India’s economy is braced for a rebound – smart investors will buy in now

David C Stevenson looks at seven funds that tap the growth in one of the world's largest economies..

This week I want to take a look at investing in India. I'm becoming ever more bullish on prospects for Asia in general, and I'll be writing about the region in more detail in future pieces, but I'll admit that I've been fairly late to the ball when it comes to India.

I've always been a tad cynical, viewing India's stockmarkets as expensive compared to China, for example. But there's no denying that it's done amazingly well over the last six months.

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The collapse in oil prices has been one key reason for that. It's a major boost for a huge oil importer like India in fact, Socit Gnrale reckons that India is one of the single biggest global beneficiaries from a slide in oil prices. Lower energy prices should feed directly into higher consumer spending.

But more than anything else, including low energy prices, India's boom is down to one man new prime minister Narendra Modi. Modi is the head of the BJP, but let's be crystal clear this is not a BJP government, it's Modi's.

As regular MoneyWeek readers will know, Modi served as chief minister in the state of Gujarat from 2001 to 2014, and was credited with boosting GDP growth per head to an average of around 7% a year during his administration, from 4.8% a year in the previous decade. He now has a unique vision of where he wants to take India (for good or bad) and he's about to execute on it.

Strong leadership and big reforms

I believe investment booms happen because of longer-term structural changes, associated with big shifts in inflation or interest rates, or due to secular booms driven by business disruptions. In India we have neither yet but the experiment will be fascinating to watch.

I wouldn't expect any huge reforms quite yet, with Modi focusing on solidifying his state election base (ahead of upper house elections) and putting in place the right team.

But I would expect a number of decent-sized initiatives, including simplified clearance for big infrastructure projects; the break-up of big state monopolies, such as the Food Corporation of India; some relaxation of the rules on foreign investment and ownership; and the partial privatisation of state firms.

Two big targets drive these reforms. The first goal is to increase manufacturing's share of the Indian economy from 15% of GDP to 25% in a decade. The second is for GDP growth to rise above its recent 5%-6% trend, to hit 7%-8% in two to three years.

Space to cut interest rates

Assuming it stays under control, the Reserve Bank of India (India's central bank) has room to cut interest rates. Indeed, its preferred measure of inflation, the Wholesale Price index, is now rising at just 1.8% a year, from more than 10% in April 2009.

If everything works out, debt should get cheaper, profit margins should rise, and everyone should consume or invest more. Forecasts suggest that earnings growth for Indian businesses could hit 12%-15% in 2015, which should encourage even more money to flood into local equities, some of it from locals.

According to Cantor Fitzgerald "only around 3%-4% of India's $1trn in household financial assets is invested in equities (which compares to the 25%-50% range more commonly seen across the developed markets) More broadly speaking, the country's preferred store of wealth is physical gold and real estate/land."

Stunning potential

Stocks trade at around 18 times earnings for the coming year, compared to a five-year price/earnings (p/e) range of nine to 25 times suggesting that Indian stocks are average value. If earnings do rise sharply, we could see the Sensex heading towards a new high of around 42,000 implying a 50% leap from current levels.

I'm a little sceptical about that level of optimism I think investor enthusiasm for Modi is probably overdone. But I concede that he is building an astonishingly powerful base.

Modi has a massive mandate for change in a country that just needs some big nudges to start growing really fast again. Modi also appears to be committed to real structural change and doesn't just talk the talk (as appears to be the case with Japanese prime minister, Shinzo Abe).

The best funds to buy now

First State India Subcontinent Fund

Global India Equities Fund

These both have great long-term track records the First State fund even managed to eke out a positive return (1.9%) in 2013 virtually every other fund lost money that year! However, in Aberdeen's case, I'd be more tempted to switch into their equivalent investment trust, the New India Investment Trust (LSE: NII), managed by Rosie Bichard.

You should also consider JPMorgan's India Investment Trust (LSE: JII), which is the most liquid fund around, boasts the biggest assets and has a low total expense ratio (TER the annual costs) of 1.47%. It tends to stick closer to benchmark indices and is fairly sensibly run, although the Aberdeen fund has a better recent track record.

I'd also look carefully at the India Capital Growth (LSE: IGC) fund, which specialises in mid to small caps and is managed by a team under David Cornell at Ocean Dial. This fund takes more risks than its large-cap peers, but in the last 18 months that has paid off spectacularly it's gained 67% over the year to date.

Over the long run you might be drawn to the handful of exchange-traded funds (ETFs) that track Indian benchmark stock indices usually the broad MSCI India or the narrower Nifty Fifty. Amundi (LSE: CI2), DB X-trackers (LSE: XCX5) and Lyxor (LSE: INRL) all boast funds with TERs between 0.80% and 0.85% for their sterling funds a good 0.6% cheaper than their actively managed peers.