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Buy India at a 13% discount with this fund

With a business-friendly government, a highly-educated middle class, and a young, growing population, the case for investing in India is strong. Ed Bowsher picks the best way to do it.

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India: a good time to invest

India's new prime minister, Narendra Modi, received a rock star welcome when he spoke in Hindi to an excited crowd in Madison Square Garden in New York this week.

Modi is also meeting several US business leaders, in an effort to rustle up more foreign investment for his country.

And the case for investment is pretty strong. India is politically stable, and has been a democracy since 1947. It has a highly-educated middle class. And best of all, it has a young, growing population unlike China.

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So should you join the excitement and invest in India too?

India is ready for change

One of India's biggest plus points at the moment is that Modi has the backing of a firm majority of voters to push through changes.

He won May's election by a convincing margin, and he ran as a firm pro-business candidate. (He already had a pro-business reputation thanks to a successful spell as chief minister in Gujarat.)

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Since his victory, Modi has made some tentative reforms. For example, the requirement that all boilers in the country must be inspected annually by a government inspector has been relaxed.

Perhaps most importantly, finance minister Arun Jaitley plans to introduce a goods and services tax' (GST), similar to our VAT. Now, you might think that a VAT-style tax is hardly a pro-markets reform. But I'd riposte by pointing out that the Thatcher government almost doubled VAT in 1979, shortly after taking power for the first time.

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You see, economists like VAT/GST because it's a tax on consumption rather than income or profits. If you tax consumption, that should boost savings. And if you use the extra tax revenue from GST to cut income taxes, you'll give people a bigger incentive to work hard.

That said, I doubt the new consumption tax will be wholly offset by a cut in income tax simply because the Indian government has a large fiscal deficit. But if you're going to reduce a deficit by raising taxes, a consumption tax is one of the best taxes to go for.

Modi's government is also relaxing some restrictions on foreign investment. So overseas companies will now be able to own 49% of defence and insurance businesses, up from the previous 25% limit. Modi is also trying to change the culture of the public sector. He's pushing ministers and bureaucrats to, at the very least, work a full business day.

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Even better, these reforms are being introduced just as growth is picking up. GDP growth rose in the second quarter of this year to 5.7% a year, up from 4.7% in the previous quarter.

It's not all good news

That said, not everything is rosy. As well as a large government deficit (the government spends more than it gets in tax), India also has a sizeable trade deficit (it buys more from overseas than it sells abroad). What's more, some fret that Modi has moved too slowly on structural reform.

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I can understand the concerns about the pace of reform, but I'm not bothered just yet. Returning again to the example of Britain in the 1980s, many of Thatcher's biggest reforms weren't pushed through until her second term.

As for the deficits, it's a valid concern, but the best way to curb these deficits is to export more, boost economic growth, and generate a higher tax take for the government that way.

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The other important issue here is valuation. India's benchmark BSE Sensex index is trading on a price/earnings ratioof 19 which is on the expensive side Hong Kong's Hang Seng index is currently on a rating of 15 (though clearly that's been hit by the current troubles over there).

And if you look at the Cape (cyclically adjusted price earnings) ratiosfor India, our preferred measure here at MoneyWeek, the BSE index also looks expensive on a rating of 20. China, by contrast, has a Cape ratio of just 12.

However, as I said earlier, India has a real demographic advantage over China, and Modi has a solid record of helping business in Gujarat. And if you look back, India rarely trades on a cheap p/e. So, really, I think it's a risk worth taking.

How to invest

So how should you invest in India? For a relatively immature stock market like India, I'd steer clear of passive funds and instead back one or two of the better active funds. The Aberdeen New India investment trust (LSE: NII) has a decent record. Its net asset valuehas risen by 41% over the last three years, beating the Indian stockmarket, which has grown by 35%.

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What's more, the trust is trading on a 13% discount, which means that if you invest £870, you're effectively buying assets worth £1,000. The annual management charge is also fairly reasonable at 1% a year, although there is also a potential performance fee of up to 0.75% if the fund does well.

The JP Morgan India trust (LSE: JII) is another option, although its net asset value has only risen by 30% over the last three years, and its discount is slightly lower than the Aberdeen fund at 12%. On the plus side, there is no performance fee on top of the 1% annual charge.

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