Since the days of the British East India Company, investing in India has always held romantic appeal.

Investors are still chasing after returns on the Indian stock market, which have risen sharply in the last two years. As a result, the Indian market has been re-rated from one of the cheapest in Asia to one of the most expensive.

“India has seen the benefits of a phenomenal amount of money pouring in from domestic and foreign investors,” says Hugh Young, manager of Aberdeen’s Asia Pacific fund. “The market has had a fantastic run.”

Those in favour of investing in the country cite as benefits the explosive growth of India’s population, the sophistication of its companies and the wave of outsourcing which has sent western companies hunting for a cheap English-speaking workforce.

In the past year, the value of the MSCI India index has jumped 26 per cent and in the past five years, it has soared by more than 269 per cent, even after this week’s sharp falls in stock markets.

Estimates from analysts suggest the Indian economy will have grown at a record 9.2 per cent in the year to March. Last year, the Bombay Stock Exchange Sensex rose 46 per cent, nearing its high.

The country’s growing population is creating jobs and driving demand for goods and services, according to Vijay Tohani, portfolio manager of the First State Indian Subcontinent fund.

But some believe the rush to invest is a bit misguided as the market is expensive and quite risky for investors who do not want to invest for long periods, even after this week’s downturn.

“At the moment, a [further] correction in the Indian market is overdue,” says Andrew Beal, a Henderson Asian fund manager. “My overall view is that India is a fantastic long-term story, but in the short-term it is limited by macro-economic issues. Its fiscal position is stretched and inflation and interest rates are rising. I’m worried about those factors.”

This week, Indian markets fell a further 5.5 per cent as investors cashed in investments amid the global sell-off in equities. Changes in regulations introduced by finance minister Palaniappan Chidambaram as part of the budget this week also contributed to the fall.

And while the Chinese market suffered a slightly bigger correction of around 6 per cent, some argue that in the long term companies listed in Hong Kong and Shanghai offer better value.

Compared with China, India may be less compelling, analysts argue. First, India’s gross domestic product per head is approximately half that of China’s, suggesting it is
lagging behind on economic growth. Second, the stability offered by a communist state supports a solid financial system in China while India suffers from crippling bureacracy and political uncertainty. And third, China’s transportation and infrastructure is light years ahead.

The most damning concern for Indian fund managers is the risk of inflation. “With interest rates and inflation at much higher levels than they were at the beginning of 2006, the appetite for risky asset classes is coming down and that’s a concern. It may actually create a liquidity outflow in India,” claims First State’s Tohani.

But the flipside of this argument is that Indian companies tend to be better managed and hold themselves to higher standards for shareholders than their counterparts in Beijing and Shanghai.

The sectors that dominate the market in India are tech companies that perform oursourcing for western groups; financials; companies involved in the development of India’s infrastructure; and pharmaceutical groups which manufacture cheap generic drugs.

Favourite stock picks of Young of Aberdeen include Infosys, the software company specialising in outsourcing which is “extremely well-run” and trading at 35 times earnings and Alliance Industries, the petrochemical group which is entering the retail market. Tohani of First State prefers Bharti Airtel, a mobile phone operator which has seen its base of subscribers double in the past two years. “Its market penetration is only about 11 to 12 per cent,” he says.

Andrew Beal, an Asian fund manager at Henderson, likes ICICI bank and Tata Motors, the vehicle arm of the Tata group, as he can make sense of their valuations and considers them high-quality long-term growth stocks.

Other names pointed to by Tohani and Young are Ranbaxy, the drugmaker, Larson & Toubro, India’s largest construction group, Hindustan Lever, Unilever’s operations in India, Tata Consultancy, the software company, and Satyam Computer Services.

Arun Mehra, manager of Fidelity’s India Focus fund, stresses that the key to investing in companies in India is to find ones that will grow on the back of Indian’s rising appetite for consumption.

If you are interested in investing in a pure Indian fund, you are likely to have to invest in one listed offshore as there are only a tiny number of onshore India funds. These include Fidelity’s India focus fund, which has a bias to the healthcare, industrials and consumer-related sectors and First State Indian Subcontinent fund, which invests in India, Bangladesh, Pakistan and Sri Lanka; its top holdings include Infosys, the software group, Bharti Televentures, the telecommunications group, and Wipro, the tech company.

Get alerts on Personal Finance when a new story is published

Copyright The Financial Times Limited 2019. All rights reserved.

Comments have not been enabled for this article.

Follow the topics in this article