible traders buying at the peaks when the pump rings sold.

This is what took place on January 28, when a Reddit user decided Dogecoin be the next asset to pump. He was joined by Elon Musk, an obsessive Twitter user. The price of the Dogecoin rocketed up and crashed the next day.

Not just the Dogecoin, but several other cryptocurrencies, all are susceptible to such hostile market manipulation.

Too Volatile to be a global currency

All cryptocurrencies have seen massive volatility. In the image below, bitcoin and ETH are found to be more volatile than the S&P 500 itself. Even as the S&P volatility dies down, the crypto volatility keeps rising.

These are not the characteristics of a stable, fiat currency. What is expected of the currency is to hold its purchasing power stable even over long periods of time, not jump up or down 10% by the time one goes from home to the grocery store.

Poor Hedge Against Inflation

As 0% interest rates or even negative interest rates seem a possibility, bitcoin, among others, is touted as a hedge against inflation. Limited supply cryptos like Bitcoin are positioned as a hedge against this inflationary scenario. Why? Because of its 21 million limits, Bitcoin’s demand vs supply is expected to cause an increase in price as supply decreases.

Even the short history of Bitcoin is not enough to cement its position as a hedge against inflation. Gold on the other hand has had millennia of history of tracking inflation and yet it was susceptible to shocks, manias, and crashes over the shorter term. Bitcoin is no different.

Even in the recent weeks as concerns of inflation pushed the 10 year US treasury yield from 1.34% to 1.62%, bitcoin suffered its worst drop in months. Unlike other inflation hedges, cryptocurrencies’ value is based entirely on other people’s willingness to hold on to it, not on some underlying asset like oil or real estate.

It is fully possible that increasing inflation may lead to an overall recession. The real test of cryptocurrencies will be when investors pull their money from riskier assets like bitcoin or pour more into it.

The infinite supply of Dogecoins

While a few cryptocurrencies do have at least the “limited number” argument in their favor, Dogecoin does not even have that. 10,000 dogecoins can be printed every minute. This rather infinite supply of the dogecoin makes it very hard for it to gain in value.

However, in spite of this structural anomaly in Dogecoin, the prices have soared considerably over the past months.

 

So much for being Decentralised

According to a Wall Street Journal report, the largest holder of Dogecoin owns 28% of the currency! The position is worth at least $2.5 Bn today! The top 10 largest addresses combined hold 43% of the total Dogecoin supply. The idea behind Dogecoin being decentralized simply bites the dust when just 10 wallet holders own 43% of the currency. One major sell-off and the prices crash.

Will the party continue for Dogecoin?

Bears believe that the bubble could burst anytime soon. A game that has a definitive end in the near future. On the other hand, some enthusiasts feel the recent crash is just a minor setback. They still think that it has the potential to grow further in the future.

Can Dogecoin place itself as a reliable money system not limited to any particular state and government? Or will the influencers of crypto just have fun with it for a while and then forget about it for another eternity? Or will Dogecoin ever reach the $1 mark? Probably, Probably Not!

So the final question – whether to invest in this joke or not? Well, be clear about your investment goals first. It’s always a good idea to have a diverse set of investments for your portfolio which are harmless to your risk appetite. So ask yourself this – why do you want to invest in Dogecoin? To make instant money or a fortune that you see forthcoming?

Or maybe launch a crypto coin of your own. That is the sure-shot way to make some quick bucks.

                                                                   – – – – –

This article has been co-authored by Khubaib Abdullah and Yogesh Lakhotia, who are in the Research and Insights team of Torre Capital. 

Will Grab make money for its investors even post the massive $40Bn SPAC valuation?

by Sandeep Kumar

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Grab Holdings, Southeast Asia’s largest ride-hailing firm, plans to merge with Altimeter Growth Capital, based in the United States, in a deal worth approximately $40 Bn and allowing it to trade on the Nasdaq Stock Exchange.

If it goes through, this SPAC deal will be the largest ever U.S. equity offering by a South-East Asian firm, with the planned deals giving Grab a Pro-forma equity valuation of about $39.6 Bn. Grab will earn up to $4.5 Bn (SGD 6.05 Bn) in cash as part of the SPAC contract. BlackRock, T. Rowe Price, and Fidelity are among the large institutional investors who have poured money into the offer.

Can Grab justify its supercilious valuation?

We Know that Grab has a huge dominance over the South East Asian market and is also a fairly good company but the real thing to ask is that how justified it is to give a massive valuation of around $40 Bn? Is there anything for the investors to be happy about their investment in the company? If we go with the past history of Grab including the recent Private Investment in Public Equity round where it raised around $4 Bn. A total of around $17 Bn has been raised till date in 19 rounds which is way more than any other Southeast Asian startup which suggests that they have raised a huge amount from the market so far.

We believe there’s already a saturation with respect to the addressable market size. Grab has already conquered most of the market in the field with 66 concurrent rides in one second across seven countries, occupying 97% market share in the third-party taxi-hailing market and 72% in the private vehicle hailing market. This data suggests that the company already has attained a humongous market share. Despite this fact, inflating its valuation to $40 Bn seems difficult to digest making it too rich a stock.

The scale of its multi-faceted business model

Grab is Southeast Asia’s leading ride-hailing network, headquartered in Singapore with services including ride-sharing, food delivery, taxi booking, insurance, bill payment, and more. In 2018, Grab bought Uber’s entire Southeast Asia ride-hailing service in 2018.

Grab charges a 16% to 25% commission for using their services. It has around 3.5 million drivers in Malaysia, and the minimum ride cost is RM5. After a 25% cut (RM1.25), the company would gain around RM4 million if every driver gets a verified ride.

Any time the driver completes a booking, the credits deposited by the driver will be deducted in the same amount. In Singapore, Grab offered $4.30 to $5.70 for each ride last year; such offers could cost the company millions per month. Grab does not provide travelers with free or discounted rides.

Consider another example, the average gross earnings of a full-time (12 hours) driver in a month is $1435 — $1670. After a 25% commission cut, drivers will earn $1795 — $2088. Based on this, Grab would have gotten about $360 — $418 of commission from a single driver.

Scale and Leadership in South East Asia (Source: Grab S-1)

Dominance in the Southeast Asian Market

Since launching in 2012, Grab has evolved from a humble taxi-booking app to Southeast Asia’s largest land transport company, with over 200,000 drivers and over 11 Million mobile downloads.

Since mid-2015, GrabCar rides have increased by 35% on an average monthly basis, while GrabBike rides have increased by 75% on an average monthly basis. Ride-hailing services have become invaluable to Southeast Asia’s infrastructure, and the region’s industry has been shaken by the sudden emergence of now-dominant player Grab. With the departure of Uber Technologies of the United States, the sector is entering a new era of competition. Grab will not go unchallenged, and will need to prepare for competition from new corners and in new fields as it expands beyond its core business.

Stellar growth with no profitability

Though Grab currently is far off from achieving profitability in its financials, it has been growing tremendously in the past few years. Recently, the coronavirus pandemic has spurred growth in Grab’s food and grocery delivery business, turning them into some of the company’s biggest revenue streams.

Mobility segment profit and EBITDA (Source: Grab S-1)

Through the SPAC Merger, Grab will have hands-on cash proceeds namely, $4.0 Bn (SGD 5.37 Bn) in fully committed PIPE financing, led by $750 Mn (SGD 1.07 Bn) from Altimeter Capital Management, LP, the firm that owns Altimeter Growth Corp.

Snapshot of key financial metrics:

  • Revenue: $1.19 Bn in 2020, up from $455 Mn in 2019.
  • Loss: $2.7 Bn in 2020, which was $4 Bn in the year 2019.
  • Profits: The company is also expecting its earnings before interest, taxes, depreciation, and amortization to turn profitable by the year 2023.

Grab’s edge over its competitors

Grab has a lot of benefits, most of which include easy booking, insured drivers, rider ratings, and low or at least confirmed wait times.

Positioned as a forum for a variety of services; Grab offers:

  • Licensed and Insured Drivers: Grab drivers must register as a local business, convert their vehicle to a commercial vehicle, sign up in person at the Grab office, and buy commercial insurance to protect themselves and their property. If you use GrabTaxi, you will only be connected with licensed taxi drivers, not novice ones.
  • Flat rate fees: Grab charges a flat rate that you can see before you ride. This feature removes the element of surprise from many taxi fares and helps you to choose the best ride for your budget. Shorter wait times — With over 30,000 drivers in 30 cities, Grab rides are readily available.
  • Accessibility as a Super App: The network effects are one of the most important force multipliers for the business model of a super-app, which Grab is positioning itself as. i.e., as there are more rides available at any given time, more people can use services like ride-hailing from you, which makes it lucrative for drivers to register on your platform.

Concerns surrounding Grab’s SPAC merger route

Getting regulatory approvals for an IPO would have been difficult for a cash-burning business like Grab (where all the promised land of gold is in the forecasts and excels). Recent cases, such as WeWork’s failed IPO, are fresh in the minds of aspiring public companies. When there are no positive cash flows, it is easier to sell the forecasts to a SPAC rather than the general public. The markets are overflowing with the supply of cash-rich SPACs looking for big enough startups to invest in.

However, because of the SPAC’s nature, many aspects are inherently opaque, making it easier for big companies to dupe retail investors. In the case of a SPAC, unlike a conventional IPO, a company decides on the valuation, and if Grab had chosen a traditional approach, it would have been impossible for the company to achieve the same in such a short span of time.

SPACs are appealing to people who want to go public in a volatile market. IPOs are considered riskier because there is always a possibility that the papers will not be accepted until they are filed publicly. The same thing happened with WeWork’s IPO, which was canceled after the company’s details were made public and investors were forced to withdraw.

Some other relevant concerns that will arise post Grab’s SPAC Merger:

  • Disproportionate Voting Rights: The founder Anthony Tan will receive a voting share that is 30 times greater than his equity stake in the company as a result of this transaction.
  • Grab’s Cash Burn: Grab is at a point in its growth where it has a high valuation but is also cash flow negative. Shares in the SPAC that were purchased at the start of the company can be redeemed. If redemptions meet forecasts, cash availability becomes unpredictable, forcing SPACs to seek PIPE funding to make up the difference. Grab’s cash burn may be exacerbated by this contract.
  • Shareholding Dilution: SPAC sponsors usually hold a 20% stake in the SPAC in the form of founder stock, or “promote,” as well as warrants to buy more shares. They also benefit from an earn-out component, which allows them to gain more shares if share prices reach a certain level. This could result in more dilution, which could lead to mismanagement at Grab.

Should you invest?

Despite being Singapore’s largest unicorn, Grab, like many other startups, is still burning cash and isn’t expected to turn EBIDTA positive until 2023, according to Moody’s. Grab’s value has more than doubled to $39.6 Bn, up from $16 Bn in the last round of funding. Grab, on the other side, would have $4.5 Bn in cash on hand.

At more than 3 times its GMV, the company’s valuation leaves very little space for new investors, at least for the time being.

A lot would hinge on Grab’s ability to maintain its remarkable 96% CAGR in net sales over the last three years. The company may lose some of its moats in the long run as a result of legislation, market changes such as customers shifting away from ride-sharing, and competition from other regional players such as Gojek, Urge, and others.

A long way to go

SPAC Mergers are seen as a simple way to avoid the conventional IPO enforcement procedures. Many critics believe that the SPAC merger is used by low-performing companies that have no other way to get listed on the stock exchange. Even though the company has a positive outlook, it is still too rich, driving such a large valuation, encompassing negative returns (EBITDA), and generating negative emotions among many investors.

Grab’s valuation premium will take some time to catch up with the promised cash flows. However, the sheer potential of being in inherently high-growth markets with penetration levels in the single digits and lower double digits, combined with technology-enabled day-to-day services and Fintech solutions for markets with very low banking penetration (only 40% penetration), could eventually propel Grab to emerge from a long list of failed SPAC mergers. For the time being, the valuations are on the verge of becoming a bubble, and they are still pricing in a lot of stuff happening for Grab, making us cautious to dive deep into the Grab SPAC at the moment.

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This article has been co-authored by Sargam Palod and Sayan Mitra, who is in the Research and Insights team of Torre Capital. 

A Comparative Guide to Alternative Investment Opportunities for Holistic Wealth Management

by Sandeep Kumar

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One of the key drivers of the boom in wealth management has been the rise of alternative investment funds (AIFs), essentially either structured products, cryptocurrencies, thematic funds, real estate funds, private debts, and other such, where HNIs make sophisticated bets on new investing strategies, unlike the conventional world of mutual funds that are used by millions of small investors.

Alternative investments represent approximately $13 Tn (or 12% of the global investable market). By 2025, the industry is expected to grow to $20 Tn – $25 Tn (18-24% of the global investable market). India’s alternative investment industry has grown by nearly 265% since 2017. But the industry is still underdeveloped relative to the rest of the world. As of June 2020, the industry is estimated at $54 Bn in India. The recent growth of India’s alternative investment industry can be highlighted by two recent developments. First, India’s private equity space took the spotlight when Reliance Jio raised $20 Bn via notable blue-chip investors and tech giants, despite the global Covid-19 outbreak.

Source: Grand View Research

A Camaraderie of Risk and Opportunities


An investor who is looking to diversify the investment risk in various asset portfolios. An ideal investor will be the one who is willing to take the underlying risk involved in these unlisted and illiquid securities. Usually, Resident Indians, NRIs, PIOs, OICs, and foreigners are eligible to invest in various types of alternative investments.


Structured Products

These are financial instruments consisting of three components:

  • A Bond
  • Multiple Underlying Assets
  • Derivatives

Depending on the investment objective of the structured product, the interest generated by the bond component is used to buy the derivatives. The underlying asset helps generate the return component. The derivative is of paramount importance in the construction of a structured product. Most of the time it is what determines the level of return. The choice of derivatives will depend on the:

  • desired risk level for the product (capital protection or not),
  • preferred investment horizon,
  • type of return and exposure sought, and market conditions

In the current time, structured products seem to be appealing for customers who try to optimize and diversify the portfolio of savings and achieve the target returns. But with a change of generation, the future holds place for investors moving for fast-paced money-making opportunities rather than the traditional buy and hold investments. The risk with structured products is the lack of liquidity that comes along with low returns and it can be considered more as a buy and hold investment. Along with the lack of liquidity, the potential loss of 100% principal is a huge risk involved.

 

Cryptocurrency

Cryptocurrency is a digital currency that can be used to buy goods and services but uses an online ledger with strong cryptography to secure online transactions. The highlighting characteristics of cryptocurrencies are:

  • Decentralized
  • Volatility
  • Trust-less

The global market of cryptocurrency in 2019 was approximately $792 Mn. The market is expected to grow at a CAGR of 30% and have a market capitalization of around $5100 Mn by 2026.

One of the most notable acceptors of cryptocurrency as a viable medium of payment is Apple Inc. PayPal, Starbucks, and Coca-Cola are amongst the other giants accepting cryptocurrencies.

It is also one of the most lucrative investment options currently present. Its value appreciation is supremely dynamic and can prove to be an excellent avenue for capital expansion.

When it comes to cryptocurrency, the investor sentiments are at all-time high currently. The biggest risk involved in cryptocurrency is the threat of cybersecurity including malicious activity. Loss or destruction of the private key will lead to a 100% loss of principal.

Overall, it is wise to place your bet on crypto in the coming era, keeping in mind that there might be periods of underperformance from time to time.

Thematic Funds

Thematic Funds are equity mutual funds that invest in stocks tied to a theme. Currently, SBI Magnum COMMA Fund and Aditya Birla Sun Life MNC Fund are the most popular thematic funds in India. The idea is to concentrate on making a portfolio with one core element of the economy. Exposure in different sectors helps to partially diversify the risk. It is less risky than sector-focused funds.

Thematic Funds are equity mutual funds that invest in stocks tied to a theme. Currently, SBI Magnum COMMA Fund and Aditya Birla Sun Life MNC Fund are the most popular thematic funds in India. The idea is to concentrate on making a portfolio with one core element of the economy. Exposure in different sectors helps to partially diversify the risk. It is less risky than sector-focused funds.

The practical application of thematic funds can be seen as wealth managers create different portfolios as per the theme that the investor wants to focus on. For example, outdated industries use more suitable examples like fintech, supply chain, or SaaS. 

However, if you are a very conservative investor, you may not consider investing as these funds come with higher levels of concentration risk. You must have an investment horizon of at least 5 years to mitigate the associated risks.

A mid to long-term investment trend should underlie the investment rationale behind thematic funds. Let us understand how thematic funds are a good investment with an example. Due to Covid-19, we saw a boom in the healthcare, pharmaceuticals sector. Considering the Covid-19 is going to stay a bit longer than expected, there will be an increasing demand for healthcare.

Thematic funds should concentrate more on investing in the specific companies which stand to benefit from this boom- like healthcare, pharmaceuticals, medical instruments manufacturers, etc. Similarly, hybrid and electric vehicles might be the road runners for tomorrow. So accordingly, thematic funds would look forward to investing in those specific sets of companies. Ideally, thematic funds should constitute 5- 10% of your portfolio if you are an aggressive investor willing to take higher levels of risk.

 

Real Estate Funds

A real estate fund is a sector fund that invests in securities of companies that invest in real estate projects. Investors get broad exposure to real estate for a low investment level. A Real Estate Fund can comprise investments either directly in real estate companies or in Real Estate Investment Trusts.

Some of the characteristics of real estate funds are:

  • Long term investment
  • Returns depend on the growth of the sector
  • Liquidity to investors, which is not the same if invested in physical real estate

With inflation on the rise, the prices of properties will increase which in turn will increase the value of real estate making it a protected investment for the investors willing to invest their money into long-term investment plans for at least 5 years. And the people who are in search of quick returns might not fit as suitable investors for these funds. Overall, they are being seen in a more traditional light, due to new opportunities. Present case on their growth opportunities and are they still relevant post covid.

The two common risks with these funds are the market risk of the real estate sector and the interest rate risk. Retail investors have a large amount of disposable income so investors like them can consider real estate funds for a diversified investment portfolio.

Private Debts

A private debt fund specializes in lending activity and raises money from investors and lends that money to companies. It represents an alternative to bank lending as well as providing investors with exposure to the more bond-like returns occurring from private debt as an asset class.

Private debt funds come in different shapes and sizes. For example, some private debt funds provide capital to sponsor-backed borrowers, others fund real estate development projects, and some invest entirely in the debt of distressed companies. By 2019, the assets invested into private debt reached a record high of $812 Bn and it was expected to exceed $1 Tn by 2020 but for the Covid-19 outbreak which slowed it down.

Private debt in Europe has grown by nearly 380% in the past decade and the Asian market has taken off in recent years. The lower volatility and regular cash income are really attractive to investors. Already one of the fastest-growing alternative asset classes, with total AUM rising 168% from $315 Bn in 2010 to $845 Bn in 2019, this growth is expected to continue with a 73% increase in AUM to $1.46 Tn by 2025. It is thus expected to become the second fastest-growing alternative, next to private equity, by 2025.

 

AIF as per Investor Risk Appetite

The Journey Ahead

The future of the alternative investment industry seems likely to be one of both growth and significant structural change, accompanied by an increasing maturity of the industry’s infrastructure, regulation, and investment relationships. The importance and need of the alternatives industry are likely to become even more evident to the public as individuals begin investing in the sector through retail alternatives, to strengthen the value of personal long-term investment portfolios. Ultimately, demonstrating the value addition that the industry generates and doing so in a transparent fashion will be the key to the industry being accepted by the public and policymakers. The Indian Alternative Investments Market still represents a minuscule share of the global market and is poised for unprecedented growth in the years to come.

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This article has been co-authored by Yogesh Lakhotiawho is in the Research and Insights team of Torre Capital.

 

 

 

 

NFT: An Opportunistic Future or a Bubble?

by Sandeep Kumar

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An NFT is an on-chain token of an off-chain asset. At the most bare-bones, it is a social contract between the asset creator and the surrounding community.

So, what makes it different from a crypto currency and what is this fuss about non fungibility. An NFT is a digital token that’s like a cryptocurrency but can’t be exchanged for another NFT. This is what makes it non fungible. A bitcoin for a bitcoin, but not one NFT for another. Each NFT is different and unique.

This token is added to a blockchain that supports this special ‘NFT type’ token (such as Ethereum) recording the details of ownership of some commodity, somewhat like how a house deed records the ownership of a house.

The only catch is the commodity, the off-chain asset, must be ownable and somewhat nonfungible. So, you can’t have an NFT on currencies or gold (non-fungibility), nor on Mars or Niagara Falls or the Mona Lisa (unless you own the Mona Lisa of course, then you can do whatever you want, also its highly likely won’t be reading this anyway).

Examples of NFTs Trades: 

  • Digital Art: The $590,000 selling of the famous Nyan Cat Gif, for example, could have only happened because of the meme’s enormous success over the years. 
  • Sports Collectibles: Similarly, the NBA’s highest-selling NFT was a highlight reel of LeBron James, which sold for $200,000. Less well-known players, on the other hand, had reels that sold for as little as $9.
  • Tweets: In March, Jack Dorsey’s original tweet sold for $2.5 Million, paving the way for more similar deals.

Why all this chatter on NFT then?

Because NFT allows storing more data per block. Bitcoin blocks allow only 1MB of data for example, just enough to record a bunch of transactions and some other details. 

This single feature elevates the NFT from more than just a ledger that records transactions (essentially what a cryptocurrency is) to record/store the ownership of pretty much anything such as jpeg files, music files, videos, internet domains, real estate, vintage cars, in-game purchases, art pieces, ad spaces, unlisted shares, horses, just anything.

So just to make things clear, if you are an artist, this is an easy way to monetize your work securely. NFTs also allow a share to the artist each time the NFT changes hands.

As a buyer, which you most likely are, you can buy NFTs of an autograph or highlight reels of an upcoming sports star that you think may strike it big. If in case that happens, it is likely the value of the NFT would have climbed manifolds.

Role of the community in guaranteeing NFTs

Unlike the fiat currencies that are legally backed by central banks, gold, governments and who knows what, a particular NFT only falls back on its scarcity to back it up (the other two tenets of an NFT are its utility and authenticity, both of which are not as effective as an NFTs scarcity is). The ploy of scarcity is a delicate one. The artist or NFT holder may not be able to enforce his ownership, may not get any special rights to own it, may very simply be fooled into buying that NFT or the creator may break its promise. It is the community however that enforces scarcity and hence values it. The creator of the NFT has no say in it.

The value of the NFT comes not from the NFT or the art or the off chain assets that it brings on the chain, it is the NFT and on chain assets’ community and its interactions that hold and/or derive value. It is not the NFT, but the community that is holding value. Most NFTs are worthless, but a few NFTs are focal points of creators and admirers both. Call it a digital bandstand or an art gallery if you wish. 

NFT “An Opportunistic Future”

  • NFT can be a new revenue stream for gaming, sports, art and technology.
  • Like Decentraland, NFTs can transform our attitudes toward ownership and make it possible to own a real-world asset that’s thousands of miles away.
  • Many crypto unknowns could introduce cryptocurrencies for the very first time through NFTs.

Risk associated with NFT

  • It may end up like the initial ICO (initial coin offering) craze as people’s attention shifted to other technology and the space cooled down.
  • What may seem like a hot commodity today may not be as so in the future as seen in the case of Jack Dorsey’s tweet.  
  • Complaints of several pieces of art being stolen and purchased as NFTs leaving the original art creators with no proof of their work.
  • NFT owners must also trust that the maker will not produce another batch of tokens with nearly identical artwork, devaluing the NFT they paid for.

Why the craze of NFT holds despite the associated risk? 

NFTs can be called collectibles. People buy paintings or any other kind of physical art for the same purpose. Utility, authenticity, and scarcity are typically the driving factors behind their demand. 

The obvious one is utility. People are willing to pay for an NFT ticket because it helps them to attend a meeting. Alternatively, they are more likely to purchase art if they can view it in a virtual environment. They’re also willing to spend money on an object that gives them unique abilities in a game. The definition of authenticity explains how an NFT works. What was the source of it? Who has owned it previously? Finally, Leonardo Da Vinci’s famous painting “The Mona Lisa” better describes scarcity. There may exist millions of copies, yet there’s only one original Mona Lisa.

The big player of the NFT market

OpenSea is the first and largest marketplace for user-owned digital goods, which include collectibles, gaming items, domain names, digital art, and other assets backed by a blockchain-based in New York. The number of unique participants after the bubble of 2018 has grown steadily from 8,500 accounts in February of 2018 to over 20,000 accounts in December of 2019. The market is driven by a core group of power users. On OpenSea, the median seller has sold $71.9 worth of stuff, whereas the average seller has sold $1,178 worth of stuff, indicating a large number of power sellers.

Market sentiments and perception

The market for non-fungible tokens is quite small (yet). It is also harder to measure than cryptocurrencies due to the lack of spot prices. Focussing only on secondary trading volume (peer-to-peer sales of NFT, not the creation of NFTs) as an indicator of market size the current secondary market is expected to be roughly $2 – $3 Million USD in volume per month on average.

The total trading volume of non-fungible token (NFT) artwork hit an all-time high of $8.2 Million in December 2020 compared to $2.6 Million in November 2020.

It might sound like a gold rush right now, but the main question is how long will value be produced in all of these new forms if the supply is unlimited? And what would be the most prudent position to take?  A good way to get a piece of the action, yet to stay unharmed is to service the bubble, not to take part in it. Case in point: do now what Levi’s or Wells Fargo did then. NFTs will tokenize everything. It won’t be long before off chain assets get on the blockchains. All valuable assets will then be stored on a decentralised digital ledger, with the NFT being a token of digital representation of an object or person on the chain.

 

This article has been co-authored by Sayan Mitra and Khubaib Abdullah, who are in the Research and Insights team of Torre Capital.

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