Zerodha co-founder’s hedge fund clocks 40% return in first year of launch

True Beacon, the hedge fund launched by Zerodha co-founder Nikhil Kamath has reported a 40.7% return over the past year. The ₹400 crore odd fund is classified as a Category III Alternative Investment Fund (AIF) and was launched on 1 September, 2019.

A Category III AIF can go long (profit from gains) and short (profit from corrections) in the market. The fund does not charge any administrative or management fees, restricting itself to a ‘carry’ of 10%. This means that 10% of the gains made by the fund would be paid to the fund manager, bringing down the post fee return to about 36%. AIFs have a minimum investment amount of ₹1 crore. Data on returns of other Category III AIFs is patchy. However, the return posted by True Beacon is higher than all other Category III AIFs reported by PMS-AIF World in its November performance report.

Category III AIFs do not enjoy the favourable tax position that mutual funds have. Their trading activities are typically taxed as business income, which can go as high as 42.7% with surcharge and cess. However, such funds typically try to segregate trading from the buy and hold portion of the portfolio, offering the latter to tax at a 15% short-term capital gains tax or 10% long-term capital gains tax. The result is a blended rate of the two. According to Nikhil Kamath, Chief Investment Officer (CIO) at True Beacon, this would come to 20-25% over a 2-3 year period. Category III AIFs deduct the applicable tax at source each year.

Kamath, however, believes that the market is relatively overvalued, driven by flows from foreign institutional investors (FIIs). True Beacon has increased its hedged portion to 50% of the fund. This means that a 10% gain in the market will roughly translate to a 5% gain in the fund and vice versa. According to Kamath, the fund’s active hedging strategy when the markets corrected in February and March helped it notch up this year’s high return. Over the longer term, Kamath is targeting a 15% CAGR.

"While analysing any hedge fund, we look first at the attribution of returns. Usually such returns come from sources like - long only, shorts, algo trading strategies and sometimes treasury allocation. If the fund is relying too much on any one source or if one of the sources of returns is constantly a detractor, it is a cautionary sign. We have to be able build a return profile for the fund and hence ideally we prefer a track record of at least 2-3 years," said Munish Randev, founder, Cervin Family Office, a Sebi Registered Investment Advisory firm.

Investors who are unable to conduct this analysis themselves can approach a Sebi RIA. should also note that hedge funds are high risk products. Consider your risk appetite and time horizon before investing in such types of funds.