Investing in India

India sounds like a promising place for investors, but all that economic promise hasn't translated into equity.

The promise of investing in India is easy to see. After all, the country is home to 1.1 billion people, there's a burgeoning young middle class sucking up more and more consumer goods, and the government has adopted a pro-business attitude. Not to mention that GDP is expected to grow by roughly 6% this year and the year after.

Sounds great. But unfortunately, all that economic promise hasn't translated into equity returns. A dollar invested in the MSCI India equity index in 1994, when the country was liberalizing its restrictive business policies, was still only worth about a dollar 10 years later–a return that badly lagged the world index during the same period. The poor performance was partly due to the Indian economy's boom-and-bust cycle, but also because investor enthusiasm in the country–probably more so. While it is opening up to foreign direct investment, individuals and institutions still have to register as foreign investors with the Securities and Exchange Board–a process Guardian has been going through for the past nine months–before they can buy stocks directly on India's exchanges. Most individuals will likely find the red tape too daunting to cut; ex-pat Indians, however, have it easier because the government is encouraging such repatriation of capital.

The rest of us will have to be content with country funds, mutual funds or American depositary receipts listed on the New York exchanges. Created by JP Morgan in 1927 to allow Americans to invest in British retailer Selfridges, ADRs mirror shares traded in an issuer's home market. There are more than 20 Indian ADRs, including Dr. Reddy's Laboratories (NYSE: RDY), Infosys Technologies (Nasdaq: INFY) and Satyam Computer Services (NYSE: SAY), and more than 80 so-called global depositary receipts–equivalent listings on London or Luxembourg. But Indian ADRs tend to trade at a premium to underlying shares on the Mumbai Stock Exchange (India's oldest and largest) because they are often the only way investors–whether institutional or individuals–can get into India. Some depositary receipts are also rather illiquid, according to a UBS report last year that examined investment opportunities in China and India. However, Paul Taylor, chief investment officer at BMO Harris Private Banking, which manages $6.5 billion worth of assets, points out that as long as the company you've invested in doesn't tank, you should be able to recoup any premium when you sell.

Don't want to take that risk? That leaves funds. Most investment houses have funds with at least some exposure to Indian securities, although China gets much greater interest. Nearly 40% of Guardian's $54-million Asian Growth and Income Fund is in Chinese assets, but just 4.2% is in India–through holdings in carmaker Tata Motors, generic drug manufacturer Sun Pharmaceuticals and Indian Hotels. Graham says the reasons behind the three picks are different: Tata is a longer-term middle-class bet that could pay off as India improves its highway infrastructure; Sun is an export play; Indian Hotels is a hard currency generator with exposure to rising travel by both foreigners and residents.

Guardian also has 10.9% Indian content in its Emerging Markets Fund, with companies such as Reliance Industries, the country's largest firm; Bajaj Auto; Satyam; aluminum miner Hindalco Industries; and State Bank of India. “We've been cautious about India as compared to China because India has been a great story for a long time, but the market is no higher than it was 10 years ago,” says Graham. “Ten years ago it was really expensive, but now it's pretty good value.”

But anybody looking for a quick buck, says Taylor, would be wise to look elsewhere. He says investors should watch to see how India manages its growth– a task a central government such as China's can undertake more easily– as well as potential unrest as the gap between the rich and poor becomes more obvious to all Indians.

Investors should also be aware that India is still a relatively domestic-based economy. Sure, many of the world's big names, such as General Motors, Wal-Mart and Microsoft, are there or about to be, but they haven't really flexed their muscles yet. Still, India's excellent demographics and growth are widely expected to pay off for equities, if only in the long run. “We've had such attention paid to China that people lose sight of the fact there are a billion consumers in India and its growth rate is almost equal to China,” says Taylor. “I see no reason why at some point in time a Canadian investor's allocation to China and India shouldn't warrant their own discrete meaningful weight in their portfolios.”

Just don't get sucked in too quickly.