Fed in on the inflation offensive and it is time for consolidation

The US Federal Reserve has taken a determined stance against inflation raising its key benchmark rates an aggressive 75 basis points at the latest FOMC meeting in one of the highest rate hikes since 1994. The US Fed’s rate spike comes after a 50-basis point hike in the Fed rate the last time with cumulative rate hikes now showing at 125 basis points increase.

With the US consumer price inflation accelerating to a 40-year high of 8.6% in May rising 100 basis points from a month earlier, the Fed’s policy shift is a little late, but a step in the right direction. Housing, food and surging oil prices are beginning to take a toll on household finances. High oil prices are further fuelling transportation costs continuing the pressure on global inflation.

The US Fed noted that inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, high energy prices and broader price pressures. With the conflict in Ukraine driving oil and gas prices higher, global inflation is likely to remain elevated in the foreseeable future.

More hikes on cards

Fed forecasters see inflation continuing to play truant for the rest of the year with average rates at about 5.2%. But the US Fed is ‘strongly committed’ to clawing back Inflation to about two per cent, and according to its policy inflation should decline to 2.2% in 2024.

More rate hikes are on the horizon with the US Fed seeing another 50 or 75 basis points hike in the next FOMC meeting due in two months. Indeed, aggressive rate hikes could continue with forecasters anticipating the US median rate to be about 3.4% by the end of this year.

While the rate hikes are expected to impact US and global growth rates, however, one of the key positive takeaways is that a deep recession is not on the cards. The US economic growth is expected to decline below 1.7% this year further showing signs of decelerating in 2023. US unemployment is also expected to inch up in the coming quarters.

Growth effects

The Indian economy is expected to feel the heat of the global slowdown due to fiscal tightening. The rupee, which has remained steady for the last many quarters, has come under pressure lately with its pricing breaching the Rs 78 mark to the dollar. High oil prices are India’s biggest concern and if it continues to remain elevated, the slack in the economy could be prolonged.

For now, the global and Indian economies will have to come to terms with this period of stagflation. Global asset prices have weakened this year and may remain under stress for the foreseeable future. Asset prices are now being re-priced after factoring in higher interest costs. High growth companies, whose valuations were even driven higher by the liquidity-fuelled markets, should see a more sobering price-earnings multiple in the foreseeable future.

One of the good things is that India’s gross savings rate is high, and these savings are being funnelled into the broader economy. A thrust on infrastructure investments including roads and railways will lower costs and improve economic efficiency should benefit the growth in the longer run. Some of these savings may be shifting to the fixed income side as interest rates rise which should increase liquidity with banks and financial institutions leading to higher core infrastructure lending.

All in all, for the economy, this period of rate tightening is a time of consolidation and increasing capital allocation and efficiency. India’s investments during this phase will determine how quickly the economy will begin to recover back on the growth path.

Fractionalization of Assets - ‘Democratising access to Alternate Investments’

Asia and the emerging economies, especially India, are poised for the next big growth in alternative investment products and are primed for the next wave of alternative growth. As of May 2022, over 900 AIFs had been registered with the Securities and Exchange Board of India (SEBI), with capital commitments increasing at 63 per cent CAGR between 2012 and 2022. Global alternative investments AUM increased from $4.1 trillion in 2010 to $10.7 trillion in 2020 and is anticipated to reach $17.2 trillion by 2025.

Overall investments through AIFs is expected to grow at 25 per cent CAGR between 2022 and 2025, led by wealth managers providing AIF products as alternatives to high net-worth individuals (HNIs), family offices, and insurance firms. 

Fractionalization of Assets:

AIFs in India require a minimum investment of ₹1 Cr (with angel funds requiring ₹25 lakhs). Participation in large scale by retail investors remain a distant dream till now. Retail participation in these instruments therefore needs to be facilitated by reducing the minimum investment size requirements through ‘fractionalization’, i.e., by dividing the underlying asset into smaller units. Other areas requiring such fractionalisation for greater retail participation include amongst other products the following,

• Corporate debt
• Commercial real estate funding
• Less liquid and high-risk equity investments, such as in start-ups, and
• Other forms of financing employed by companies such as operating leases, inventory financing, invoice discounting, etc.
  

Market Size: 

TAM(Total Addressable Market)

Total retail wealth in India is estimated to be in excess of ~₹ 450 lakh Cr across financial and physical assets1. The TAM for alternative investment platforms (AUM basis) can be assumed to be 10-20% of this overall wealth, viz. ₹45 to 90 lakh Cr, on an AUM basis 

SAM (Serviceable Addressable Market)

As per RBI, aggregate deposits in scheduled commercial banks in India totalled to ₹ 162 lakh Cr, of which ~₹ 142 lakh Cr was time deposits2, and ~₹ 138 lakh Cr was attributed of residents. Indians have a further ~₹ 4 lakh Cr invested in debt mutual funds and ~₹ 1 lakh Cr invested in bonds & debentures.We expect that a portion of this wealth can move to higher yield alternative investments with fractionalisation.

A product such as a commercial real estate investment remains as an investment option for only the top 5% of the Indian population in terms of household wealth. Top 5% of Indians constitute ~50% of the overall household wealth.. Based on this, we expect the serviceable addressable market for alternative investment platforms to be in the range of an additional ₹ 5 to 10 lakh Cr, on an AUM basis. 

SOM (Serviceable Obtainable Market)

• Considering the low penetration of alternative investments till date, and the levels of risk associated with some of the more innovative products, it is likely that their penetration may remain low in the near future. Assuming potential penetration growing up to 20% over a 5-year period, the SOM would be the range of ₹ 1 to 2 lakh Cr, on an AUM basis. Assuming average annual take rates of ~2.5%, this translates to ₹ 2,500 to 5,000 Cr, at the revenue level
• Further upside is available through international expansion by targeting NRIs as well as international investors from markets such as the Middle-East or South-East Asia, by offering Shariya-compliant investment products
  

Benefits of Fractional Investing: 

Flexibility: Emphasizing the core principles of simplicity, diversification and liquidity, fractional investment seeks to establish a trust-based financial platform for investors with transparency and customizable options that helps increase the opportunity of the investors. 

Accessibility: With fractional investing, which divides this big chunk into small slices, the ticket size decreases, making it more affordable for people across all income brackets. It can also yield short-term returns to retail investors, oncethe market reaches a threshold and reasonable size. 

Pre-vetted investment options: Investing in Corporate Debt or real estate funding may involve high risk. Most of the firms engaged in these areas, have or access to an experienced team, and also provide digital governance tools to allow investors to continuously monitor their investment. One practical example which is currently operational is a real estate investment trust (REIT) a company that owns, operates, or finances income-generating real estate.

• REITs generate a steady income stream for investors but offer little in the way of capital appreciation.
• Most REITs are publicly traded like stocks, which makes them highly liquid (unlike physical real estate investments).
• REITs invest in most real estate property types, including apartment buildings, cell towers, data centers, hotels, medical facilities, offices, retail centers, and warehouses.

Diversification: Another way by which the risks are mitigated is through diversification of investments. Most of these asset classes are market-independent providing predictable cash flows and fixed returns despite market volatility.

Regulatory environment: Currently, fractionalized investment products are not subject to any additional regulatory or compliance requirements, if the broader requirements for the product (i.e., bonds, or angel investments) set by the respective regulator (i.e., SEBI or RBI) are being met. Current operations are compliant with the bare minimum regulations applicable (Companies Act, Debt listing requirements, etc)

Fractionalized Alternate Investment platforms in India:

In the last few years, several start-ups have set up operations aiming to fractionalize alternative assets to make them accessible to retail investors. Their aim is to ‘democratize’ access to alternative investments by,

• Providing higher degree of returns than traditional investment options like fixed deposits, gold, and low yield bonds, and

· Reducing exposure to the systematic risks as in the case of equity (direct / mutual funds) investments. The following figure presents a space map of the fractionalized alternative investment platforms active in India as at today

As the figure shows, the activity in this space has been divided among fixed income products and fractional real estate investments, with Property Share Capital (“PropShare”) being the earliest entrant. We note that this is similar to the global market scenario, where we have seen numerous start-ups offer options to invest in fractional commercial and residential real estate. Globally, several such firms have established themselves with large AUMs and have been backed by marquee investors. for example:

1. Cadre is a US-based platform that allows investors to invest in real estate projects and has an AUM of ~US$3.5 billion, and has received investments by General Catalyst, A16Z and Goldman Sachs.

2. Moonfare, a German online platform that lets wealthy and qualified individuals invest in a portfolio of private equity funds through a pooled feeder account, raised US$ 125 million in its Series C, from Insight Partners in Nov’21.

3. Roofstock, a US-based platform that allows investors to purchase residential assets for rental income and also offers fractional investments through a portfolio management solution. Roofstock raised its Series E, led by Softbank and valuing the firm at USD 1.9 billion post-money in March 2022.

In the following table, we compare the key metrics for some of these platforms:

Company Primary Products Founded Post-money Valuation (₹ Cr) Total funds raised (₹ Cr) Investors

Fixed income Grip Leases Jul-20 90 (Pre-Series B, Jan’22) 35 Anicut, Endiya Partners, Venture Highway Wint Covered bonds Jan-20 150 (Seed, Nov’21) 89 3one4 Capital, Rainmatter (Zerodha), Better Capital KredX Invoice discounting 2015 1,110 (Series B, Nov’19) 188 Tiger Global, Sequoia, Prime Venture Partners

Real estate Strata Office spaces and warehouses 2019 137 (Series A, Jul’21) 56 Elevation, Kotak, Mayfield, Sabre Capital PropShare 2014 1,200[1] (Series B, Apr’22) 18 Lightspeed, Beenext, Pravega hBits 2018 Not known 5 Shree Naman Group, Nebbiolo Solutions

Note: [1] valuation ask for Series B basis term sheet received by the Company

1. Grip is a fractional alternative investment platform that offers retail investors options to invest in alternative assets. Its product portfolio currently covers fixed income products (movable property leased to start-ups, inventory financing, etc) as well as commercial real estate.

2. Debt investment platforms such as Wint offer retail investors the option of investing in covered bonds, NCDs and MLDs issued by financial services companies with cheque sizes as low as ₹ 10,000 (and in some cases even lower). This effectively fractionalizes debt instruments as typically investments have required a minimum cheque size of ₹10 lakh.

3. KredX was the first player to offer retail investors the option to invest in short-term corporate loans, in the form of invoice discounting. The KredX platform is available to individual retail investors as well as institutions.

Digital Banking Units – a perspective

RBI has recently released guidelines for Digital Banking Units [DBU] in pursuance of budget announcement to open 75 DBUs this year. Hon’ble PM would be launching commencement of operations of DBUs on August 14, 2022.   

DBU is a specialised fixed point business unit housing a certain minimum digital infrastructure for delivering digital banking products and services. It will be a fixed business unit operating under the retail banking division of the bank and will deliver new digital products and services and service existing financial products digitally, in a cost-effective, efficient and secure manner with 24X7 availability.

Digitalisation of Banks:

The Reserve Bank of India (RBI) on Thursday said existing banks can open DBUs to offer products and services in both self-served and assisted mode. According to the guidelines of the establishment of DBUs, the services and the products should include,

• Opening of accounts.
• Cash withdrawal.
• KYC updates
• Loans
• Compliant registration

How DBUs are different from existing digital offerings:

1. DBU’s are housed distinctly, separate from an existing Banking Outlet with formats and designs most appropriate for digital banking users.
2. For the front-end or distribution layer of digital banking front-end or distribution layer of digital banking, each bank would choose suitable smart equipment, such as Interactive Teller Machines, Interactive Bankers, Service Terminals, Teller and Cash Recyclers, Interactive Digital Walls, Document uploading, self -service card issuance devices, Video KYC Apparatus, secured and connected environment for use of own device for digital banking.
3. The back end including the Core Banking System and other back office related information systems for the digital banking products and services can be shared with that of the incumbent systems with logical separation. 
4. Banks are free to adopt an in-sourced or out-sourced model for operations of the digital banking segment including DBUs.
5. As the purpose of DBUs is to optimally blend digital infrastructure with ‘human touch’, it should be lined up in a purposeful way to accelerate the digital banking initiatives.

Why DBU’s?

1. Cost-effective: DBU’s involve less cost as there is reduction in cost of employment. This is because transactions are digitalised and involves fewer manual operations. This also helps in reducing the number of physical units of banks required as all the processes are automated through digital platforms.
2. Quick process: As automation plays a major role, the process is quick, and it helps in reviving up with the current economy. It also helps in easy documentation and hence provides easy access to the customers.
3. Enhances value creation: The DBUs work entirely on kiosks resulting in lowering the physical presence. The banks can fast-track the digital transactions which can enhance the value creation from overall economy perspective; hence is implemented and measured on a macro level through revised policies by the Government.
4. Data storage: In DBU’s, the data of each customer is recorded by kiosks which reposit the data on a long-term basis and helps in timely access of data whenever required. This avoids the problem of loss of data and prevents client record detriment.
5. Operating Model: Customers are in need for a hybrid experience, a combination of never-seen digital experience in terms of speed and convenience, and personal look and feel of the product. The model needs to be seen from different perspective, viz.
6. Digital as Business – At the management level
7. Digital as New Line of Business – At the next level as separate digital division to take care of digital activities
8. Digital Native – New setup with its own technology stack, focusing directly on customers.

Emerging market

Neo-banks presently bridge the gap between the services that traditional banks offer and the evolving expectations of customers in the digital age. They are changing the face of traditional banking and could one day eclipse traditional banks. According to statistics, the global neo-banking market size stood at $47.39 billion in 2021 and is estimated to grow at an astronomical rate (compounded annual growth rate) of 53.4 per cent from 2022 to 2030. 

The total digital payment value in 2020 accounted for USD 750 trillion with digital transactions exceeding 900 billion in volume globally Traversing to next stage, DBUs are likely to transform the way people “feel” sense of undertaking banking transactions. Digital Banking Market size exceeded USD 8 trillion in 2020 and is projected to register gains of around 5% from 2021 to 2027.

Advantage over physical branches:

Digital Banks and Neo-banks offer amazing products with high quality interactive capabilities and offer hybrid custom made products to the customers. It helps in reduction of regulatory costs as there is less regulatory process involved competitively. On-boarding of customers on an entirely digital platform may help the customers to have adequate fulfilled service including redressal of their grievances on a timely manner. Digital Banking Units are expected to offer hands-on customer education on self-service and easy access through mobile banking or net banking in the near future.

The convenience of banking from home round the clock in a secured manner with less human interface helps in providing customer centric services. DBU’s also helps in reduction of circulation of money in the economy, encountering inflation in the long-term and reduces the risk of counterfeit note circulation and promotes digital transfers.

Challenges:

Consumers in India still believe in the brick-and-mortar model when it comes to banking transaction where they get more confidence while interacting with front end staff. Still majority of the population believe in going to banks to carry out different transactions. The loans and business products are tough to document digitally and thus requires physical verification. Risk assessment process while evaluating loans needs more advisory-based tailor-made services rather than service-based banking systems as it involves more expertise and insights. Hence minimum physical touch points are required to have an organised banking system. The technical threats such as unencrypted data, spoofing, phishing etc may also needs to be dealt with, due to lack of awareness, weak data management and lack of expertise.

Market to witness ‘Prolific growth’

A recent study, conducted by the strategic consulting and market research firm Blue Weave Consulting, revealed that India digital banking platform market was worth USD 776.7 million in the year 2021. According to the study, the market is estimated to grow at a CAGR of 9.8%, earning revenue of around USD 1,485.5 million by the end of 2028.

As a boost for the Digital Economy, the Centre has proposed to set up 75 Digital Banking Units in 75 districts across India through scheduled commercial banks. In April 2021, NCR Corporation launched the first interoperable cardless cash-withdrawal (ICCW) solution based on the UPI platform which facilitates customers to withdraw cash using their mobile with any UPI. The growth of the India digital banking platform market can be attributed to rapid digitization and growing adoption of advanced technologies, such as cloud computing, the Internet of Things (Internet of Things), Artificial Intelligence, and so on.

Yes, the banking customers are in for interesting and interacting experiences going forward!!

The economy must look beyond FY22 challenges

Intro: With a global stagflation-like condition, the economic ground work for a revival next year is underway.

While there is much market mayhem going on, the economic front is facing an uphill battle in showing good growth rates. There was a glimmer of a revival after the pandemic re-opening, but now there are a new set of challenges for the corporate, household and economy after the Russian-Ukraine conflict.

A recent RBI report on currency and finance titled ‘Revive and Reconstruct’ highlights the difficulties in shoring up economic growth rates. One important consideration summarises the economic picture is succinctly reflected in a paragraph from the report.

“Corporate balance sheets have coped with the pandemic by deleveraging and increasing liquid assets, but investment appetite that should motor a renewed capex cycle is still weak,” underscored the report. “Frail household balance sheets and labour displaced from contact-intensive activity have impacted consumption demand and quality of capital. As a result, the trend growth path of India may have shifted downwards, warranting urgency in putting in place a comprehensive range of measures for re-invigorating growth, while negotiating net-zero transition costs, de-globalisation and broken supply chains.”

In a slow gear

In short, the economic growth rates have to be calibrated downwards given the multiple global headwinds. The RBI has pointed out that a feasible range for the medium-term steady state GDP growth in India works out to 6.5-6.8%. For the Indian economy which needs a much higher growth to lift standards of living, this downshift from earlier expectations of upwards of 7.5% this re-calibration is not good enough. This does not reflect the potential of the economy.

A risk to economic growth comes from the fact that the government debt levels are high. In fact, the government needs to bring down its debt to below 66% of GDP over the next five years. One of the second-level outcomes of this will reflect in the release of available resources for the private sector to increase its capex activity.

However, it’s pertinent to note that the general government debt may not decline to below 75% of GDP over the next five years in the best possible outcomes. In adverse conditions, debt may even hover above 90% of GDP. With the debt-to-GDP hovering above the 88% mark, that could be a distinct possibility.

Another big challenge for the economy is to re-balance monetary and fiscal policies. One of the key considerations is to withdraw the large surplus liquidity overhang in the economy. Consider this, average inflation rises by 60 basis points with every percentage point increase in surplus liquidity above 1.5% of net demand and time liabilities (or deposits with the banking system). In other words, price-stability is now paramount.

Long term drivers

For longer and more sustained revival, there is plenty of ground that needs to be covered . The government has introduced several measures  to boost economic activity, such as the PLI, tax reforms, increasing capex spends. However, reviving private investment will need access to cheaper land resources.

Further, the quality of labour has to be enhanced which means raising expenditures on education, health and Skill India initiatives. Private sector research and development activities also need to be stepped up considerably, which can be a driver of innovative growth. The government must encourage corporate investment in agriculture and create an enabling environment for start ups and unicorns in research and innovation.

Inflation control over growth

Nevertheless, for now the monetary policy committee (MPC) is prioritising inflation over growth at its April meeting. One of the first things, the RBI has done is increased interest rates in the economy by about 40 basis points. Even so, when there is an upward pressure on interest rates in the global economy, the Indian economy will find it difficult to isolate itself and keep interest rates low.

Global inflation is worrisome, particularly food and commodity inflation. US inflation is galloping and Fed watchers are forecasting sharp rate hikes to reign in inflation. China is battling a resurgent covid epidemic. Europe is going through its own set of challenges to stave off a recession due to food shortages and high oil and gas prices. 

Against this backdrop, driving an economic expansion in India is not easy. The rupee also breached the Rs 77 mark to the dollar to touch Rs 77.46.  The persistent FPI outflows and the Fed’s aggressive rate hike cycle are weighing on the rupee. So far, though the rupee has been holding on well, and the RBI is lending support to the rupee through direct interventions or swap auctions.

Globally central banks have to face the issue of high inflation and low growth. The RBI’s sudden rate hike and the pullback in the accommodative policy along with the hiking of CRR is a pointer to the upside risks in inflation. Hence, stagflation can be a major hindrance and one of the biggest challenges in the short run.

Groundwork in progress

The initial trends in consumption activity is patchy. However, monsoons are likely to be normal, and fertiliser sales showed an upward momentum. This will alleviate the stress in the rural economy. Farmers are also likely to get higher income given the increase in global food prices, hence that should see rural demand pick up over the second half.

The good thing is that India’s GDP growth of about 6.5-7% will still be one of the highest in the world. Foreign investors are bound to take cognisance of this fact once the carry trade position swapping begins to taper. Domestic investors continue to keep the faith, which will help capital formation.

For now, the economy will have to tide over the current global stagflation conditions. But post this consolidation phase, in FY23, India would be in a much better position to build on this consolidation phase.

Near term macro challenges – Indian economy

Global inflation is surging, roiling the Indian economy. Markets fear that steep rate hikes could be the only way out

The Ukraine-Russia conflict is fuelling higher prices of food and commodities. We have no visibility as to how long the sanctions could remain in place or what course the political situation in Ukraine will take. While countries have spoken about refusing Russian oil and increasing supplies from other countries, oil prices so far have hardly shown signs of coming down. Russia has signalled lower prices for some buyers, but transporting these supplies is a huge logistical issue. On the other hand, natural gas prices have been incessantly rising, giving authorities in Europe the chills.

One of the effects of all this is inflation trending uncomfortably high. The impact will be felt around the globe. Already, CPI inflation in March in India shot up, nudging 7%, much above the consensus estimates of 6.28% with higher figures reported in both food and non-food inflation.  Core inflation rose too to 6.32% driven by personal care (gold prices), clothing and household goods. The downside on the inflation front is that it may not abate in the next few months. Supply-chain price pressure, higher transportation costs could continue to pile the pressure. For this reason, the RBI may have to step in with rate hikes to cool prices.

Prima facie, the recently released Consumer Price Inflation of 6.95% for March does not seem too high. India has dealt with higher inflation in the past. However, the RBI had projected 5.3% inflation for FY22, and the recent figure has already exceeded the broad target range. The next one or two quarters could track a similar trajectory.

In the coming months, base effects should ease for some other segments as well, but second order effects (e.g., higher freight rates) and a likely weakening of the INR can provide an upside pressure to inflation. While the MPC's 1Q forecast of 6.3% may be beaten, the challenge would be in finessing out the "one-time" contributors and in this backdrop RBI’s projection of 5.7% in FY 23 appears highly optimistic.

Large rate hikes calling

Last year, the price of oil averaged around $71 a barrel; today crude trades at $108. Hence, some economists have forecast more than 6% inflation in FY23, far higher than the RBI’s 4.5% forecast. Of course, much will depend on whether oil prices ease in coming months. But if global inflation persists, the growing worry is that rate hikes in India would be about 100 basis points.

US consumer prices surged 8.5% in the 12 months ending March, from 7.9% in February. This is one of the highest levels, and the biggest jump since 1981. In the past the US Fed has reacted a mite slowly to rising inflation, though it has started to take cognisance of the fact that inflation is real and could prove to be challenging. Its recent 25-basis-point hike is a step in that direction. Fed officials hinted at more rate hikes in coming quarters.

However, in India the RBI has kept the policy rate unchanged at 4 per cent since February 2022. The MPC has pointed out that inflation is expected to peak in Q4 FY22 (within the tolerance band), then soften in H2 FY23, closer to the target. Nevertheless, with US interest rates being hiked, India will find it difficult to keep rates low or unchanged in coming quarters. India’s 10-year bond yield surged to about 7.2%, the highest since May 2019.

Macros slide

While export growth remained strong at 20% in March 2022 taking FY 22 exports to a record $420 bn, aided by growth in exports of engineering Goods and chemicals, higher petroleum prices, trade deficit rose to $4.9 billion taking the total deficit for FY 22 to a record deficit to USD $192 bn. India’s current account deficit widened to 2.7% of GDP from 1.3% in Q2 FY22. The run up in global commodity prices in the third quarter is one of the factors that led to the swelling deficit.

India’s economic output is another worrisome factor. In February, the Index of Industrial Production grew a meagre 1.7%, against the widely expected 2.7%. The low base has not helped much. Most sectors have seen declines. One reason could be supply disruptions, leading to higher input costs. Ahead, recovery could be hit by lower consumption, squeezing corporate profitability.

All these point to challenging times ahead on the macro front.

Markets resilient

The investment climate, though, is not that bad. After a scare on February 24 when the Nifty 50 dipped to a low of 16,247, the bellwether clawed back to about 17,500 in April. Despite the anticipated rate hikes, domestic investors are keeping faith in stocks. The recent strength in the stock markets point to the fact that investors are more than willing to give the benefit of the doubt to economic growth holding up despite the inflation.

The other view is that the market sees the US Fed as successfully navigating the inflationary era and making a much-needed soft landing. That’s one huge factor that longer-horizon investors will certainly hope pans out.

Insurance Broking Business– An investment perspective 

Background:

The overall size of insurance industry as measured in terms of Total Premium was ₹ 8,27,500 Crores (US$ 110 billion) in FY 2021 as per data collated from IRDA. This industry is expected to grow at a 17.8% CAGR to reach ₹ 39,00,000 Crores (US$ 520 billion) by FY2030, with life, health and other non-life insurance growing at 18.8%, 15.3% and 13.5% CAGR respectively, as per Frost & Sullivan report.

However, as compared with global peers, India has a highly underpenetrated insurance market. India was amongst the lowest in the world in terms of Sum Assured as % of GDP in 2020. India mortality protection gap as a percentage of protection was at 83.0% in 2019, one of highest in the world, despite Indian households being disproportionately dependent on a single income earner.

Financial illiteracy, lack of awareness of need and sufficiency of insurance, low household disposable income, complex products, gaps in product offerings and inefficiencies in distribution system has attributed to Low penetration in Insurance Industry. Opaque cost structures, hidden fees, incomprehensive language and jargons being used by the industry participants, has made people averse to insurance products. With limited disposable income, it is also difficult for most people in India to pay annual premiums to protect their life, health and other assets. The majority of people in India also view life insurance as an investment and tax-saving tool. People have been unenthusiastic to pure protection products as no monetary benefits accrues during life of the individual. On the distribution side, reach remains low and is a push driven model with agents, brokers and bank channels serving as primary sales channel. Lastly, there is no legal requirement for people in India to purchase non-life insurance (except for vehicle owners to have 3rd party motor insurance), contributing to its low penetration.

Recent changes:

With the intention of increasing distribution reach as well as enhance penetration of insurance in the country, IRDA introduced the Point of Salespersons (PoSP) model of distribution in 2015. Prior to the passing of this regulation, an agent could only sell policies from 1 insurer each in motor, health, and lifelines of businesses. The way agents usually used to work around this would be to register with multiple insurance companies using names of family members like wife, brother, father, mother etc.  This has now been modified. But now PoSPs after undergoing basic training and certification, can sell a variety of pre-underwritten or standard insurance products to their customers across insurers. PoSP need a minimum qualification of just 10th pass to qualify compared to traditional insurance agent.  The training and certification are also basic and easy to follow for beginners, who may not have in-depth knowledge of insurance products. It is an ideal choice for people looking to enter the industry and start an independent self-fulfilling career. Broad differences are highlighted hereunder:

This has created the emergence of this PoSP agent mode of distribution. Number of PoSP agents increased from 539,080 in FY20 to 827,901 in FY21 recording a growth of 50%+. The inherence advantage that a PoSP agent has is his ability to sell policies across insurers and across products. This allows him to cater to the variety of tasks from his customers rather than being limited to products of one insurer.  

In addition to functionalities other difference between an insurance broker and an insurance agent is the people/organization they represent respectively.

An insurance broker represents the end client whereas an insurance agent represents the Insurer. An Insurance Broker is normally interested in selling, buying, or negotiating various financial products best suited to their individual client’s needs for compensation. This means that they are more interested in finding out what’s best for the client and can offer a host of options from across Insurers, as per client’s requirements. An Insurance Agent, on the other hand, sells, negotiates, or promotes financial products on behalf of their employer organization. They act as the sales representatives for the company and its financial products.

 It would be evident from the above explanation that the PoSP agent is not directly linked to or represent any particular Insurer but associated with or works like an insurance broker. In fact, the creation of the PoSP agent framework with the ability to work across Insurers has created a new breed of large Insurance brokers. These brokers invest significantly in technology and process to enable them to scale up the business.

Progress of broking business:

Insurance broking as distribution mechanism has been growing rapidly over the last few years

• Motor Insurance: Rise in people’s affordability of owning motor vehicles is expected drive demand for motor insurance. Penetration of broking as a distribution medium has been greatest in the motor insurance line of business given the easier nature of the motor insurance product. Broking revenue has increased from 23% of overall retail revenues in FY17 to 35% in FY21. Distribution via agents contributed to 39% of motor GWP in FY21. Our view is that the broking distribution medium contribution would be able to take even incremental share from the agents share of the business. Overall motor industry size in FY21 was INR [67,800] Crs. At a [13.5] % CAGR the industry is expected to reach INR ~ [211,905] Cr by FY30. Of this the broking distribution would at least contribute 40%, thereby reaching a likely market size of INR ~ [84,762] Cr.
• Health Insurance: Health insurance historically has grown at 15%+ over the last 5 years to INR 25,840 Cr. The lack of public health infrastructure, insufficient coverage of health insurance by government and expensive private healthcare facilities has brought insurance into limelight particularly during impending COVID-19 pandemic. Going forward, with rising medical costs and ~15% of the population in India turning 40 years old in the next ten years, India’s health expenditure is expected to grow manifold. As a result, health insurance segment will become one of the most significant contributors to the growth of overall non-life insurance in India. Agents and brokers put together contribute 79% of the overall FY21 revenues. Of this Broker contributed 5% of overall FY21 revenues. We believe the broker’s share of overall revenues by FY30 should increase to at least 20%+ i.e., ~INR 46,000 Crs as there is increased focus in this segment from players such as Turtlemint, Renewbuy, InsuranceDekho etc., to cross sell health policies by its existing broking distribution network.
• Life Insurance: India’s life insurance market is expected to grow at 18.8% p.a. to reach ₹₹ 29,63,500 Crores in FY2030, driven by favourable macro indicators, rising awareness towards financial products and services, digitization and simplification of products and processes, widening of distributions channels, innovations and customizations in products and favourable government policies and regulatory push. 40% of the gross Life insurance premium booked during FY 21 was from the individual policies. LIC has ~50% market share and we believe this may continue. We believe 10% share of the individual retail life insurance market can be contributed by broking firms from the current 2-3%. Hence share of broking firms can go up to INR~ [59,000] Cr by FY30

Overall broking industry expected to increase to INR ~190,000 Cr by FY30, growing at a CAGR of 22+ %

Key funded brokers leveraging digital onboarding and rapidly expanding the POSP agent network are:

• Turtlemint: Started in 2015, raised ₹975 Cr till date from Sequoia, Jungle Ventures, CGV Capital, Nexus Ventures and Blume ventures. Current market leader in this space.
• Renewbuy: Started in 2014, raised ~₹700 Cr till date and is funded by Mount Nathan Advisors, IIFL Asset Management with last round in November-2021.
• InsuranceDekho: Started in 2018, Company is part of the CarDekho group which has been funded by funds such as Sequoia, Hillhouse Capital, CapitalG, Leapfrog.
• PolicyBazaar: Biggest B2C player in India. However recently launched B2B operations. Got listed on the exchanges in Q4CY21.

The top 3 players in this space have already crossed INR 1000 crores of Gross Written Premium (GWP) per year and are scaling up rapidly. The key to growth in this space would be incremental addition of PoSP agents as well targeting areas where existing agents haven’t penetrated as yet (Tier 3 and 4 cities). We believe given the inherent differences between a PoSP agent and a regular agent, agent additions would also over time migrate to more of a PoSP broking model. There are multiple well-funded players operating in this broking space, and they would spend on ramping on up technology integration with insurers, marketing spends, technology innovations for ramp-up of agent additions, process improvements etc. Over time this could have 2-3 large players with pan-India reach and ability to sell policies across motor, life and health lines of businesses.

When and how did it all start?

It is said to have started during eCommerce 2.0 in the mid-2000’s in the US when platforms such as Shopify, BigCommerce and Magento made it possible for vertical brands to make and sell their own products directly to consumers.

Brands such as Diapers.com, Warby Parker, Bonobos, etc were early pioneers with an explosion of experiments in new business models through flash sales directly to consumers.

After 2010, the US saw a sophisticated cadre of vertical brands such as Allbirds, Away, Glossier, etc launch and improve – product development, manufacturing, customer feedback loops, customer experience, mobile shopping experience, payments options, purpose driven products and big investment in Brand.

Examples of the early D2C brands 

1.Diapers.com

In 2005, Vinit Bharara along with his school friend Marc Lore started 1800 diapers.com. Took control of the number, put up a website, did Google search ads. They could not purchase directly from manufacturers as they needed a 2 years’ operating history to start hence, went to Costco and BJ’s to buy inventory, hired a stay-at-home mom to do the fulfilment and customer service, were doing just a few orders a day. 6 – 9 months later, a magazine called Babytalk mentioned them and that’s when Diapers.com really took off.

There was nobody else doing it except for Amazon, and Amazon was doing it in a very small way, hence it was not a big part of their business. So, if one wanted to buy diapers, one could not order them online in any reasonable way. You might need them the next day because it is an emergency. But no one delivered that way, or the cost was so expensive because of the shipping. There was not a market for buying diapers or really any essentials online in a reasonable way. The only other thing that selling was drugstore.com but they were not focused on diapers.

1800diapers was renamed at Diapes.com, they also launched soap.com and beautybar.com, added new product categories for babies.

2. Warby Parker

Founded with the object of offering designer eyewear at a revolutionary price, while leading the way for socially conscious businesses.

Every idea starts with a problem. Theirs was simple – glasses are too expensive. They were students when one of them lost his glasses on a backpacking trip. The cost of replacing them was so high that they spent the first semester of graduate school without them, squinting and complaining. Others had similar experiences and were amazed at how hard it was to find a pair of great frames that did not leave our wallets bare. Why?

The eyewear industry is dominated by a single company that has been able to keep prices artificially high while reaping huge profits from consumers who have no other options. Started Warby Parker to create an alternative.

By circumventing traditional channels, designing glasses in-house, and engaging with customers directly, they are able to provide higher-quality, better-looking prescription eyewear at a fraction of the going price.

They believed that buying glasses should be easy and fun. It should leave you happy and good-looking, with money in your pocket. And, that everyone has the right to see.

Almost one billion people worldwide lack access to glasses, which means that 15% of the world’s population cannot effectively learn or work. To help address this problem, Warby Parker partners with non-profits like VisionSpring to ensure that for every pair of glasses sold, a pair is distributed to someone in need.

3. Bonobos

Started Bonobos because the founders could not find pants that fit. They were either way too tight or too boxy. They fixed it. Now they have expanded their playbook to shirts and suits.

The secret is our signature curved waistband. It conforms to the natural shape of your waist.

Like most guys, they were not big fans of shopping. That is why they set out to build the best online shopping experience in the world, and we made it the core of what we do. We are now the largest clothing brand ever built on the web in the US.

What sets them apart – Easy returns and exchanges, Free shipping both ways and Ninja Customer Service.

4. Casper

Believe sleep is the superpower that charges everything people do – Spent years studying the magic and science of sleep. The more we learn, the more we are sure: Great sleep changes everything. It makes us friendlier, faster, smarter... even warmer-and-fuzzier. If we all got great sleep, the world would be brighter.

Dreamed a big dream – We started by creating an outrageously comfortable mattress and shipping it to your door in a tiny box. Now, over one million sleepers later, our mission has only grown...

Setting a new standard in sleep innovation – Our researchers, designers, and engineers at Casper Labs spend their waking hours studying sleep and creating products based on real customer needs and feedback. The result? The most innovative sleep products that no one else had ever dreamed possible.

As obsessed with service as we are with sleep – Mattress shopping should be as comfortable as crawling into bed. Whether it is our award-winning customer experience team helping you get a new bed for a big move, or our commission-free store team answering any question under the moon, we want you to rest easy.

Bringing joy to a tired industry – We want the world to love sleep as much as we do. From designing lovable products like our Nap Pillow and Glow light, to taking comfort to the sky with American Airlines, we are creating ways to turn yawns into smiles — one well-rested person at a time.

5. Away

Believe all travel makes us better. At Away, it is not only our job to make every one of those journeys more seamless, but our responsibility to make a positive impact on the world. We do this through our products, through the platform we have, and the community we create. In fact, before selling a single suitcase, we made it a priority to partner with organizations seeking to create a better world for everyone. Since then, we have worked with Global Giving, Peace Direct, International Medical Corps, God’s Love We Deliver, and the Trevor Project. If you have bought anything from Away, you have also contributed to their work. The world is a shared place - together, we can leave it better than we found it.

What we make – Quite simply: everything you need away, and nothing you do not. We started with the perfect suitcase, then built from there, creating a range of travel standards developed from the travel stories of friends and seatmates. Our pieces are not “smart,”

they are thoughtful, with features that solve real travel problems and premium materials chosen to be resilient and beautiful. The result is a group of travel standards that help you find your way by staying out of it.

How we do it - To give the entire world access to better travel standards, we took the direct-to-consumer approach. Our pieces are made with the same top-quality materials as other premium luggage brands.’ But our overhead is much lower, and our quality is guaranteed—your Away suitcase will be with you for life.

6. Harry’s

The founders, Jeff, and Andy created Harry’s because they were tired of overpaying for overdesigned razors. Instead, they wanted simple, high-quality products that felt good to use, all at a fair price. When they asked around, they learned lots of guys were upset about the situation too, so they decided to do something about it.

They donate 1% of our sales to non-profits helping men access therapy and other life-changing mental health resources. They are on track to reach 500,000 men—and donate $5 million—by 2021.

7. Allbirds

Launched in San Francisco in 2015 by Tim Brown and Joey Zwillinger. As a New Zealander, Tim was aware of the wonders of merino wool, one of the mainstays of his home country's economy. He wondered why shoemakers were not taking advantage of the material and started researching its place in the footwear industry. Several years later, he partnered with Zwillinger. The two of them created the flagship Allbirds shoes.

The company originally made wool sneakers with laces, then created a slip-on version. Earlier this year, it branched out into another material and introduced a shoe line made from the fibers of eucalyptus trees. They are similar in aesthetic to the original: Both are simple and feature zero branding. They are also the same price: "Tree runners" cost $95 per pair, the same as the wool version.

The company started out with a DTC business model, though it is since opened two storefronts, one in New York and one in San Francisco, and its currently operating pop-up shops in nine Nordstrom locations in US.

A few more DTC Brands globally - Meundies (Innerwear), Glossier (Cosmetics), Xiomi (Mobile Phones), Hims (Men’s grooming), Burrow (Furniture), Brandless (Private label groceries)

What is common for all these DTC companies?

Each one tells a story to appeal to customers, a lot of them were inspired / invested by DTC Guru – Prof David Bell of Wharton (who runs Idea Farm Ventures now) and serviced by common Brand / PR / Ad firms

Funding raised by DTC brands

It is estimated that there are now over 400 DTC brands globally and since 2012, DTC brands are estimated to have raised over $ 3b of capital, about half of which was raised in 2018 itself.

Investors have realised that most of their money is going to expensive and ever-rising customer acquisition costs (‘CAC’) via Google, Facebook, and Instagram. As a DTC investor put it, ‘CAC is the new rent’.

How these DTC brands fared

• com’s holding company ‘Quidsi’ got acquired by Amazon for $ 545m in 2011, which it finally shut down in 2017 as it failed to turn it profitable. It was a great brand which continued to offer its selection on Amazon.com
• Warby Parker founders raised their first $ 2,500 while at getting their MBAs at Wharton and it got valued at $ 1.75 b a decade later. It raised its last round of $ 245m in Aug 2020 at a $ 3b valuation, has been profitable since 2018 and the founders talk about an IPO like it is a ‘when’ but not an ‘if’.
• Bonobos got acquired by Walmart for $ 310m in cash in 2017, as it increased in focus on
• Casper which was once valued at over $ 1b in a private round, IPO’ed in Feb 2020 at around a third of this valuation and has a market cap of $ 320m. There are 175 online mattress companies, and one cannot tell them apart
• Away raised a total of $ 181m funding at a $ 1.4b valuation but soon found itself meshed in a PR crisis and is trying to recast itself and has many adjacent venture-funded expansion in the works trying to position Away as not just a travel company but playing a role in all kinds of products that one might need to carry along during a travel
• Harry’s cut a $ 1.37b deal in May 2019 to get acquired by Edgewell compared to its competitor Dollar Shave Club which got acquired by Unilever for $ 1b (at 5.5 – 6x revenues) 3 years ago. It was to give Edgewell the millennial edge – the data, marketing prowess and R&D but this acquisition did not consummate, and the co-founders of Harry’s are pursuing legal action against Edgewell
• Allbirds recently raised its Series E round of $ 100m at a valuation of $ 6b in Sep 2020

Indian DTC brands 

Indian DTC startups have raised $2 Bn in the past 8 years. In year 2021, 28 startups have raised $290.7 Mn.

Fashion DTC brands raised $756 Mn between 2014 and 2021 with a CAGR of 27.5%. Lenskart, Bluestone and Zivame were the most funded fashion startups in the DTC space.  

FMCG startups have raised a total of $677 Mn funding between 2014 &2021 and witnessed a growth of 135% in funding in 2021 as compared to last year. In DTC home décor startups raised $477 Mn funding during 2014-2021. Pepperfry, Furlenco and Wakefit are major home décor brands in this space.   

India is said to be a decade behind the US when it comes to DTC brands.

The Russia-Ukraine crisis poses a challenge, but the equity asset market is resilient

The Russia-Ukraine crisis has sparked an upward spiral in commodity and oil prices. Global authorities have imposed stringent sanctions on Russia, which will put additional pressure on global supply chains. Hence, pressure on global and domestic inflation is expected to rise.

Russia’s absence in the global commodity market will be felt over the coming quarters. It is one of the biggest commodity exporters globally with a significant export base in metals and oil and gas markets. Russia exports commodities like aluminium, nickel, steel, and other commodities. Replacing the global supply chains and finding alternatives to Russian supplies could take a long time to replace.

Disruption spikes inflation

In this scenario, prices of metals and other commodities could remain elevated in the coming months. Russia and Ukraine are major producers and exporters of Agri-commodities such as wheat and oil, which will have an impact on food prices in the coming months.

Already, the global economy has been reeling under rising inflation for some time with covid-19 playing truant with supply chains for some time. The US economy has been hit hard with inflation in the past few months which has risen to a 40-year high. For some time, the US Fed had been dismissing the inflation pressures as transitory, but inflation is now hitting the roof. With global commodity and agri-prices shooting through the roof, inflation-control will be the main focus of central bank activity in the coming year.

The US Fed’s upcoming policy meet will clear the fog on whether the US will bite the bullet of inflation control or wait for the markets to settle down. Before the Russia-Ukraine crisis, the market had factored in a high probability of the US Fed raising interest rates. If the US Fed does indeed hike rates in the upcoming policy, foreign investors will continue to be underweight on emerging markets, which could put added pressure on the Indian markets.

Double whammy

The Indian economy could face the double whammy of rising commodity prices and higher global interest rates. These are seen as a stumbling block for demand growth as well, which could pose a major challenge to the economy in the near term.

Further, India will also have to foot the bill of the oil price hike. Much of that will be passed on to consumers through higher prices of goods and services. India imports about 85 per cent of its oil requirements, while the rest is met in-house. In case, oil prices remain at elevated levels, the Indian economy is looking at a scenario of high inflation along with higher current account deficits, which will also result in higher bond yields.

Already, the signs are showing. CPI inflation has increased to 6.1% in February from 6% last month, and 5% a year ago. Food inflation has increased to 5.9% from 5.4% in January. The pressures on inflation will be even more striking in the coming quarters. Crude oil prices have risen nearly $20-25/bbl in the fourth quarter, but the full pass through to retail pumps has been muted.

If the oil prices remain elevated in FY23, retail inflation could rise higher than RBI’s estimates. It is estimated that a $10/bbl increase in Brent crude price impacts retail inflation by about 30-40 basis points. Hence, much will depend on where oil price settles down or it could hit the nascent post-covid recovery of the Indian economy.

Every dark cloud has a silver lining. Ukraine & Russia are among the world's largest exporters of wheat. The war has sent global wheat prices soaring. This gives India a golden chance to export record quantities of wheat. Several years ago, India exported a few million tonnes per year. This fell to zero when Indian wheat prices became higher than global prices. But in the current year rising world prices have made Indian wheat viable so exports can shoot up. If India can get a average price of $400 per tonne that will mean a whopping $ 8 billion for 20 million tonnes of export. Massive Indian wheat exports will not merely fetch a forex bonanza. They will also facilitate a sharp reduction of government’s bloated food stocks. These have been rising for years, since procurement has exceeded offtake from the Public Distribution System [PDS] and exports of wheat have been un economic for quite some time.

Strong backing by domestic investors

There are several pockets of resilience in the Indian market, given that the frontline indices have high exposure to sectors that will benefit from the rising commodity prices. Some of these sectors are metals, oil and gas, and export sectors such as IT and pharma that stand to gain from a strengthening dollar.  Sectors that could be hit would be domestic consumption, autos, FMCG, paint companies that tend to face higher input costs thus impacting margins.

Domestic investors are standing like a fortress. After an initial knee-jerk reaction, the Indian market has shown remarkable resilience in the last few days. Domestic investors have stepped up their investments. Foreign investors have remained net sellers in India in the last few months due to the risk-off sentiment. Since October ’21, foreign investors have pulled out more than $14 billion from the Indian markets.

On the other hand, domestic investors have more than offset the heavy FII selling by purchasing stocks worth more than $16 billion since October ‘21. Equity mutual funds have seen a net inflow of about ₹ 15000 crore in January or nearly 2 billion. This well-illustrates the fact that domestic investors have come of age and see the corrections as opportunities to invest.

So, on an optimistic note, even while the short-term sentiment is disrupted, domestic investors are keeping the faith and betting even bigger on the long-term resilience of the Indian economy and markets.

Pro-growth Budget is good for jobs, investments, and elevating income levels

India is well over the mid-point in the journey to becoming a $5trillion economy crossing the $3 trillion mark in GDP. The recovery in growth in the face of the global covid-19 pandemic shows the resilience of the Indian economy. But it was still imperative for the government to consolidate the foundations with a major thrust on structural growth.

The economy has challenged the resources available, and the country needs to do more with less. The demands of putting together the finances for a strong growth push balanced with fiscal prudence was equally no less challenging.

In that context, Finance Minister Nirmala Sitharaman has pulled the right levers to spur growth and regain the mantle of one of the fastest-growing economies. Budget 2022-23 is an investment-oriented budget focussing on capex driven growth, and rightly so. The government has shied away from announcing monetary stimulus despite the fact that a few major States are due for elections.

Budget 2023 continues to tread on the path that growth will be revived by capital expenditures, which has been the central focus of the government in the last few years. The government’s focus on schemes such as the Production-Linked Incentive (PLI), green energy with a focus on fiscal expansion is on the right track as opposed to monetary expansion.

The government has emphasised that a strategic push had to come from the infrastructure sector which required a larger spend in order to raise growth rates. The need of the hour was to match resources with strategic initiatives that would spur the economy and pace the recent momentum.

Venture capital in focus

On the venture capital front, the Budget rightly recognises the contribution the industry has put in facilitating start-ups, boosting employment and reviving economic growth. The Finance Minister mentioned that more than Rs 5.5 lakh crore was invested last year ‘facilitating one of the largest start-up and growth ecosystem.’

Even so, the Budget has seen the need to scale up these investments requiring a holistic examination of regulatory and other frictions. In this regard, the government will set up an ‘expert committee' to examine and suggest appropriate measures to scale up investments. It signals the government’s clear intention of clearing the roadblocks for further investments in start-ups.

The stance further corroborates the growing influence of venture capital in raising vital capital and complements the infra-led push in capital expenditures the government has outlined in Budget 2022-23 and is a good and welcome initiative to support investments through the private equity and venture capital vehicles.

In addition, the government has also made a small change to the tax structure. The surcharge on long-term capital gains tax has been capped at 15% for all listed and unlisted companies. While this is short of the long-standing demand for tax parity for unlisted firms, it’s a small step in the right direction.

Another major announcement is to create Thematic Fund-of-Funds, in areas like Climate change, deep tech etc., with Private Public partnerships, to create 2-3x multiplier effect like SIDBI NIIF Fof. The ask included creating Fund by NABARD for promoting Agritech start-ups which has also been acceded to

Capex thrust

On the economic front, the government continues to do the heavy lifting. On that count, Budget 2022-23 announced the much-needed increase in capital expenditures to Rs 7.5 trillion rupees.  With this strong push, an increase of 35% over the last fiscal, there will be more opportunities, jobs, and growth in the economy.

The government aims capital outlays in the region of 2.9% of GDP showing that it is intent on putting infra-led growth at the heart of the recovery.

In these engines of growth, the government will focus on developing roads, ports, railways, mass transportation systems, airports, and other transportation infrastructure across the country. The Budget has also envisaged an addition of 25000 kilometres of new roads by 2023. Indeed, the government has put an added impetus on infrastructure spending under the Prime Minister’s Gati Shakti Yojana.

Budget 2022-23 announced a spending of Rs 200 billion to expand highways and also said that 200 new trains will be manufactured over the next three years. The railway has also seen an increase of 14% in capital expenditures in FY23, led by new lines and doubling investments in public sector undertakings. The government will also add 100 new cargo terminals to speed up the movement of goods.

The focus on infrastructure and transportation networks clearly has the propensity to be a catalyst to drive India’s GDP growth significantly over the next decade, and we have seen many countries progress greatly as transport networks improved. These initiatives will go a long way in addressing the supply-side constraints and propel the Indian economy forward on a multi-year growth path.

In addition, the government extended the PLI schemes to domestic manufacturing in the alternate energy sectors such as the manufacture of solar panels. The PLI scheme has also been extended to the 5G ecosystem to enable the penetration of high-speed broadband and increase rural and remote area connectivity.

Conservative yet decisive

The Budget has an expansionary element on the fiscal front, but the increase in expenditures has been rightly channelised on capital expenditures rather than monetary stimulus. The fiscal deficit for FY22 is expected to marginally increase to 6.9% of GDP, which given the second covid-19 wave pandemic and the slowdown in growth is acceptable.

For FY23, the fiscal deficit is estimated at 6.4% of GDP, which is moderately above the consensus estimates of 6-6.3%. Considering that the Indian economy needs the infrastructure push and the additional expenditures to drive jobs and increase growth opportunities. But in all likelihood, the government is expected to meet its target the next year given the nominal growth in GDP is on expected lines, and the tax assumptions are quite realistic and achievable.

The government’s focus this year has been conservative on tax receipts, but firm on the growth agenda. The disinvestment figures have been whittled down to about Rs 65,000 crore against last year’s target of Rs 1.5 trillion, which was revised lower to Rs 78,000 crore.

Although some expenditures such as subsidies and welfare expenditures may overshoot the targets, the fiscal deficit for FY23 could still come under 6.4% emphasising the push in the government's ‘growth agenda’ will pay off.

Financial implications

Budget 2022-23 has envisaged a sharp increase in gross borrowings, however. Borrowings are expected to jump to Rs 14.95 trillion in FY23, as per budget estimates, from the Rs 10.47 trillion in FY22 revised estimates. This is quite a huge increase and it is intended to meet the higher spending targets.

While the Reserve Bank of India has kept the policy rates unchanged, in its policy release on 10^th January 2022, the higher borrowing program could thwart the liquidity normalisation efforts unleashed post the pandemic. Given the underlying inflation pressures in the domestic market, there could be a hardening of bond yields in the coming quarters.

The government’s higher borrowing requirements could limit private investment in capital expenditures. All this could result in heightened volatility in financial assets. Higher priced assets and valuations models could be pruned given the rising bond yields. Clearly, the investor focus will be trained on high return on equity and good cash flow generating companies in the coming quarters.

Budget – from TVS Fund perspective:

Our Fund’s focus on evolving themes have been reinforced through the Budget be it digital lending and financial inclusion especially the large SME market, and the growth in logistics space.

1. Lending space
   1. Revamped CGTMSE scheme to create additional credit of ₹ 2L Cr.
   2. ECLGS scheme expanded to ₹ 5 lakh cr. to include services sector
   3. 75 digital banking units – immense opportunity for neo banks and fintechs.
2. Logistics space
   1. 25K new Highways, GATI SHAKTI masterplan for express ways, 100 new cargo terminals with 4 multi modal logistic parks, to connect urban transport to Railways with 100 new railway logistics hubs and Unified logistics interface platform to be created for data transfer between diff modes of logistics for reduced documentation and seamless transportation.
   2. Compared to the global average of approximately 8 percent, the logistics cost in India stands at about 14 percent of GDP (about $400 billion).
   3. initiatives provide a massive opportunity to address the competitiveness gap of about $180 billion (about $500 billion by 2030). After having seen early adoption of RFIDs, GPS and IoT devices, Indian players are now transforming in line with global peers to adopt Industry 4.0 trends, based on artificial intelligence (AI), robotics and blockchain to build agile, high-visibility, resilient and green networks. Close to $6-7 billion of investment opportunity in the warehousing/logistics therefore looks bright.

We are more bullish now and thus focus on tech adjacencies in financial services and logistics space.

FY22 to end on a good note

Nevertheless, FY22 is set to end on a good note, despite the setbacks due to the second wave. Higher corporate tax collections, a robust increase in income tax, an increase in indirect taxes and other excise duties have reflected in the strong increase in revenue collections as per revised estimates for FY22. Some of these are being offset by additional spending due to the second wave and also the lower re-calibration of the disinvestment target.

One sour point in the outlook, though, is rising global inflation, which is causing a great deal of discomfort in the global market. The US Fed may get aggressive in controlling inflation which could mean a tighter monetary policy. Further, global geopolitics has elevated the risk of oil prices rising higher, which till recently has been arguably tilting the scales in favour of India.

Within these constraints, however, the evolving dynamics required the pro-growth agenda that the government is pursuing through increased capital spending. Over time, this stance will propel the economy towards higher GDP growth, increase jobs and raise income levels.

Never in the history of Indian Banking that so much is happening, in so short a time – be it payments, lending, collections – large scale disruptions and disaggregation of different segment of banking services – by various start-ups.  To top it all, open banking as a concept has started gaining traction in India with enabling infrastructure through Open Credit Enabling Network [OCEN] and Account Aggregator [AA] models. To understand this and more as to what is in store for Indian Banks, we had the opportunity of hearing from Shri Saurabh Tripathi, MD and Senior Partner, BCG on January 7, 2022.  This session is part of our series of Expert Talks which we organise on Fridays.

While it will be a pleasure to listen to him directly, from the video recording (appx 1 hour), we are prompted to collate some of the points of reckoning for quick reference. We strongly suggest that you take your free time to listen to him directly.

What is changing?

• Share of semi-urban and rural customers in loan retail lending has been steadily rising. This is independent of shocks caused by COVID and one-off events
• Branch density in India has been growing steadily, but remains well short of developed nations
• Success of UPI – Number of transactions gone through the roof.
• Also, many merchants have started putting QR codes leading to lower cash utilization. This would lead to cash digitization.
• Daily cash transaction moves from other modes to digital modes which leads to presence on digital statements which are machine readable. This helps banks to evaluate and provide credit to both the person paying to the merchant and the merchant itself.
• Bank Statements have higher ability to predict the ability to pay of any person

Neo-banking landscape:

• 45% of total Digital transactions are actually happening on non-bank platform à 75% in next 5 years – not be surprising though transactions may continue to happen in banking platforms as well. 5% of savings account on non-bank platforms currently and this may go up to 25% in FY 26.
• But for neo banks, path to profitability is only through lending
• Given RBI’s existing policies, digital banking licenses may take longer time.
• The neo-banking platforms might therefore need to consider seeking registration from RBI to operate as NBFC.

Enabling lending through tech: 

• It can be reasonably expected that by FY26 the bulk of banks’ digital services will be originated on and available through third party platforms and therefore, in the future, lending process will be facilitated by availability of data from third-party platforms and service providers
• Borrowers’ data that lenders require for their assessment will be available on third-party platforms (GST, Electricity bill, Utility bills, EPFO details, MoC registration data etc.,) and data providers (like an Account Aggregator), made accessible to the lender on demand and per consent of the borrower.
• Bank Statements combined with information collated by Account Aggregators from GST, MF Data, Insurance Data, Income Tax etc. would make the predictability of ability to pay higher and enable further credit.
• Even in secured lending, processes can be expedited, through digitization of records (land and property records) and financial assets
• This would be enabled by OCEN (Open Credit Enablement Network), which will provide a single set of APIs to connect and integrate all lenders – enabling it to act as a super Account Aggregator
• Open availability of data will ensure high levels of transparency in the system, in turn resulting in competition among lenders
• Massive potential with Open Network for Digital Commerce [ONDC] – can create a digital ecosystem connecting many players, all of whom can be involved in providing banking services / lending. Any platform that receives customer traffic can become a loan service provider [LSP]
• There can be ‘big tech’ play that sits on top of banking solutions to capture customer relationship. A public stack through ONDC, or some such solution can level the playing field for smaller players.

Valuations and market caps

• We should see changes in the market cap shares of financial services companies.
• In the future, the share of PSU Banks and NBFCs are likely to go down, while the share of Private Banks and Fintech companies are bound to rise – core banking solutions with banks presently in operation, are not able to match fintech’s in uptime / availability and may need to be upgraded to keep up with the pace and competition.
• Cybersecurity may be another key issue to address
• Even within Fintech, payments accounts for the largest market cap currently. But this will soon be overtaken by lending tech
• BNPL is another area that will scale massively, and will soon surpass credit cards in customer base

Way forward:

• Unlock potential for embedded finance by neo banks
• Pivot to sector specific digital ecosystem solutions for industry with embedded finance
• Leverage existing networks such as FPOs, dairy collection centres, post offices, ration shops
• Build partnership business units
• ‘Federated lending’
• Build tech, AI, and digital talent
• For Global banks, the standard has been that 10.3% of staff are tech staff. This figure is at <2% for Indian banks. Over time this gap will have to bridged
• Apps and products must be designed keeping customer experience at the fore front
• Collective action as an Industry – as a SRO or Association to bring in changes from regulator depending on market requirements.

  Video Link: https://youtu.be/oJOnblqE9gs

Digital Bank – NITI AAYOG paper

“A Proposal for Digital Banks in India: Licensing & Regulatory Regime”

Background:

1. Nachiket Mor Report in 2014 – Payment Banks, SFBs, differentiated banking policy, harnessing narrow specialisation instead of doing everything.
2. Payment banks – 11 licences granted only 6 are functional
   1. issue deposits, no credit but earn income from HQLAs and fees from distribution, aimed at furthering financial inclusion.
   2. envisaged as distribution points for other socially relevant financial instruments (e.g. insurance).
3. SFBs – 11 licensed and still operational
   2. Have to maintain at least 50 % of the loan portfolio in ticket size of ₹ 2.5 million and below.
   3. 75% of the credit to sectors identified as priority sector
   4. Are envisaged to leverage technology to increase coverage and financial deepening
4. Other developments:
   1. Under PMJDY, launched in 2014, 420 million bank accounts have been opened till date.
   2. UPI, launched in 2016 was the bellwether of enabling real-time payments system, clocking ₹ 4 trillion (in value) transactions till date
   3. India’s own version of “Open banking” through the Account Aggregator (“AA”) regulatory framework enacted by the RBI. – Likely to deepen credit amongst underserved.

What is left?

While regulatory innovation has catalysed payments sector reforms, upended the user experience, i.e., the engagement layer of payments but making little improvement in the core utility banking layer – large segments not benefitted by the digital revolution.

A substantial fraction of 63.88 million MSMEs remain outside the ambit of formal finance -with reliance on informal money markets like money lenders (quick disbursal without documentation) or chit funds - no credit history – unviable with extensive due diligence required. Documentation by banks is large and takes long time to complete.

Credit gap to MSMEs is still ₹25 trillion – Supply side factors

1. Limited underwriting ability
2. High transaction costs
3. Lack of innovation in products
4. Low risk appetite

Thus, there is both demand side and supply-side friction that results in what economists refer to as “market failure” in the formal MSME debt markets.

NBFCs by digitising value chain has higher market share in MSME lending. TReDS also suffer from (a) procedure restrictive (b) reverse factoring by corporates (c) limited pool (d) limited to MSMEs and corporates don’t want multiple platforms.

5. New Business Models – public policy intervention on banking license innovation required-
   1. Digital native -MSMEs- using SaaS vendors – requiring WC tailored to its billing and payment cycle. Traditional banks cannot customise credit codes on CBS on the fly for these clients.
   2. Researchers found that lending to a random sample of 40,000 MSEs by a Digital bank (My Bank in China) was positively associated with sales growth at borrowers. They further established a possible causal relationship between lending by a Digital bank and the MSE’s higher sales growth during the pandemic, due to absence of high touch due diligence.

 What is Digital Bank?

1. Digital Banks” or DBs means Banks as defined in the Banking Regulation Act, 1949 (B R Act). In other words, these entities will issue deposits, make loans and offer the full suite of services that the B R Act empowers them to. As the name suggests however, DBs will principally rely on the internet and other proximate channels to offer their services and not physical branches
2. Same prudential norms as with other commercial banks
3. New regulations for DBs as regulatory innovation and not arbitrage.
4. Relying on digital channels have high efficiency metrics and Govt can empower unbanked small businesses with ease.
5. Three models in use:
   1. Neo banks: These neo-banks partner with licensed banks to offer “over-the-top” services to the consumers “renting” the balance sheet of a bank (properly so called) to lend and issue deposits from. (Open Technologies, RazorPayX, Dave). Neo banks bring in the engagement layer and the licensed banks bring in the “utility” layer and offer both sides of their balance sheet
   2. Digital Banks: These entities are fully functional banks, regulated by the banking regulator and issue deposits and make loans on their own balance sheet. (Starling, Webank, Kakao, Monzo, N26)
   3. (Autonomous) unit of traditional banks: These are essentially neobanking operations of traditional banks that function autonomously and compete with stand-alone neo-banks. (Marcus,25 (Goldman Sachs) 811 (Kotak Mahindra Bank), and Yono (State Bank of India)
6. DBs are better than front end neo banks as
   1. They combine niche products to under catered to segments
   2. They offer speed
   3. Superior user experience
   4. Recording profits through on balance sheet lending - like Starling
7. DBs are better than commercial banks
   1. Low-cost income ratio compared to PSBs and Pvt sector banks
   2. Lower CAC
   3. Can offer BaaS solutions – for example to a RRB or Coop Bank (need not spend on technology and offer niche offerings to existing clients) B-a-a-S makes it possible for the existing banking ecosystem to “do more with less” (in other words, to enhance unit economics) thus making it more competitive and efficient.
   4. Fintech NBFCs can partner with a Digital Business bank and leverage their credit card issuance infrastructure to issue and manage its own credit card clientele. The cloud-native architecture of the Digital Business Bank can potentially cut down the time-to-market for the NBFC by an order of magnitude, as opposed to traditional banks that can take up to 6 weeks to integrate and run such a program
8. Augmented Credit Under-writing: Account Aggregators (AA) can on-board Digital Business banks on the AA ecosystem. Business consumers can then use the consent architecture to share their data with these banks with “financial information users” to enable better credit underwriting. On the same lines, can augment their own credit models and underwriting by relying on historical data provided by incumbent “financial information providers” to offer business banking and lending products to their customers.
9. Limitations of neo banks:
   1. Limited revenue potential – only fee sharing on channel partnerships (account opening, investment support, credit etc.,) and inter payment charge on cards (challenge on MDR persists)
   2. Restricts the ability to leverage their balance sheet and their own technological stack to create “ground-up” credit products and user experiences, their potential will never be fully unlocked – obsolete CBS with banks does not permit
   3. High cost of capital (no access to low-cost deposits) and low entry barrier (Me Too Risk – herd mentality of so many coming up

Recommendations on framework:

1. Start with sandbox environment with Restricted Digital Bank licence (with lower capital requirement of ₹ 20 cr. etc.,) graduating to Full stack Digital Business Bank licence, contingent on satisfactory performance. For full stack Digital Bank recommended capital is ₹ 200 cr.
2. one or more controlling persons of the applicant entity to have an established track record in adjacent industries such as e-commerce, payments, technology (e.g. cloud computing). Existing neo-banks seeking to upgrade or small finance banks / other regulated entities may also apply.
3. Access to all public infrastructure – including ATMs, UPIs, AA eco system and Deposit insurance cover from DICGC.
4. All the statutory prescriptions like CRR and SLR would also be applicable.
5. The applicant should comply ex ante technological preparedness and ex post business continuity planning.
   1. Ex ante technological preparedness will entail:
      1. Continuing compliance with industry-grade certifications like PCI-DSS and the attendant audits of the Digital Business Banks.
      2. Board-level policies and expertise in assessing evolving cybersecurity risks, by mandating a defined fraction of executive directors to have relevant skill sets.

• Additionally, installing and upskilling technology risk supervision personnel of the RBI commensurately to offer intelligent oversight of the first line of defence.

1. Finally, due to their “digital-native” avatar, new technologies such as machine learning and blockchain can be more easily and seamlessly integrated into the overall operations of Digital Business banks (as also DBs generally). These technologies can provide an extra layer of security.
2. Business Continuity Planning: Digital Business banks will be required to submit BCPs to provide for exit strategy for all potential creditors for all financial, operational, and saliently, technology risks. Regulatory oversight over BCPs is especially important in the context of DBs given that they can leverage their APIs to have relationships to numerous counterparties that risks can originate from.
3. Technological neutrality: Consistent with the best practices the Digital Business bank license and the ambient regulation should be technologically agnostic. It should neither express a preference for nor bar a Digital Business bank from using/ not using any technology.

1. Products and services: Subject to asset and deposit limits and other restrictions (including for eg, number of customers), a Digital Business bank should be able to offer standard banking services: Loans / Current Account /business banking Services / fixed deposits to MSME businesses / Factoring / Distribution (Channel Partner) and Others specified in Section 6 of the BR Act.
2. Progressive interpretation of branch mandates: Consistent with the best practices the license may stipulate that the Digital bank may have one place of business. Furthermore, consistent with the RBI’s continuing progressive re-interpretation of branch mandates, to account for technology as a factor in delivery channel, the license may lay down the objective of delivering banking services to defined unbanked areas leaving the channels of delivery to be determined based on the bank’s policies.
3. Value Added Services: APIs enable digital banks to integrate services like payroll, accounts receivables/ accounts payables management, tax compliance and other S-A-A-S based services in the business flows of their customers directly. These services offer both an engagement avenue and revenue source for the proposed Digital Business Bank. VAS offers a robust revenue model and thus digital bank have the permission to engage in non-financial business complementary to their core financial business, under this license subject to there being no prudential risk in the same.
4. RBI will have the authority to issue licence under BR Act, vesting banks to undertake NFB services, RBI may require approval from Central Govt.

Rising inflation and taper talks make cash flows the metric to watch

Global equity and bond markets are faced with a paradox. As supply-chain disruptions, rising demand, and accommodative central banks create havoc with this one major macro-economic indicator, inflation, the immediate concern for policymakers is: when is the most appropriate time to begin to raise interest rates.  

US inflation jumped to an alarming 7% from a year ago, spooking policymakers that the persistent rise will require tighter inflation-control measures than earlier forecast. While high inflation is not new in the US, it reduces the purchasing power of the savings investors built up during the pandemic. 

Minutes of the US Fed’s latest FOMC meeting minutes, released in early January, offers some pointers to what lies ahead. The minutes left on the table the option of raising interest rates earlier than anticipated. While the US Fed had forecast that it would raise its benchmark rates thrice in 2022, global equity markets are bracing for what could be four or even five rate hikes that may be needed to tame runaway inflation.  

Watch for the Ides of March

Some experts are of the view that the rate hikes could start as early as March about the time quantitative easing ends. That could unnerve and unsettle financial markets. Bond yields in the US are soaring. The 10-year benchmark bond yield jumped to 1.77% in December. Contrastingly, US bond yields were about 1.25% around the middle of 2021. 

More pertinent for investors is the pace of reduction in the US Fed’s balance sheet. Over the past two years since the lockdowns, governments have been quick to unleash massive amounts of liquidity that has fuelled the incessant rise in equity markets and lowered bond yields. 

The US Fed’s balance sheet has more than doubled, from $4.1 trillion to over $8.7 trillion, due to accommodative stance by Fed to nurture the US economy since the pandemic began. Some of that liquidity has flowed to emerging markets, boosting asset prices, and puffing up equity valuations way above average for some time now.  

Valuation re-jig

Faster-than-anticipated rate hikes could change the dynamics of global markets. First, some of the high-growth technology stocks could be in for a repricing if the rate hikes are persistent. Technology stocks are sensitive to rate hikes as they reduce the valuation multiple investors are likely to give them based in the discounted cash flow valuation model. 

Technology stocks are valued on the basis of discounted cash-flows, which price future earnings growth. When interest rates rise, the discount rate on these expected earnings increase, thus driving the net present value of future earnings lower. Some of this could rub-off on valuations of fintech companies and start-ups with frothy valuations based on anticipated high-earnings growth. 

However, even with rate hikes, while some of the valuation sheen could come off, the US Fed’s balance-sheet-tightening plan is still some time away. The Fed is expected to whittle down its balance sheet only later this year. This will, however, be closely watched, depending on whether the US Fed’s initial rate salvos manage to curb inflation or not. 

Suffice it to say that the equity markets are bracing for some rough weather, although CY 2022 has been off to a great start with bellwether indices once again nearing new highs.  

India in a better shape 

India has come a long way from the 2013 'taper tantrum' though. There is a high import cover of more than 13 months due to its swelling forex reserves of nearly $640 billion. That puts India a better balance of payments situation. Second, inflation is still very low unlike 2013 when it was near double-digit. Back then, Indian markets were relying heavily on foreign capital. And so any unwinding of trades put emerging markets at high risk.

Not this time. Domestic capital had ushered in a huge change in India, which is now redefining India's market dynamics.  

Re-focus on cash flows

For asset managers, of course, the risk of inflation is a concern. Over the last few years, start-up valuations sky-rocketed in the rush to their becoming valuable Unicorns. 

If inflation starts to get out of hand, there will be a push to invest in companies that have real metrics, of performance and stronger cash-flows. 

Investors will begin to focus on sectors like inflation-hedged assets as cash generation will be the important indicator in the next two three years. 

When this shift in investment stance from chasing growth and valuation to cash flows and real earnings will happen is hard to tell. Nevertheless, our investments have been following this basic tenet from the beginning. 

Investment Theme – Litigation Financing

With capital moving in search of higher yields, we have witnessed significant interest in alternative forms of investment over the past few years. This has resulted in private funds pursuing opportunities in non-traditional areas of value creation. One such area is that of Litigation financing – a “third party funding’ practice of providing financial resources to a litigant over the course of a commercial litigation or arbitration proceeding. For the purpose of this blog, we aim to discuss the definition of litigation financing, its requirement, and the market available for the same.

What is litigation financing?

Litigation financing involves an arrangement where a third-party financier of a litigant receives returns from the investment either as a fixed percentage of the monetary relief or as interest on the funded amount or the potential relief awarded.

The arrangement of third-party funding itself is an old and established process, having been explicitly recognized and legalized under the Common Law of England and Wales in the 1960s.  That said, third-party funding is not yet a well-accepted practice the world over – thanks to concerns over ethicality as it may lead to the possibility that one litigant can essentially outspend the other, and thereby get a favourable award.

Given the concern with ethicality, it is important for one to note that all third-party contracts are executed on a non-recourse basis. Essentially ensuring that the funding party will only receive monetary benefit only if the litigant receives monetary relief pursuant to the proceedings. This affords the litigant the opportunity to match the spending power of the opposing party, free up resources which would have otherwise been tied up and manage the overall exposure to the dispute. Moreover, given the non-recourse structure, the litigant cannot be held liable for expenses incurred by the funding party if claims have not been awarded.

Requirement for litigation financing

While we utilise the term litigation financing, the concept is equally applicable for arbitrations, especially international arbitration proceedings, where the costs can beprohibitive.. As such, requirement for financing exists for both smaller litigants and large corporates to ensure a significant portion of the company’s assets are not tied up in unproductive and time-consuming endeavours.

As an example, a typical dispute would see a corporate incur costs in the following areas:

• Flat fees paid to ICC for hosting the dispute
• Administrative fees (arbitrators fees and expenses)
• Lawyer’s fees (billed on a per day basis)
• Fees payable to any external witnesses
• Overhead costs of senior management

As such third-party funding arrangements have been seeing increasing adoption as companies (and in some cases individuals) get drawn into high value commercial disputes, requiring expensive litigation and arbitration proceedings that might be drawn out over months, and in some cases years.

Market for litigation financing

There exists a large difference between global and domestic awareness and acceptance of litigation financing or third-party funding as there exists some contention on its legality in India. Internationally, several exist in the space and range in size from a few million dollars to a few hundred million dollars, and in some cases over a billion dollars. A survey by Westfleet Advisors estimated that (i) the US litigation funding industry had USD 11.3 billion worth of assets under management in 2020, and (2) third-party funders deployed USD 2.5 billion of capital form mid-2019 to mid-2020 to finance litigations in the US.

The first major player in the third-party funding space to be aware of is Burford Capital. Burford was founded in London in 2009, in the immediate aftermath of the global financial crisis, and was immediately listed on the London Stock Exchange’s Alternate Investment Markets. Today, it has nearly USD 3 billion in assets under management, and is listed on both LSE and NYSE. One major variation that can be observed in the global market is in relation to the nature of the processes being funded. In the UK and in the US, the bulk of the third-party financing activities are to bear the costs of arbitrations. However, in the third best established market for such services, Australia, the bulk of third-party funding flows into litigations.

As mentioned, third-party funding is still a new and contentious concept in India. The general understanding appears to be that third-party funding of legal costs is permitted but might be at risk of judiciary scrutiny on a case-by-case basis.

LegalPay is the only major Indian firm offering third-party funding for litigations and arbitrations. LegalPay was founded by Kundan Shahi in 2019, and finances commercial litigation cases. Its typical ticket size is 25 to 50 lakh per case, which is quite minimal compared to the global players, and practically rules it out from financing big ticket litigations and international arbitrations.

Legal Pay follows a typical AIF model for its revenues, and earns 2% management fee on the capital managed, subject to providing a minimum IRR of 14%, and has publicly disclosed its aim to provide an IRR in excess of 30%. It aims to raise in excess of ₹200 Cr in assets under management by the end of FY2022.

Pros and Cons from an investor perspective

Per a New York Times report, litigation funders in the US were highly profitable, and realized 30% IRR on investments. Sophisticated investors, including pension funds, had included litigation funding in their investment portfolio.

Some of the obvious benefits that an investment in a third-party funder offers to its LPs include:

• Returns that are not directly correlated to the market
• Returns not subject to market-related systematic risk
• Returns that might be inversely correlated to market crashes – an adverse market event often ensures that there will be a higher number of disputes
• Higher degree of diversification – thanks to lower cheque sizes

At the same time some of the obvious demerits are:

• Each investment has a higher-than-average risk of wipeout, as funding is always non-recourse.
• Possibility of long timelines – litigations can take a long time to reach their conclusions as it wends its way through the legal system (particularly in more challenging markets like India).
• Challenges to the proceedings – litigations and especially arbitrations can be delayed because of delay tactics employed by the defendant including by initiating new proceedings challenging the jurisdiction and validity of the first claim.
• Difficulties in enforcement – enforcing the results of arbitration or even litigation awards can be challenging, including as a result of hiding of assets, or through follow-on proceedings initiated by the defendants. 

Conclusion

Despite the above-mentioned demerits of litigation financing, there appears good  potential for growth in the domestic context. Further, with the increased instances of arbitration and litigation along with the rising costs associated with the same, the option of receiving third party funding will ensure that all associated parties will be on a level playing field. From an investor perspective, while this may not be the ideal place to invest a majority of your portfolio (especially without detailed knowledge of the field), this offers another way to diversify your portfolio given its lack of correlation with the market.

The Indian IPO Boom

The IPO boom is a win-win for everyone

The primary market is blooming. Founders, entrepreneurs, and businessmen are showing an immense zeal in getting their companies listed and publicly traded. More money is pouring into equity IPOs with this year seeing record subscriptions in several IPOs. Entrepreneurs on their side are not shying away from the public scrutiny that comes with the listing, but many are even confident that their companies will do better post the initial offers.

Over the last year, particularly the fourth quarter, large marquee IPOs have tapped the primary market in 2021 many of them led by first-time entrepreneurs. In the sizable number of companies that have recently listed, many are backed by private-equity investors, while even more private-equity-backed firms are queuing up to launch IPOs.

No doubt, the abundant liquidity has meant that the appetite for equity is good, and valuations are high, but with the many IPOs particularly in the internet space meeting with immense success, it shows that the Indian markets have also matured enough.

What is noteworthy of this IPO boom is the coming of age of internet-based companies in sectors like e-commerce. A few years it was perceived that the market was not conducive for participation in internet-based platforms because their business models were either complex or not fully understood by retail investors. Some of these companies needed to make greater investments in technology and visibility to gain scale, while many of them were not showing sizeable profits in their bottom lines.

However, investors surprisingly lapped up these companies with amazing appetites. Internet companies, namely Nykaa (with TVS Capital Fund an early investor), Zomato and PolicyBazaar, have smoothly transitioned from privately held to listed players. PayTM has had a wobbly start on the bourses, but still garnered enough subscriptions for its IPO.

Besides, several more internet-based platforms are lining up plans to list. In the next few months, Oyo, Mobikwik, Delhivery and Ola have signalled IPOs. Further, in the coming year, Indian companies are expected to see IPOs of several tech companies backed by private equity. The shift toward digitisation has meant that the internet-based model has become hyper-scalable within a shorter time.

The one good thing of all of this is that it shows venture capital is funding start-ups not just to find the next hyper-scalable model but also to showcase it in the primary market. While there have been secondary exits, companies benefit immensely from private-equity partners. Venture-capital firms are more active in many cases in helping businesses scale up and turn market ready.

Even on listing, several private-equity players continue to hold stakes because the Indian market still offers tremendous scope for growth. In many cases, the handholding and contribution in nurturing the firm with the insights of private-equity players in scaling up their businesses prove invaluable for new companies eager to grow.

Nykaa is a recent good example of a successful listing of an internet company even as it is still investing in growth. FSN E-Commerce Ventures Limited (Nykaa), the consumer-technology firm, delivering a content-led lifestyle retail experience to consumers, and where TVS Capital Funds had been one of the early investors, took the untrodden path of brand discovery for customers partnering with content creators.

Since then, there has been no looking back. Nykaa’s diverse range of beauty, personal-care and fashion products, and its own brands are huge draws for customers, along with an omni-channel experience. Interestingly, Ms Falguni Nayar, founder, turned entrepreneur in 2012, scaled up her business rapidly in the past decade.

Another noteworthy feature of the IPO market is that while it continues to be dominated by financial-services companies, new sectors are also listing. A case in the point is the recent offering of Medplus Health Services Ltd, where TVS Capital had been an early investor. The company, founded by Mr Gangadi Madhukar Reddy, focusses on offering genuine medicines and delivers value to customers by reducing supply-chain inefficiencies.

In fact, Medplus has already scaled up considerably and is the second-largest pharmaceuticals retailer in the country in revenues and number of stores, a commendable achievement. The firm further plans to increase its store count substantially in the second half, and enjoy the benefits of scale.

A non-banking finance firm slated to tap the markets is Five-Star Business Finance Ltd, where TVS Capital Funds Ltd is an investor. Providing secured business loans to self-employed individuals, Five-Star Business has seen the fastest AUM growth within a subset of large peers with more than Rs 3000 crore in AUM, with a CAGR growth of 65% from FY17-FY21.

Five Star’s investors include TPG Capital, Sequoia Capital, Matrix Partners, Norwest Venture Partners, KKR, and TVS Capital Funds. The investors along with the senior management have been instrumental in formulating and executing core strategies.

The good thing is that the tide of money flowing from investors is also giving opportunities for new ventures to tap funds for growth. But while there is no dearth of funds, there is overvaluation in this market and one has to make sure that private equity or venture capital does not over allocate in this vintage asset class. Allocating private equity money is all about being judicious, even while exits through primary equity market sales are increasingly the option.

Nevertheless, one thing is quite clear: the market is rewarding the good entrepreneurs with several firms commanding a good market cap. The internet IPOs are not only gaining critical mass, but Indian entrepreneurship is also getting rewarded. While valuations may appear stretched for now, in the long run, it seems likely that the boom in the IPO market will be win-win for everyone.

With several prominent founders and CEOs stepping out of their work and family lives to take part and share their entrepreneurial highs and lows with distinguished and elite guests and entrepreneurs, TVS Capital’s Founders’ Day celebrations witnessed a rousing start.

The event drew a diverse crowd of seasoned entrepreneurs including Ms Falguni Nayar, the founder of Nykaa, recently listed on the exchanges. TVS Capital was its early private-equity partner. Over 50 joined in person. Many more live streamed the event that also saw two sets of young entrepreneurs showcase their new and promising business ventures. 

Distinguished guests, Mr R G Chandramogan, founder, Hatsun Group; Mr Ananth Narayanan, Founder and CEO, Mensa Brands; Mr Yogesh Mahansaria, Founder, Alliance Tire Group; and Mr Gopal Srinivasan, founder and managing director of TVS Capital Funds participated in the traditional lighting of the lamp. 

In his welcome address Mr Gopal Srinivasan expressed delight that TVS was celebrating Founders Day with many exceptional entrepreneurs present. Many entrepreneurs are also investors in TVS Capital’s marquee funds, Mr Srinivasan highlighted. In many ways, the venture funds are also India’s Entrepreneurs Fund since several investors are entrepreneurs and members from business families. Welcoming the guests, Mr Srinivasan said, “India is blessed to have many, many founders and we are very fortunate and privileged to be able to associate with so many of them.”

Mr Gaurav Sekhri, Principal, shared some of his thoughts on working with great founders. He noted that one of the key attributes of great founders is an insurgent mission, where the founder is at loggerheads with industry standards, thus generating tremendous energy and focus. Second, an owner’s mindset is key to an inversion to the bureaucracy that leads to the keen desire to look at problems differently and take responsibility right away. 

Mr Alok Samtaney, Principal, pointed out that great founders need to be able to zoom in and out as situations demand. They need to be able to share the vision of the company over the next few years, while simultaneously zooming in to review performances, identify issues and be up to tackling them; in short, focusing intensively on execution. Alok also highlighted that frontline obsession and doing everything possible to be able to constantly improve and get things right is a key trait of great founders. 

In an enlightening panel discussion moderated by Ms Rashmi Bansal, panellists - Mr Ananth Narayanan and Mr Yogesh Mahansaria shared their entrepreneurial learnings. The former pointed out that one should not worry about the result, but instead should enjoy the present moment. One can also make decisions based on gut, and not always on data.

The latter noted that, in his initial days, he learnt everything by himself, and those foundation years defined him. Notably, handling adversity and turning it into an opportunity was a key attribute. He highlighted that one of the pitfalls to watch was growing the business too fast without having a stellar team to take it forward. 

Mr R Chandramogan, founder, Hatsun Agro, in his address noted that he has a team of five lakh people, including 4.5 lakh farmers and about 50,000 more directly and indirectly working for the company. He highlighted the importance of always being a change initiator. “Don’t be an adaptor or follower. Focus on investing in building brands even though it is a slow cooking process and profits take time to build up.”

He highlighted that professional education is not necessary for entrepreneurs as skills can be learnt through hard work and experience. Hatsun's sales have grown 500x in 25 years. On navigating change, Mr Chandramogan noted that one should do things differently to adapt to changing times. “We grew our stock valuation CAGR at 37% while Buffet only grew at 19%!” ($ terms) What an achievement over 25 years!

Ms Falguni Nayar, founder, Nykaa, a former investment banker, had met many entrepreneurs in her role as MD of Kotak Mahindra Investment Bank. What she found inspiring was their early journey where they believed in their ideas despite the many naysayers, who did not believe in what the entrepreneurs were trying to communicate. However, self-belief and determination motivated them.

Mrs Nayar did not know retail, beauty and tech and most things when starting Nykaa. She noted that the challenges she faced in the early stage of entrepreneurship were the toughest when everything can, and will, go wrong.

On team building, she affirmed that, while people may not have domain expertise, they should be passionate and learn on the job, with an entrepreneurial mind-set to build something despite failure, and be solution oriented. 

Another highlight of the Founders' Day celebrations were two young entrepreneurs who showed their eye for spotting business ideas showcased their models. Litmus Eye, founded by Ms Manasa Shetty and Mr Nikhil, is a full-stack WMS that helps companies prevent vendor over-billing and fraud. 

Another start-up, Infinite Cercle, founded by Ms Divya Shetty, presented a business that makes innovative products from plastic and textile waste. The company has built a solution for the waste-management ecosystem, which ensures waste pickup and recycling with full traceability. 

In his concluding remark, Mr Gopal Srinivasan succinctly summed up the entrepreneurial spirit in the following words: Kaam karo ustsaha se, bado mahenat se, baanto kushi se, aur kaho na kisi se. 

Investment Theme – Revenue Based Financing

At a time when the creation of unicorns and successful technology IPOs are becoming increasingly commonplace, we are beginning to see a revolution in another investment structure which equally deserves investor attention. This is ‘Revenue Based Financing’, an investment mechanism which allows for traditional growth start-ups to raise debt funding rather than rely on equity infusion from private capital.

What is Revenue Based Financing?

Revenue Based Financing is an alternative investment structure with different mechanics/ returns compared to both equity capital and traditional lending products. It is a debt instrument, that is paid back by pledging a portion of the company’s future revenue.

Target Companies for Revenue Based Financing?

As mentioned above, Revenue Based Financing investors look for traditional high growth start-ups which:

1. Are not inclined to receiving equity capital to fund their expansion
2. Do not have assets and meaningful profitability to procure traditional debt products

As such, these would involve bootstrapped SaaS companies or other Direct to Consumer (D2C) brands which acquire their revenues through digital means rather than a cash business. This further allows the revenue to be escrowed prior to distribution.

Requirement for Revenue Based Financing

From the investor perspective, Revenue Based Financing allows for investors to gain exposure to smaller scale start-ups which do not have a path to exit for large investors. Rather, these investors will now receive a royalty on future revenue while taking little to no risk in the form of equity in the business. It is, however, important to note that if the companies fail to generate sufficient revenue, the investors will be forced to take equity in the company to recover their investment.

From the company perspective, this investment structure allows for flexibility in raising capital as current cash flows are not stable enough to ensure consistent servicing of debt. Traditionally, there is a 3-to-6-month gap between investment and revenue as the company needs to spend time on building inventory (in the case of a D2C brand) or developing their product (in the case of SaaS companies). Further, as these start-ups don’t have visibility or invoices on future revenue, there is currently no scope for invoice discounting. As such, companies find this form of financing more attractive, providing the opportunity to build scale as they pay back their investors and reducing the time taken to reach term sheet stage.

How Does Revenue Based Financing Work?

As against traditional methods of raising debt capital, the risks involved with Revenue Based Financing requires a more involved underwriting criteria by investors who are well versed with these types of businesses. The criteria for underwriting these investments primarily revolve around the following:

1. Existing Revenue traction and Customer stickiness
2. Revenue growth – nominal growth of 20% to 30% will be adequate (lower than expectations from traditional VC investors)
3. Quality of Operations – Ability to survive with 80% to 90% of revenue

Upon disbursal of the investment, the payback is structured around the multiple of revenue achieved as well as the period of payback. Therefore, unlike other forms of debt capital, Revenue Based Financing is dependant on the actual cash flows of the company in a certain period rather than prior agreed interest rate. Further, the actual IRR received by the investor can be a minimum of 12% to even as high as 50% depending on the company’s performance. To note, higher revenue growth will product higher IRR and vice versa.

In conjunction with the debt method of Revenue Based Financing, investors may also choose a hybrid debt/equity instrument for longer term capital. This allows for investment of 4 to 5 years where the remaining unpaid capital gets converted to equity when the company decides to raise a further round. 

Revenue Based Financial as an Investment Theme

There has been a structural shift in purchasing behaviour arising from the pandemic. This coupled with the regulatory push to decouple ecommerce platforms and sellers has created a large opportunity for D2C brands in India. Further, most D2C brand operate in a long tail market such as fashion, F&B, handicraft goods, kitchenware, lifestyle, etc, where both typical debt and venture growth capital are unsuitable.

On the software front, India continues its journey to becoming a SaaS hub given lower cost of economics and availability of talent pool. India currently has over 1000 SaaS companies, with more than a quarter of them being founded in the last two years. The majority of these companies don’t meet VC SaaS metrics but are strong businesses in terms of margins and cash flow.

Finally, we also note that the banking and NBFC industry has been unable to keep pace with evolving needs of these start-ups. Most banks still need hard collateral, which is a challenge for D2C start-ups who work on an asset light model. Moreover, these banks take anywhere from 6 to 15 months for loan disbursements as opposed to the 30 second terms sheets we can see in this segment.

Conclusion

The US now has 32 companies which are investing via revenue-based investing instruments and have a total estimated AUM of USD 6bn. India, is beginning to see a similar shift with over 250 companies being funded through Revenue Bases Financing, including companies such as Label 56 Life, Petsutra, TagZ Foods, Sanfe, Tjori, and Pipa Bella. However, there remain a few unanswered questions and challenges to ensure successful scaling of this investment structure.

1. As a company outperforms with higher IRRs (40 to 50%) they become attractive for VC funding. Given this case, there exists potential that Revenue Based Financing investors may be stuck with the low yielding companies, while others move into the VC ecosystem.
2. As the investors primarily follow an AIF or VC debt structure, there exists a challenge in attracting a similarly large quantum of capital for AIF II structures.

Notwithstanding the above challenges, given the unique requirements of these start-ups coupled with the inability of traditional VCs and banks to service the segment, we believe the Revenue Based Financing revolution has potential for significant growth in India.

Nykaa IPO - Overview

Not for the first time in 2021 and certainly not for the last, we witnessed the public market debut of a technology company provide stellar returns to investors. 2021 has been a year like no other for Indian equity markets, but what is noteworthy is that it has resulted in a convergence of private market and public market valuations. To go one step further, it seems that now private market valuations are having a direct impact on public market multiples. Interestingly, this could result in legacy companies considering their options for sacrificing a portion of their profitability for growth.

Nykaa is one such company which crossed a valuation of 1 Lakh Crore on listing day. At current levels, the company trades at a Price to Sales of ~40x with a Price to Earning multiple upwards of 1600x! If one was quoted the ~40x number, one would most likely assume that this refers to earnings multiple rather than sales (despite being a discount to Zomato’s valuation of 54x P/S). Indeed, there are multiple voices within the market echoing similar concerns with Nikhil Kamath of Zerodha tweeting “Nykaa lists at 1600 times price to earnings. They sell cosmetics online, Paytm next, the best thing for a value stock investor might be to go on a really long holiday right about now.”

While many macro factors have played a role in the Indian stock market rally over the past year, it is imperative that we look at the company independently of these factors to ascertain it growth potential. As such, we have included a brief overview of the company below along with industry factors which could play into our investment rationale.

Company Overview

FSN E-Commerce Ventures Limited or “Nykaa“, incorporated in 2012, is a multi-brand beauty, personal care and fashion platform. The company boasts a diverse portfolio of products, including owned brand products, allowing it to establish itself as both a retail platform as well as a popular consumer brand. Further, Nykaa provides Omni Channel experience through mobile applications, websites and 80 physical stores across 40 cities. This online model allows for ~2.0 million SKUs from 3,826 national and international brands to consumers across business verticals, which normally becomes a constraint in physical retail set-up. As of August 31, 2021, the company had cumulative downloads of 55.8 million across all its mobile applications and during the five months ended August 31, 2021, 88.2% of its online GMV came through our mobile applications.

1. Beauty and Personal Care – This segment is managed through an inventory led model, ensuring direct sourcing from brands to maintain authenticity of all products sold. Moreover, such an inventory led model also ensures consistent availability products.
2. Fashion – This segment, unlike beauty and personal case, is operated through a marketplace model where it does not carry any inventory and pushes orders directly to its partners. This is a capital efficient model for the fashion business and allows for a wide array of offerings as there is no need to maintain inventory.

Nykaa is founded and promoted by Falguni Nair, a former managing director at Kotak Mahindra Capital Company. She serves as a great example of the more recent phenomenon of professionals turning entrepreneurs – what we term as next-gen entrepreneurs.

Industry Landscape

The Indian consumption story is a recurring investment theme across categories and while it has certainly played out over the past 20 years, there continues to exist a significant growth potential. Indian retail, in particular, is expected to grow from Rs. 55 Lakh Crore in 2020 to Rs 91 Lakh Crore by 2025. Further, the retail market has grown at a CAGR of 5% over the last four years, driven by rising middle class, soaring income levels, increased spending by youth, increasing demand from Tier III & IV cities and rural markets, improvement in infrastructure and entry of new domestic as well as global brands. More importantly, once the impact from the COVID 19 pandemic ameliorates, we would expect to see a 11% growth CAGR until 2025.

With regards to the beauty and personal care market, we note that the segment has been growing at 13% for the last 3 years and despite the reduced spending due to Covid, is expected to grow at 11% until 2025. As we narrow our focus down to the online beauty market, we see a stark difference with growth at over 60% for the past 4 years. Further, this is expected to continue at more than 30% CAGR as online beaty products take up a larger chunk of the overall market. 

Investment Rationale

1. Strong headroom in online beauty, personal care, and fashion markets –
   1. Online BPC/Fashion markets remain underpenetrated and are expected to deliver a strong CAGR of 12% and 18% across BPC and Fashion segments. This will be driven by increased digital adoption and rising adoption of e-commerce by Gen-Z and Millennials
2. Strong/ Sticky Customer Base –
   1. Nykaa’s key strength exists in their ability to retain customers, resulting in a healthy growth in GMV over the years. The brand has innovated for customer satisfaction and purchasing behaviour by integrating across touchpoints. This has ensured their ability to meet customer needs and maintain a high level of loyalty
3. Private label portfolio to fill potential gaps –
   1. Consumer insights collected by Nykaa also aid the company in identifying gaps in the market which have not been addressed. This allows them to fill them through their own brands – many of which perform well even as independent brands. 

Risks

1. Stagnation in shift to online –
   1. If the company fails to acquire new consumers or fails to do so in a cost-effective manner, it may not be able to maintain profitability
   2. Alternatively, if the online commerce industry in India stagnates due to macro factors, this would adversely affect the company’s long-term growth
2. Correction in valuations –
   1. A key concern which was alluded to earlier, is the price at which one enters the Nykaa investment. If liquidity does dry up, there exists the potential for the valuation of Nykaa to correct, even if the company continues to meet its targets.
3. Changing Regulation –
   1. Changing regulations in India could lead to new compliance requirements for e-commerce companies, leading to uncertainty 

Conclusion

While we haven’t discussed exact valuation numbers, the above serves as an introduction to the company and the potential factors which may deliver returns for investors in the long term. While entry valuation continues to be a key risk, especially in the macro context, the company is set to benefit from prevailing tailwinds in the industry. Further, its strong technology platform, its relationship with brands and customers ensures it is well placed to capture long term value.

Building future Business: India@100

“When we wanted capital, we did not get money” – Deepinder Goyal – Founder and CEO of Zomato $13 billion enterprise – poster boy of India@60 –Zomato was founded in 2008

“We focused on survival, for days, for weeks and some months – success tasted after years” – that was Sanjiv Bikhchandani, founder of Info Edge – early investor in Unicorns including Zomato and Policy Bazaar – product of liberalised India –-took to entrepreneurship in 1990.

 “Listened to my Professor Mr. C.K. Prahlad’s advice to open the door to new entrepreneurs, give them capital and knowledge” more so, when I did not like our own large businesses –– my first Fund 14 years before, with 600 investors, was born to Empower next gen entrepreneurs like Deepinder” – Gopal Srinivasan, Founder TVS Capital Funds – first institutional investor in NYKAA way back

• Unbelievable statements but true. Obviously, there were more and why not?
• if three iconic entrepreneurs of different eras come together on a single platform to discover future of India@100, it cannot but be exciting.

To hear them out, directly, I plugged into special invite from Shri Vikash Agarwal, President, Indian Chamber of Commerce [ICC] – many may not know, ICC would be celebrating its centenary celebrations in a few years from now – got me a sense of pride in joining the event.

Who can be better choice to lead the discussion on India@100 other than Mr. Rajan Navani, MD&CEO of Jetline Group and National Chairman of CII’s Council on Future Businesses, India@75

Optimism was all pervading.  Naturally.  10 years ago, India’s GDP was half of France – last year we managed to push them behind. Gopal said – we may reach India@100 in less than 25 years- what a statement – India’s GDP could grow easily to $10-$15 trillion by then.

Let me break the whole conversations into different buckets as I briefly recall:

What makes you succeed?

What takes to build future businesses?

What are key learnings and suggestions?

Success

• Success is result of continuous trying and hard work. As Sanjiv said, we first focussed on survival. We did not have money for weeks in initial years -literally broke up - so success at that time for us was survival.  Endorsed by Deepinder -Focus on customer and his experience- success would automatically follow; for the first 4/5 years we focussed on doing what we know and could – we failed – later we started focussing on what the world wanted us to do and there we are now before you. Gopal in his true style said follow your Vasanas – follow your Swadharma -not Paradharma – try what is natural and do your best and focus on execution.

• Success is also not to fix up with an obsessed goal? Sanjiv said we tried several ideas and stumbled upon Naukri –it was an experiment after 6/7 years where we found the right connect to the demand and stuck to it; Deepinder said we had several goals – shifted goals from years – ultimately when we found this business exciting. Gopal followed it up with Vedanta when he said Vedanta is for entrepreneurship and entrepreneur focussing on execution of what you can do best. Gopal started his entrepreneurial journey to address shortage, which was everywhere – when India was riddled with long term optimism and short-term pessimism – It all changed again when he met Mr. C.K. Prahlad who told him to come out of multi-generational family business to open the door for new entrepreneurs- insisted on Old India meeting New India.

• Success is working for customer experience and his satisfaction; try creating value for customer. Success is not in chasing valuation. Valuation would follow those who create values for customers. We need to be one step ahead of change always. Therefore, we need to keep working on this.

• Of course, Govt policies, mobile telephony, data explosion, increased digitisation all contributed to success in every sphere

Building future businesses

• Rajan set the context rolling – In Fortune 500, we have just 2. When India@100, can we have at least 15 companies there?
• Large companies have built on home markets first and then expand globally – take example of Google or Amazon; even in China they played on domestic economy first before expanding their footprint- Need to build something for India first ; capture the domestic story in full, valuation would easily follow – for example Zomato has presence in 14 countries but main feed is in India – If India witnesses growth successfully then I think we can easily ride on that to build great businesses – Sanjiv shared.
• Visualising India@100 is like witnessing Vishwaroopam – beyond our normal imagination – 15 years before things were totally different – even a few years before, when we discussed on Swiggy or Zomato, we used to estimate on 2 / 3 million deliveries in a month – now Deepinder would counter these deliveries in a minute – this has been made possible through technology. Gopal added by reiterating that we should focus on what we could do best and emphasised on three key Pramanas to facilitate this
  • Atmanirbharta – domestic capital –
    • Govt is doing a lot – created a Fund of funds through SIDBI. We were beneficial. It has helped flow from other contributors with multiplier effect. But still, if we see, 85% of capital into the start up eco system is from overseas money- need to pool in more from large patient capital lying with PFRDA/Pension Funds etc. with ~₹ 20 lakh cr; even if ₹1 or ₹2 lakh cr flows to this, it can make a huge difference. Info Edge or Sanjiv are exception to support Zomato or Policy Bazaar. Global funds are driving up the major decision swaying the flow.
    • Democratise domestic capital – provide more access to non-English speaking disruptors or innovators; no of such people coming out from smaller towns; bring social equity- Like what Mr. Kamath used to bring in bright boys (local dialects and non-english) from smaller towns in ICICI Bank with native intelligence.

Rajan endorsed this to state that during a recent College interaction he found that more than 60% wants to be job creators than job seekers –

• Taxation – disparities
  • Long term capital gains taxation differentiation between public and private markets to go – riskier investments attract higher taxation at > 27% while public markets attract 10%

Rajan emphasised to compare this with Capital gains offset in land sale – when Capital gains from exits is invested in another start up similar concession could be considered.

• Adoption of digitisation
  • Govt has pioneered more digital initiatives and created public digital infrastructure, be it UPI, or JAM trinity – We should try to fully exploit and embrace this. In the NIFTY basket, 17% comes from IT sector exporting about $130 bn – but pureplay digital is just 2.5% of market cap if you exclude conventional IT and IT services. This must grow. Even many of old and traditional business have not fully adapted themselves. This should change and they should drive this.
• Deepinder was quick to point out that out of $1 bn raised $900 million came from overseas – 66% of his capital is owned by overseas firms - because of absence of availability of large amount of risk capital in India, till recent times – but he said, a few factors to ring in
  • Investors should try to “partner” with the founders and not try to own them- we want to help the new founders unlike VC Funds who chase monthly MIS ignoring larger picture-Every five-year new product cycle emerges- we need to support and nurture the ambitions of such founders.
  • When Zomato tries to invest in another start up it is treated as FDI. We are all Indian, - founders, employees, end users and the entire services in India. But just because 66% capital is from outside our investment in India is treated as FDI. This should change and we should be equated to domestic capital.
• Gopal built on this to add that this is the new culture – every part of India trying to help every other part of India – what he saw when he invested in NYKAA as well - cycle effect – successful start-up founders supporting other start-ups – great thing happening and has created kind of an investing culture

Key learnings and suggestions

Investment

                Sanjiv – Startups are no doubt good asset class – but need to study properly and make a systematic and informed call- diversify risk appropriately. Need to wait for long to see results. When Info Edge went public in 2006, one of the objectives in the DRHP to pursue in organic growth as we were profitable. Valuations were high. Decided to invest in innovators and disruptors. Found Foodiebay and now Zomato. Started investing with 1.5 persons in 2007.  For the first 5/6 years nothing worked. We stayed put for long. From 2010 I spent full time investing. We continue still. Zomato, for example, we have now invested for 14 years. If you want to exit early, you have to sell stake to Series B investors, but the company might not have scaled its full potential by then. Culture of investing in intangibles is growing but it is better to use PE/VC Funds like TVS Capital as this requires considerable time and effort.

                   Gopal - There is huge selection bias – I saw 31 deals in the last quarter –– 17 companies have moved up from series A to B – with increase in valuation by 4.78x. There is a question of access to right deals which gets cornered by Funds whom the Founders see as bringing value to them. There is therefore greater probability for Funds to get winners – it would be easier to join the race through the Fund. Family offices who have been the backbone for promotion of entrepreneurship in India, if they can spend time and resources with right team can of course pursue this. Gopal added that there is no need to choose or pursue any particular sector as we are talking of India touching $10-$15 billion driven by huge consumption story. Let’s focus on Swadharma instead of Paradharma –where we see strength from within and let’s follow that – lets follow our own vasanas – he added.        

   Valuations

                   Gopal – Ignore valuations – matter of context. During the last two years I saw that Central Banks have expanded their balance sheet by nearly $35 trillion (appx 30% of Global GDP). This has obviously brought down yields and increased flows to EMs including India. Now there is confluence or Sangam between Public and Private markets in terms of valuations. No more PE deals are happening at discount to public market. Public markets may now start on focussing on growth in place of EBITDA.

                   Sanjiv – never chase investment. Focus on product and customer. Valuations would automatically flow in. Spend time on building product and user experience. We chased Deepinder to invest in Zomato when we found that this is truly disruptive.

                   Deepinder – when we wanted to raise money we did not get. We started looking from within. We started on focussing what the world wants us to do and build. We worked on this continuously and investors came rushing. So Outside In approach is better than inside out.

  Technology

                   Change is constant and certain. When new technology comes it disrupts. We have seen what Zomato or Policy Bazaar has done. Answer is how you are going to embrace the new technology quickly. How are you going to digitise your operations? What is required is embrace the change and adopt it. On the other side, there is a huge talent shortage despite demographic dividend. What needs to be done is to train continuously to equip them to face the change.

                   Gopal said traditional business should not be trapped to their old businesses especially when dealing with next gen. Give some capital and don’t expect them to do what was done years before. Let them learn to do what they can do. Follow higher cause and give them freedom to follow their vasanas.

   Quote of the day to conclude:

   How to handle failures – Take a deep breathe and think of next steps – Deepinder.  

KI.Mani – Sr. Advisor TVS Capital Funds

30^th October, 2021

Buy Now Pay Later

It is undoubtedly true that the Covid-19 pandemic has accelerated the existing trend towards digitisation in India with e-commerce now expected to grow by over 80% in the next four years. However, despite the growing dominance of e-commerce, the majority of customers continue to use cash as their primary means of payment. This phenomenon can be attributed towards several factors such as safety, convenience, and access. To further exacerbate this issue is the difficulty that the average consumer faces in obtaining credit cards with the total unique credit card holders being in the 35m range, while the requirement for credit extends to over 200m people.

This is the requirement which Buy Now Pay Later (BNPL) players are looking to satisfy. BNPL is a powerful tool that provides a digital credit card experience even to those left outside the structured financial system. Not only do these companies do away with the tiresome approval processes of conventional lenders but they also provide short term interest free credit to make products more affordable for the aspirational consumer. Further, by streamlining the purchase process, BNPLs lower shopper hesitation, resulting in higher conversion rates and average order values.

However, with the plethora of advantages being provided, one must pause to consider the potential risks associated with the growth in these short-term unsecured loans. To fully explore this idea, we must first begin with an understanding of BNPL and how it works.

What is BNPL?

Buy Now Pay Later (BNPL) is a short-term micro credit model, where consumers pay little to no interest for online purchases. As such, the core tenet of BNPL service is that it enables one to pay over a period for what they choose to buy today. Typically, the credit period for BNPL services ranges from 30 days to 36 months, depending on the transaction size.

While the initial iterations of the BNPL product saw primarily lower ticket sizes with a pay in instalments model, the new models see larger ticket sizes where the consumer is pre-qualified and provided a loan which eventually gets securitised by an NBFC. In both models, the amount is paid by the BNPL service provider to the merchant, who then pays a specified fees to the service provider.  To note, the credit amount depends on the lender – for instance, while Flipkart offers a seamless checkout process for up to Rs 10,000, under their BNPL services, ZestMoney, another BNPL lender, offers up to a personalised limit of Rs 60,000.

Why is BNPL so attractive?

For Customers:

• Transparent and frictionless platform
• Longer repayment periods than what is offered by Credit Cards
• Lower interest rate and avoids hidden fees associated with credit cards
• Completely digital and instant – making it easier to apply and obtain approvals

 For Merchants:

• Easy customer acquisitions, lower CACs, Higher retentions
• Increased sales, Improving repurchases and higher order values (up 40-60%)
• Credit risk is borne by Lender / Fintech partner

 Market Opportunity

While BNPL has only scratched the surface of the $22tn global payments industry, its sharp growth highlights its journey to becoming ubiquitous. Multiple agencies expect the market to reach >$700 bn by 2025 from current ~$350 Bn growing at a ~20% CAGR for the period. More importantly, during the same period, reports expect the usage of credit cards as the method of payment for e-commerce to drop from ~24% to ~21%. Mobile wallets and BNPL players are set to be responsible for the slow decline of Credit Cards, Debit Cards and Direct Bank Transfers.

Focussing on the Indian context, we see a starker shift towards BNPL and digital wallets even in the two years between 2018 and 2020. While Wallets and BNPL increased from 32% to 40% and 1.6% to 3% respectively, credit cards, debit cards, bank transfers, and most importantly – cash on delivery, all saw a proportional drop in their usage in e-commerce transactions. To provide context, in absolute terms India’s BNPL market is expected to grow to $100 billion by 2025 from about $15 billion levels now.

Further, the anecdotal evidence provided by the initiatives undertaken by large digital marketplaces points to the increasing importance they are giving this business model. Flipkart, Amazon, Paytm, Byju's and others are betting big on India's BNPL segment ahead of the festive season. Some of these strategies have been highlighted below:

• Flipkart facilitates such transactions through its subsidiary Flipkart Advanz, while Amazon has partnered with non-banking financial company Capital Float.
• Paytm is offering BNPL as part of its post-paid service in a tie-up with Aditya Birla Finance.
• In the EdTech space, Byju’s and Unacademy have partnered with Lazypay and Capital Float, respectively.
• Private banks are experimenting in this segment. ICICI Bank offers pay-later services on its app, while Axis Bank-owned Freecharge has also entered the space.

 Key Risks

As mentioned in the introduction, something that sounds almost too good to be true – could also pose a certain amount of risk if not dealt with appropriately. For starters, many companies use BNPL as payment product where credit reporting does not happen. This could potentially result in the situation where a customer’s actual pay burden is not calculated when they are applying for other loans, causing them to be approved despite being overleveraged.

Just as importantly, the regulation surrounding BNPL serves as a risk both to the fintech companies as well as the investors. With the growing attraction of the segment, there is increasing probability that it will attract the attention of the RBI. The ambiguity around providing a credit facility marketed as a payment service could potentially dilute the borrower’s responsibility to pay back the loan. 

Conclusion

Despite the risks mentioned above, TVS Capital continues to take keen interest in this newest disruptor in the payments ecosystem. We see BNPL services becoming ubiquitous like credit cards and digital wallets through increased adoption compared to traditional methods of payment

Moreover, with its large market opportunity, lower delinquency rates when compared to credit cards, and strong Indian payments infrastructure, we see the potential for these service providers to play a key role in a digitised India.

Evergrande weighs on Chinese debt markets, but global contagion limited

Ever since Evergrande, China’s second largest property developer, announced that it missed its bond payments, the Chinese debt markets have been in a turmoil. Bond prices have slumped and its effect in the $5 trillion real estate sector is causing investors billions of dollars in losses. Several other Chinese real estate companies are faced with a severe cash squeeze.

Some high-yielding Chinese real estate bonds yields have slumped some even more than 75% showing that the financial difficulties run deep. This has been further aggravated by the fact that the Chinese property prices have slowed considerably in recent times.

Property curbs

The Chinese government has been trying to curb the overheating in the real estate sector for some time now by regulating the leverage levels of property developers. Since then, Evergrande has been scrambling to pare down debt levels, selling stakes in subsidiaries and offloading properties at discounted prices.

The property binging spree that started several years ago, saw Evergrande, the biggest and one of the most indebted real estate companies in the world with near $300 billion in debt, triple its borrowings in the last five years. The firm amassed large land reserves over many years to build scale in its real estate business banking on the rising property asset values and increasing sales for liquidity.

However, ever since the Chinese government cracked down, curbing leverage, real estate players have been scrambling for liquidity. 

Containing the contagion

For now, restricting this crisis to the real estate sector will be paramount. A large portion of Evergrande’s borrowings and bond issuances are in the form of domestic debt, while about $20 billion is in the form of foreign currency debt, held by overseas investors. With much of the debt local, a global contagion can be ruled out.

Notwithstanding, the worries over the possible spiralling effects of a debt crisis has driven the Chinese high-yield spreads to record highs. Investment grade spreads have also widened to the highest in two months as many warn that a disorderly correction in the property market could hit the personal wealth of homeowners. Further, it may be worth pointing out that if is not contained with intervention by the Chinese government, it could spill over to other sectors of the Chinese economy. Any failure by Evergrande to restructure its debt with creditors could even lead to liquidation that could send the domestic Chinese debt market into a tailspin with possibly spill-over effects on the financial system.

Contagion risks include supply chains, which in turn include commodities, vendors and even Chinese home buyers. Credit risks issues could get aggravated if not checked quickly as the government has been tight-lipped about the situation. The Chinese Central Bank, however, continues to pump in liquidity keeping the situation under control.

A Chinese government intervention is probably the most likely path forward given the circumstances. One reason is that real estate comprises of a large portion of the Chinese investors’ assets. Household savings of about 66% of Chinese wealth is invested in real estate.

Hence, the odds for the moment are that China avoids a default scenario as it could lead to a severe liquidity crunch. A similar situation in India involving infra-lending institution IL&FS led to tightening in domestic liquidity, particularly for a large number of non-banking financial institutions.

Domestic tailwind gains

For now, the crisis in China does may not pose a risk for Indian markets apart from heightened volatility that accompanies such situations. However, commodity markets could witness bouts of choppiness given China’s hefty weighting on the global commodity markets.

The positive fallout is that it could cause a pause in commodity-led inflation, which has been a dampener for several Indian sectors. This could also lead to lower inflation, but these are still early days.

Globally, debt markets will be bracing for turmoil, and some of that could lead to rate increases. However, the larger risks emanating from rising rates may be some time away as the US Fed has already announced that it will keep rates at low levels for the next two years.

Overall for the Indian economy, the Evergrande crisis in China could give further impetus to the China + 1 policy that several global producers have been shifting to lately, which could benefit India. The other benefit that India could see is increased global capital inflows if confidence in the Chinese market wanes.

All in all, for Indian investors, there appears be less systemic tail risks, while the scales appear tilted toward tailwind gains.

Regulatory Technology

With the acceleration in digitisation becoming a staple part of all investment themes, we are beginning to witness increased burden on the risk and compliance functions – especially in the financial services industry. Moreover, these companies are not only expected to swiftly adapt to these pressures, but also do it in a cost-effective and secure manner. Given these factors, we now see RegTech (Regulatory Technology) companies gaining prominence in the eyes of investors as they are viewed as essential to the core operations of banks and other regulated entities. 

What is RegTech?

Before we delve deeper into the solutions provided by RegTech companies, we must first arrive at the scope we use to define them. Coined by the UK’s Financial Conduct Authority (FCA) in 2015, they described it as “A subset of fintech that focuses on technologies that may facilitate the delivery of regulatory requirements more efficiently and effectively than existing capabilities.” Essentially, RegTech is the label given to any technology which helps financial services providers manage regulatory processes. 

Growth of Regulation

Depending on the need of the hour, different regulators bring in variety of regulations which have some overlapping aspects.  Taking an example; There are regulations relating to Credit Information Companies in India which are approved by/registered with Reserve Bank of India under the Credit Information Companies (Regulation) Act 2005 [CICRA]. There are multiple fintechs in India providing credit underwriting support to lenders including NBFCs/Banks, where they extract data from multiple sources, collate, compile, and do some analytics and make them available for lenders to take decisions. Are these fintechs then falling within the realm of CICRA?

India unveiled the Account Aggregator (AA) network, a financial data-sharing system that could revolutionize investing and credit, giving millions of consumers greater access and control over their financial records and expanding the potential pool of customers for lenders and fintech companies. Account Aggregator empowers the individual with control over their personal financial data, which otherwise remains in silos. Here again, you would see multiple fintechs engaged in some form of data extraction at the consent of his client from multiple sources, collate them and present to lenders for credit underwriting. Are these fintechs come under the framework of Account Aggregators or do they have to register with RBI as NBFC-AA as per regulations? There are no clear and direct answers.

There is indeed a plethora of examples – like payment companies operating in India – some are payment gateways, some are payment aggregators, some are wallet companies, and some are pure tech cos giving backbone to these operators. Whether all are required to be brought under Payments and settlements Act – here again, there would be no clear and direct answers unless every aspect of the business is analysed and compared with the scope of regulations in detail.

Regulation Tech therefore helps articulate clear distinction in application of multiple regulations and help the companies to handle compliance easily where multiple regulations bordering on breach on some aspect or the other confront them. 

Technologies Utilised

As we noted earlier, the current legacy solutions are unfit to tackle the constantly evolving demands of regulatory compliance. Further to the growingcomplexity of regulation, we also note that the increasing costs associated with non-compliance have made investing in RegTech products financially viable for both regulatee  as well as RegTech companies. This is indeed over and above the financial risk of losing customers due to slower, error prone processes. As per a PWC report, more than 10 to 15% of the workforce is dedicated towards regulatory compliance, with >500% change in the volume of regulatory updates over the past decade.

Thus, given the financial incentive to ensure consistent compliance, RegTech firms can invest in cutting edge technology to bring about digital transformation to the world of regulatory reporting. These include:

• Data Mining and analytics – Simplify data management and aid in providing real time updates for analytics
• Artificial intelligence and machine learning – Play an integral part as they allow for faster decision making without need for human intervention
• Blockchain – Role of distributed ledgers continues to expand as they can provide validation for KYC obligations as well as ensure traceability of transactions to serve as an anti-money laundering tool 

Use Cases

Given above mentioned advances in this segment, RegTech company solutions are becoming more robust and cover a widening range of use cases, as described below:

• Regulatory Reporting – Enables automate data distribution and regulatory reporting through big data analytics and real time reporting
• Compliance – Real time monitoring of current state of compliance; as well as monitor changes and evolutions of regulations (per Deloitte estimates, there are around 220 regulatory revisions each day)
• Risk Management – Detecting compliance and regulatory risks, assess risk exposure and anticipate future threats
• Identity Management – Facilitating counterparty due diligence and KYC procedures to promote anti-fraud screening and detection

Future of RegTech

While RegTech companies have undoubtedly benefited from Covid-19 led acceleration towards digitisation, their continues to be areas of improvement and growth within the ecosystem. We can expect to see these technologies being utilised in sectors beyond financial services and extend into areas such as ESG reporting. To note, areas such as energy and healthcare, with strict reporting requirements, are prime candidates for future disruption by RegTech companies. 

Additionally, as these technologies continue to grow in importance, we will most likely see a more detailed breakdown in ‘RegTech taxonomy’ to allow for clear demarcation and identification of fields which make up the ecosystem. A universally agreed taxonomy can help stakeholders to ‘speak the same language’ and refer to the same concepts, creating a foundation for further research into the field. 

Finally, we also expect significant advancement through merger between regulatory technology and business processes. As these solutions will go from a ‘nice to have’ to a necessity, we will witness RegTech becoming a part of the fabric of a company – providing holistic end to end solutions. 

Overall, RegTech is yet another segment which stands at the confluence of multiple driving factors. The robust technologies available to address the ever-growing compliance risks will continue to drive the market, making it attractive for investors, business partners and regulators alike.

GDP Update

First quarter GDP numbers, as released by the government, are quite encouraging and potentially set up a strong platform for growth to rise beyond pre-pandemic levels by FY23.

The recovery in the Indian economy continues well with real GDP growing at 20.1% y-o-y in the first quarter despite the pandemic-related restrictions. This high growth rate was, no doubt, due to low base in the year ago quarter, when the economy shrunk by more than 24% due to stringent closures in the year ago quarter. To provide further perspective, the real GDP number stands at Rs 32.4 trillion compared to Rs 35.6 trillion during the pre-covid times in Q1FY20.

GDP growth numbers in the first quarter is complimented by the robust pickup seen in the recently released industrial production numbers, highlighting a solid growth of 11.5% in July 21. Thanks to the gradual reopening of the economy, the IIP growth now is just 0.3% lower than pre-covid levels seen in July 19.

Demand signs are evident

Indeed, both the macro-economic and high-frequency data point towards steady growth in the coming quarters.  While the base effect will wane over the coming months, the continued easing of restrictions and the faster pace of vaccinations, averaging at about 7 million doses per day, will see the recovery persist as demand and investment activity gathers pace.

As a result, the broader consensus among economists is that the economy should be able to scale the 10% growth mark this year, thanks to the lower covid-19 cases coupled with the response of the government and the private sector.

A deep dive into the GDP numbers suggests that the demand side is picking up strongly. Except for a blip in government consumption, all other demand-side components such as exports and private consumption have recorded strong growth in Q1. While growth in exports has been truly exceptional.

Moreover, with the coming festival season, consumption growth is likely to grow substantially as we witness a pickup in some of the high frequency indicators. Hence, private consumption could be better than the 19% growth seen in Q1.

The manufacturing and construction side shows a good recovery too. Manufacturing grew at 50%, while construction grew 68% in Q1. The trade sector also showed strong growth of 34% in Q1.

Agriculture remains the backbone

One of the highlights of the current GDP numbers is the resilience of agrarian economy with agricultural activity recording high growth, despite the severe impact of the second wave to the rural economy. However, with relatively low levels of lockdown and restrictions, the agricultural sector has been witnessing growth at ~ 8% higher than its pre-covid level.

Of course, it will be a while before the whole economy reaches its earlier highs with one of the key risks being an escalation in the third wave of covid-19. If there is no third-wave or its effects are limited, then the third and fourth quarter growth will indeed be much better than anticipated.

Strong platform for FY23

One thing that was striking was the ability of the economy and the corporate sector to weather the fierce second wave. The Q1 sales and profit numbers were sharply higher for the formal sector in Q1. The private sector has taken several cues from the first wave having implemented cash-conservation methods. This has enabled them to stay much ahead during the second wave. These measures will also play a safeguarding role if a third wave strikes, further highlighting the preparedness of the corporate sector.  

Besides, the government is likely to step up capital expenditures in the coming quarters, post the monsoons. This should also see a revival in investment activity going forward. So even while GDP may not reach the pre-pandemic levels, it provides a much stronger platform entering FY23.

Government Securities 

For most countries across the world, direct access to the bond market was the preserve of banks, financial institutions, and corporates with large treasury operations. However, as of February this year, we have seen a major structural reform as the RBI has granted retail investors direct access to the domestic market for government debt. Though, the RBI has been allowing small investors to participate in G-Sec market since 2001, it did not gain significant traction as the ticket size was high and is mostly confined to institutional investors being a high-volume game and specialised in nature. This makes India the 3rd country, apart from the US and Brazil, to have done this. This move essentially allows retail investors to lend to the government, providing them with a potentially higher return while increasing the available pool of investors for the Centre. Further, with additional tax incentives and the ticket sizes being as low as ₹ 10k, this would allow for public savings to simply be a click away.  

Notwithstanding the above, one should note that the RBI has been encouraging retail participation in the government securities market for long with several initiatives like introduction of non-competitive bidding in primary auctions, permitting stock exchanges to act as aggregators/facilitators for retail investors and allowing odd-lot segment in the NDS-OM (negotiated dealing system-order matching) secondary market, among others, in the past. As such, the most recent initiative is another effort by the RBI to manage a ₹ 12 Lakh Crore in government borrowing for the coming year. The ultimate hope being, that the RBI has opened an endless tap for the government to borrow from the public, similar to what has been done in the stock market, to match the demand to the supply of G-secs.   

Corporate Debt 

While the government securities market continues to create incentives for retail investors, we potentially see a mismatch of supply and demand in the corporate bond segment as well. As per a CRISIL study published at the start of the year, the supply of corporate bonds in the domestic market is expected to reach ₹65-70 Lakh Crore by March 2025, while the demand is expected to be around the ₹60 lakh crore mark. Further, in order to fill the gap from the demand side, various enablers such as credit default swaps, index linked funds along with the essential increase in retail participation in the corporate bond market.  

The report goes on to highlight some potential methods in which retail participation can be bolstered in the corporate bond market. These methods include:  

1. Encouraging more bond ETFs, including thematic funds 
2. Offer tax sops for retail investment in debt MF 
3. Bringing tax parity in capital gain tax between equity and debt products 
4. Increasing liquidity support for secondary markets  

Govt. has already pioneered the initiative by approving launch of Bharat Bond ETF linked to PSU Bonds. SEBI has also announced that it will be announcing launch of Bond ETFs soon. Given expectations as highlighted by CRISIL, SEBI is currently contemplating the creation of “market makers’ in the corporate bond market to create liquidity in the secondary market for such bonds. Moreover, SEBI is also looking to revamp the corporate bond database which will provide granular level information about debt covenants to all investors. Furthermore, in a proposal from SEBI, the Union budget for 2021-22 saw the announcement of a creation of a backstop facility that would purchase investment grade debt securities both in stressed and normal times and help the development of the bond market. It is strange that when retail investors could participate with much riskier assets in equity market they don’t have access to bond or credit markets in same fashion. While individual investors can participate in public bond issuances, small retail investors don’t get opportunity to participate in large no. of private bond placements – due to lack of access as well and the higher ticket size of ₹ 10 lakh. 

 Private Company Initiatives 

While we see significant steps being taken by Govt. and regulatory agencies to deepen bond markets, a review of the facilitating framework towards greater retail access would give us a more complete picture. Currently the entire private market placement of bonds is confined to institutional investors and very few HNIs. Despite SEBI taking steps to bring in Electronic Bidding Platforms [EBP] for issuances of above a certain threshold and making it mandatory for insurance companies and mutual funds to invest and trade only through RFQ platforms in the recognised stock exchanges, order matching continues to be driven through bilateral negotiations and over the counter form of trades.  

In addition to the above, New age companies are taking a step forward to make their products (including bonds both primary and secondary) investor-friendly by providing both recommendations as well as a thorough understanding of the basics. Some of them have come with a user-friendly platform with better access to information, analysis and recommendations. This is an essential service in a country where the financial literacy rate hovers around 27%. Further, these companies are looking to spearhead the digital revolution of the bond market in India and assist individual retail investors in getting access to a wider choice of bond investment opportunities that provide stability, thus helping them in generating predictable income and meeting their own investment objectives.  

A few companies in this space have been highlighted below:  

1. India Bonds 
2. Golden Pi 
3. IndMoney 
4. Bonds India 

But we also see Robinhood models of platform like Zerodha giving access to bond issuances including Market Linked Debentures which is gaining popularity. Some of the models being piloted include underwriting large issuances and disseminating them into smaller lots with retail investors. 

We also see much more sophisticated platforms like Cred Avenue which curates bonds for specific institutional or HNI investor interest and able to offer for subscription – providing extensive data analytics and information – both in primary and secondary segment. This platform by providing access to suite of fixed income products to institutional investors – be it PTCs, Securitisation pools, supply chain offerings, enterprise loans. Investors are able to see as one stop shop access to various offerings in the fixed income market. 

Further, the types of services provided in the corporate bonds space include:  

1. Curating bonds based on investor preference  
2. Facilitating bond sale 
3. Providing insights and reports 
4. Directory of bonds 
5. Expert advice and assistance 

Conclusion:  

Given a confluence of factors leading to the democratisation of financial instruments, we see direct retail participation in corporate debt markets poised to grow exponentially in the coming years. As bond markets become accessible and transparent, we would be able to unlock the significant potential which lies locked away in Indian Debt Markets.  

Given the potential for deepening of the bond markets in India and the increasing awareness and appetite to subscribe to such products from retail investors, successful platforms which are able to provide extensive data analytics and enable quicker decision-making will promote greater participation of investors in the coming years.  

Three decades of economic reforms has unfolded a golden era for Indian capital-market and private-equity investors  

The past three decades have not been without its ups and downs, but it belongs squarely to India. Indeed, India’s economic revival owes its roots to the reforms of 1991. After struggling with a dire balance of payments situation, the Indian government ushered in urgent and bold reforms. Ever since, there has been no looking back.  

The lowly ranked Indian economy rose to a global powerhouse, now the third largest economy in the world in terms of purchasing power parity (PPP). With fresh reforms (GST, lower corporate taxes, boost to local manufacturing), it has set its sights on a $5 trillion economy, which will be achievable this decade.  

Many of us can recall the calamitous situation then. Foreign capital was scarce. Then finance minister Manmohan Singh took urgent steps to liberalise archaic laws that had been a hindrance to India’s growth. The policy changes of 1991 put paid to the license-and-quota Raj.  

Unshackling India’s growth potential  

We can also relate to how we waited years to purchase our first car, the Maruti 800 back in those days. The now ubiquitous telephone connection took years to come home. In comparison, India’s automobile sector is now the fifth-largest in the world by production, and getting a phone connection has never been easier. Over the last three decades, several governments continued to remove economic laws and press ahead on reforms.  

Manmohan Singh scripted the first set of reforms: dismantling industrial licensing, price controls and relaxing foreign investment rules. Lower of corporate and personal tax rates was another landmark that boosted consumption and domestic capital spending, expansion and production. Besides, restrictions on managerial remuneration were lifted.  

New beginnings for Indian corporates

The 1991 policy paved the way for several new multi-nation corporations in the country, while several segments of the economy were opened up to the private sector. On the removal of asset limits on corporate India, liberal licensing undoubtedly meant more competition across sectors. It also meant that prices of goods were lower. Simultaneously, with more capital and businesses opening, employment boomed. This brought in huge foreign investments in almost every sector that had been opened up.  

Indeed, now India’s corporate sector sees the transition to the GST era as a game-changer that will further accelerate economic growth. The goal to become a $5 trillion economy by 2025 may have been delayed by Covid-19, but that milestone should be attained sooner or later this decade.  

Major impact of capital markets and financial reforms  

However, it’s the capital-market and financial-sector reforms that have strengthened the backbone of India’s economy over the last three decades, and still does. Indeed, after the SEBI Act of 1992, India’s capital markets has been on a roll. Furthermore, in the early 1990s the government liberalised financial services, foreshadowing a new era in private banking with tech-savvy new generation private banks having been granted banking licenses.   

With the rapid strides in India’s capital markets from the days of The Controller of Capital Issues (CCI), abolished around 1992, the primary and secondary markets have created and built fortunes for India’s investors. With the advent of private-sector mutual funds, private equity, global institutional investors and hedge funds, the capital market segment is scaling higher peaks. The capital-market turnover in only the cash segment has rocketed from Rs 36,000 crore in 1992 to over Rs 160 trillion in 2021, not factoring the derivatives turnover.  

What can be expected in the coming decade?  

No doubt, a new era in the Indian capital market is now beginning as new investors continue to enter the capital markets. Domestic capital has become a big force. Inflows into equities via mutual funds and directly have zoomed. Over the course of the next few years, we could see several more tech service companies, SaaS, see listings in the secondary market. Indeed, the pipeline for tech companies IPOs is expanding given the response in the domestic market. It also goes without saying that the private equity and venture capital space will become larger. VC-focussed funds touched the highest levels of fund raising in 2021, and counting.  

While the equity segment has vaulted, India’s debt market could certainly do with greater depth to enable corporates to raise more money from domestic investors. We have seen the flush of domestic investment in equity. Even if some of that enthusiasm rubs off on the debt market, the economy could get a further fillip. While equity markets will see its ups and down, suffice it to say that new reforms and the indomitable entrepreneurial spirit should chalk a new era of growth in India’s economy, capital- and private-equity markets.   

The concurrent growth of e-commerce with digitised retail solutions have resulted in increased customer expectations from retailers. Most retailers have only one opportunity to satisfy their customer's needs, as unavailability of a certain product will potentially result in them moving to their competitors. In addition, customers are now more price conscious than ever with loyalty becoming harder to secure.  

Given these trends, Retail Assortment Management Applications (“RAMAs”) are seen as increasingly essential when looking to meet customer demand with the best possible assortments of products. Retailers are moving from annual or semi-annual category review processes to more frequent adjustments that eliminate disruptive floor resets and take advantage of market opportunities when they occur. Moreover, with the over 30% of Tier 1 retailers still using Excel as their assortment management tool, there currently exists significant growth potential for companies providing assortment management applications.  

For this brief update, we take a combined view of assortment for both long and short life cycle products. While differences exist, the aim with both is to close the gap between financial planning and store planning and accurately identify optimal merchandise mix. Thus, both solutions primarily leverage embedded data to provide an effective strategy to maximise return on inventory investment.  

Implementation of RAMAs 

Automating existing processes is the key when it comes to creating efficiencies that free up time for individuals to perform other roles. As such, the following key activities would need to be performed to support any business during this transformation:  

• Procuring and implementation of cloud-based solutions with embedded analytics, algorithms, and AI capabilities  
• Breaking down of organisational silos to promote collaboration within the organisation to ensure greater understanding of retail  
• Integration of financial targets with the quantity and depth of products being offered 

Requirements of RAMAs 

Given the above changes which would need to be undertaken for the implementation of Retail Assortment Solutions, customers would need to ensure that these applications provide a base level of functionality to achieve its expected outcome.  

• Customer centric assortment through data-driven clustering/ grading – Dynamic clustering enables retailers to shift the mix of stores across clusters based on seasonality or market growth/decline trends. Further, clustering is used to deliver localized assortment plans that meet customer demand.  
• Management of promotional strategies – Effects of promotions are modelled to ensure they are being executed in an optimal way. The solution should support building markdown models to help maximize margin at the end of an item’s life, assisting planners in moving through potentially unproductive inventory at the right price and the right margin. 
• Holistic Assortment plans across regions and channels – High-level strategic changes to the assortment plan should be made at a holistic level, reducing the number of touches a user has to make in order to execute those changes in the assortment plan. This feature is critical to making both high level and granular plan adjustments. 

Outcomes expected through RAMAs 

Retailers who fail to embrace RAMA may find themselves significantly disadvantaged in comparison to competitors that do. As mentioned earlier, to compete and win, there is a growing imperative for retailers to tailor their assortments by neighbourhood to respond to local preferences and offer shoppers the right products at the right place and the right time. 

• Improved Inventory Turn – As retailers navigate in the new post-COVID-19 marketplace, even a slight improvement obtained from the merchandising processes of selection, distribution and pricing can have a positive impact on sales, margin, inventory availability and turnover, and the resulting customer satisfaction. 
• Promote customer loyalty – In the long term, adopting an assortment planning strategy effectively will help you to better retain the loyalty of their shoppers. 

The direction of the US Fed’s interest rate policy holds significant importance in the context of how capital flows into emerging markets. The moot question is how much of an impact it will have on cross-country flows. The other significant issue that could tilt sentiment heavily on the risk side is the perception people hold about where inflation could move. All this will have significant bearing on the movement of asset prices and valuations in the private equity market.  

Rate hikes to come with a gap 

One of the key takeaways in the latest policy meet is that the US Fed has given sufficient time for the markets to digest the expected interest rates hike in 2023. In its last policy announcement, the US Fed kept interest rates at zero, but has projected two hikes by the end of 2023. As the rate hikes are still sometime away, global flows are not expected to be affected, in the near term at least. This should help keep the current asset-price inflation, quite healthy.  

The US Fed has pledged to continue asset purchases at $120 billion monthly pace. Indeed, the Fed expects to maintain this stance until ‘substantial further progress’ had been made on employment and inflation. This is a sufficiently good premise to consider that flows into emerging markets could continue for now. This has also kept global market sentiments firm.  

The minutes of the US Fed show that policymakers are optimistic that the US recovery is upbeat with economic activity and employment showing signs of strength. The US Fed acknowledged that the higher inflation readings “reflect transitory factors.” Some of the factors that are driving inflation higher, which is currently at a 29-year high in the US, is due to supply disruptions and labour shortages. Hence, the Fed believes that this could keep inflation projections elevated as higher prices could persist for now. Though the markets reacted to Fed’s likely tapering from 2023, 10-year bond yields have softened 1.37% from 1.73% at the time of Fed policy announcements. 

Inflation risks still high 

That said, sustained higher inflation cannot be eliminated.  To an extent, how the public sees inflation playing out can also influence how central banks across the world deal with the situation. This largely depends on how corporations view inflation affecting their businesses. In fact, if corporates believe that inflation is transitory, then it is quite possible that major effects of inflation will not be seen until 2023 onwards. Note that in such a situation, corporates may not bake inflation clauses into contracts as a result, inflation spikes will be smoother.  

However, if corporates suspect that inflation may not be as transitory as the US Fed believes it to be, then there is a risk of inflation spiking earlier than anticipated. This could see some global central banks potentially raising rates even earlier to contain inflation.  

Faster economic recovery signals ‘taper’ on the cards 

The other factor to remain watchful for in the coming quarters is how the broad economic recovery indicators such as employment shape up. In fact, this will determine how soon the US Fed decides to ‘taper’ its asset purchase program. Given the labour shortages and higher inflation expectations, there will be significant pressure to announce slower asset purchases as early as December.  

Given this backdrop, the pressure on the private equity market could be seen much earlier. Once interest rates are raised, capital flows could take a U-turn from riskier assets such as emerging markets to markets considered as 'safe havens'. This will certainly have an impact on the amount of capital flowing out from countries like India.   

Valuations puffed, hence caution warranted  

Nevertheless, equity valuations are expected to remain elevated for a few years at least. With dry powder from earlier capital raises is quite high, equity investors are still paying an exorbitant price for private equity deals for now.  

But suffice it to say that once rates are raised, it may become a tad difficult to raise capital Note that it will potentially mean that the era of ‘cheap money’ will come to an end. These issues are also likely to mean that investors are likely to increasingly focus on the deal pricing in the coming years.  

That would make the private equity market see a contraction in deal valuations – at least in the runaway asset prices seen in recent times. Eventually, over the next few years, we may also see profitable exits becoming harder for firms, particularly for those who have invested at these frothy valuations.  

That said, we expect to continue to focus on the bi-modal strategy for the foreseeable future as valuations continue to remain elevated. We see the need to be cautious in many of the opportunities as prices have remain elevated. In any case, there is no need to be aggressive as there are many deals in the early-stage market that is available at comparatively reasonable valuations.  

Our stance is that once the interest rates increase/ or inflation goes beyond what is manageable, we would expect any corrective action to have a direct implication on both private and public company valuations. 

Investment Theme of the Month: Agri

With India ranking 103 out of 119 in the Global Hunger Index in 2018 and at the same time wasting 40% of all harvested agricultural produce – it is surprising that only in the last few years have investors opened their eyes to the value potential in Agriculture.

India continues to be a country driven by agriculture; despite only accounting for 20% of GDP, 58% of the population relies on this sector for subsistence.  Moreover, given the pain points in the agriculture sector, highlighted below, one can slowly begin to understand why it has taken so long for VCs to see potential in the sector.

Nevertheless, these same pain points also create demand for the very services which Agri start-ups have begun to provide over the past 5 years.

1. Supply Chain Inefficiencies
2. High Finance Costs and Large Volumes of Unstructured Data
3. Access to High Quality Inputs

As such, the above factors correlate with the key business segments and thus directly try to solve the problem for the farmers and consumers. Currently, firms place the market potential for Agri-tech start-ups at ~$24bn.

Supply Chain Inefficiencies >>> Market Linkage Companies:

Market Linkage start-ups are the most well-funded in the sector and accounts for nearly half of the market potential ($12bn). These companies aim to solve the most difficult problem from the farmers’ perspective as they reduce the number of intermediaries between the farmer and the retailer.

More importantly, reforms through the new farm laws are the need of the hour when it comes to providing  farmers more control over their income. Key obstacle continues to be reliance and the exploitation by intermediaries. In the ideal scenario, there would exist significant potential for farmers to reach distant markets directly as the supply chain opens to technology from start-ups.

From TCF’s perspective, we see valuations as a potential issue as many of the larger players have scaled up at higher valuations. Team to actively look for smaller players with potential to scale.

High Finance Costs and Large Volumes of Unstructured Data >>> Agri Credit Companies:

It is a well-established fact that there is a formal credit gap for small and marginal farmers. This is evident from the fact that out of the 12.4 Cr small and marginal Indian farmers, who own 86.2% of the farmland, only 3.6 Cr borrow from formal sources. Further, due to lack of data, banks target medium and large farmers who already have access to formal capital and take >50% of the Agri credit.

In most cases, the need for informal funding shoots up after the seeds have been planted. Highlighting that, unplanned expenses are the main reason for acquiring informal funding. As such, it is essential for Agri Credit companies to be able to provide fast funding at reasonable terms.

Despite only garnering a fraction of the funding provided to Agri Tech, we at TCF see great value in this segment and believe it fits well into our focus areas. With a number of these start-ups working with FPOs to scale, they can piggyback on the growth from the market linkage players. 

Access to high quality inputs >>> Agri Inputs Companies:

The Agri inputs segment has the least barrier to entry but has seen several challenges to scale given the traditional supply chain operates with a long working capital cycle, with retailers taking disproportionate working capital risk (dues typically paid post cultivation) based on social capital with farmers.

Though people acknowledge that there are inefficiencies in the system, D2F model has not succeeded. The Start-ups in early stage are working with existing retailers in the segment and helping them with knowledge and lower priced inputs directly from manufacturer.

From TCFs perspective, we continue to explore companies who provide a combination of inputs and financing capabilities to tackle the key working capital issues faced by the retailer.

Conclusion:

Overall, we at TCF, continue to see long term value in the Agri tech space and we carry unique capability capital to underwrite and partner with companies focused on providing financial services to the sector. Further, given the market potential in segments such as ‘market linkages’, we will also continue to view the space on an opportunistic basis.

We are pleased to announce the completion of our 5th investment from TVS Shriram Growth Fund- 3 (TSGF3) in Five Star Business Finance Limited. Our INR 100cr investment for ~0.97% stake in the NBFC highlights our continued objective of financing SME lenders who are solving for the problem of “access”. Accordingly, Five Star Finance has a remarkable track record of successfully addressing the needs of the so called “Missing Middle” segment in MSMEs. This segment comprises of 53.3 million “own account enterprises”, of which a majority do not have any form of registration nor do they hire external labour on a regular basis.

Upon taking control of Five Star Finance in 2002, computer science engineer and first-generation entrepreneur - D Lakshmipathy, steered the company’s focus towards SME lending from its initial core business of consumer financing. The company underwent a significant business transformation under his leadership to eventually became a pioneer in the small business lending space. The NBFC primarily operates in the small business loan segment (₹ 3-5 lakhs ticket size), with loans backed by self-occupied residential property as collateral.

Five Star Finance has built up a strong presence in South India and demonstrated a 9x growth in AUM over the past 5 years. Moreover, the company has achieved this while continuing to maintain best-in-class operating and financial metrics. This coupled with the company's superior returns, cost to income ratio, and robust asset quality prompted TCF to actively track the company over the past 12 months. We believe Five Star is well poised to deliver high growth in the next 5 years, leveraging its strong market practice and operations excellence.

In this composite round of ~₹ 1,700 Cr, Five Star has raised ~₹ 520 Cr of primary investment as TCF joins KKR along with existing investors Sequoia Capital and Norwest Venture Partners. This investment marks yet another testament to our investment philosophy of backing the best NextGen entrepreneurs across businesses. We deeply subscribe to Mr. Lakshmipathy’s vision of building Five Star Finance into a pan India NBFC which will be among the top decile of players in this category. More importantly, we are proud to partner a company with a strong ESG framework, which is in line with TCF’s focus on building sustainable enterprises in the long run.

Team TVS Capital

It is always joyous to partner with best-in-class entrepreneurs and on this day, we wish to discuss one of our more successful business partners – Suryoday Small Finance Bank. The Listing of a portfolio entity is the ultimate aim for any Fund Manager and provides us with a sense of accomplishment which is even more invigorating than the returns from the investment.

Looking back at history; in 2007, we see a young but experienced and passionate man deciding to further the initiative of financial inclusion in the Indian Economy by catering to the ‘bottom of the pyramid’ Indians. The journey, as stated by the man himself, has been tremendously exciting with multiple ups and downs, but sheer determination, performance, and focus has enabled Suryoday to reach the stage they are in now.

Moving forward to 2017, Suryoday as a micro finance institution contested for the small finance bank license against several others. As a star performer which matched all of RBI’s criteria, Suryoday was awarded a Small Finance Bank License on 23rd Jan 2017. This marked the beginning of a new journey for Suryoday and it has not turned back since. It subsequently grew 4x in AUM from ~1,000 Cr to the ~4,000 Cr level it is at now.

TCF has always been resolute in its pursuit of “Empowering the Next Gen Entrepreneurs”. As such, Baskar Babu, a man with focus, passion, and the ability to deliver performance, ensured that Suryoday figured easily as a potential business partner for TCF. Further, we believed that the services being offered by Suryoday to unbanked India had significant potential for growth while also facilitating financial inclusion at a great scale. Despite the economy facing serious pull back post demonetization in Nov 2016, TCF decided to partner with Suryoday given the trust we had on management to deliver. TVS Capital continued its confidence in the bank by investing from 2 of its schemes (funds) in Feb 2017 and March 2019.

Overall, Suryoday has delivered a stellar performance over the last 4 years, setting new benchmarks for their peers consistently. Despite COVID being hard on the economy and businesses, Suryoday found a way to overcome the impact of the virus and was expeditious in its recovery. The confidence that many other investors have also shown in the bank over the last year further speak to the belief, hardwork and dedication of the management.

We are extremely proud to be partners with the bank and wish them immense success in their next chapter post the IPO. Great work @bhaskar Babu and team Suryoday. We are inspired by your journey.

We, at TVS Capital, continue our journey to “Empower the next gen entrepreneurs”.

Team TVS Capital Funds

TVS Capital Funds is pleased to announce the appointment of Alok Samtaney as an Investment Director, effective 1st April, 2019.

Alok brings with him more than 15 years of experience, with his last assignment at Sabre Capital as Investment Director. He has extensive experience across Private Equity and Financial Management.

In over twelve years in Sabre capital, Alok had led investments end-to-end, was a member of portfolio companies' boards and had executed successful exits. He brings with him deep knowledge of investing in sectors which strongly overlap with sectors that TVS Capital Funds is focussed on like, financial services, consumer goods and health sectors, besides extensive experience in, technology and hospitality services.

TVS Capital is confident that his wealth of experience and impeccable credentials will prove to be valuable in managing TSGF Fund 3 and for raising and managing future Funds.

Alok is a Chartered Accountant and an MBA from SP Jain Institute of Management and Research, Mumbai; he will operate from the Mumbai office TVS Capital Funds.