Thought I'd share a good article I found while researching this topic:
(Source is Morningstar)
Fund Managers Find Passage to India
by Gareth Lyons | 11-21-05 | 06:00 AM
Diversified portfolio managers typically stick to developed markets when sizing up opportunities. Lately, however, an increasing number of managers are venturing beyond the cozy confines of the United States and Western Europe and are snapping up shares of emerging-market companies. As a result, Indian stocks are cropping up with increasing regularity in nonemerging market funds. At the top of the list is Janus Contrarian Fund JSVAX. A fund that has typically stayed within U.S. borders, it currently has 21% devoted to Indian stocks. Sibling Janus Overseas JAOSX has lots of exposure to the country, too--although this is less of a surprise, as emerging-markets have always been an active hunting ground for this aggressive foreign-growth offering.
The macro-economic backdrop for India is certainly alluring. And while the country doesn't get the same level of media attention that China does, its huge population and rapid economic growth make its potential just as strong. What's more, unlike China, India is a democracy, and capitalism seems more apt to flourish in a country where there is at least some respect for property rights. India's explosive growth has owed more to entrepreneurial initiatives than government-sponsored programs. It doesn't hurt that it has a well-educated labor force made up of many English speakers. That makes it particularly attractive for U.S.- and British-based multinationals that wish to do business there. The country's potentially huge consumer market is perhaps its biggest draw, however. India's burgeoning middle class, which has been responsible for the surge in loan and mortgage activity in recent years, has been beefing up its consumer spending at a rapid pace. The numbers back up the anecdotal evidence, too; the Indian economy grew by a whopping 9% in 2004 and is expected to grow at a similar rate in 2005.
Is the Timing Right?
As enticing as all that may sound, there's plenty of room for skepticism--at least in the near term. For starters, the Indian stock market has more than doubled in value over the past three years. And even though earnings growth has accompanied the rise in stock prices, many experienced international managers who are longtime observers of the region are beginning to reduce rather than add to their India holdings. Frances Dydasco of T. Rowe Price New Asia PRASX (a Morningstar Fund Analyst Pick) is bullish for the long term, for example, but she has been taking profits, as valuations have risen. Dennis Stattman, who runs Merrill Lynch Global Allocation MDLOX, has grown cautious, too, pointing out that the rapid ascent in Indian stocks' rally has caused their valuations to rise to a level commensurate with those of U.S. equities. Stattman remains positive on India, although he has been selling some names into strength. Ben Inker of value shop GMO (Grantham, Mayo, Van Otterloo), who subadvises Evergreen Asset Allocation EAAFX, isn't buying the hype, either. Although he's bullish on emerging markets overall, he thinks company valuations are not attractive in India.
Of course, emerging-market bulls--especially those from the growth camp, including Brent Lynn of the aforementioned Janus Overseas--aren't as stressed out about valuations as some of the value hounds mentioned in the previous paragraph. They argue that picks such as Reliance Industries and Tata Iron & Steel are global businesses growing at a much faster pace than most other U.S. stocks.
Paper Tiger?
That may be so, but they're also bound to be much more volatile, mainly because most of the risks inherent to other emerging markets still apply to India. The government continues to enforce extremely protectionist policies, limiting foreign ownership in many Indian companies to about 25%. Having come to power in early 2004, the Congress Party of India has dramatically slowed down the pace of privatizations, too. Industries, such as banking and insurance--the backbone of most financial markets--remain heavily restricted and government controlled.
The logistics of doing business in India can be extremely challenging, too, due to the country's abysmal infrastructure. Inadequate transportation routes have deterred many foreign manufacturing companies from setting up facilities there.
India certainly isn't immune to external shocks, either. Sustained higher oil prices could spell trouble, for example. Over the past year, India's trade surplus has disappeared, thanks to the rising cost of oil imports. Further deterioration in its balance of trade could sway foreign investor confidence.
And that's not all. Rising U.S. interest rates could present another potential fly in the ointment. Higher yields in the U.S. or the Eurozone might well inspire investors to reduce their exposure to far-flung risky asset classes such as emerging-market stocks and bonds. And while the possibility appears to be extremely remote, an outbreak in avian flu would be particularly crippling for India, given its high population density and poor health-care system.
Liquidity Risks
India's somewhat pokey stock market could easily exacerbate those risks. Its market has gained more depth and efficiency over the past few years. Trading can still be thin, though, making it hard for managers to initiate or liquidate positions without negatively impacting stock prices. We continue to hear concerns from managers about how many Indian stocks lack the broad shareholder base of other developing markets, such as Hong Kong or South Korea. That means faster-money players, such as hedge funds, can sway the market significantly when trouble hits and they run for the exits. In May 2004, the market tanked 25% in one day amid surprising election results.
The Takeaway
Given the risks, India fans would be much better off investing in a broader diversified emerging-markets fund than in an India-only fund. Our Analyst Picks in the diversified emerging-market categories and Pacific/Asia ex-Japan offer a great way to get started. That said, now is not the time to jump in with both feet. The growth prospects for emerging markets are compelling, but there are bound to be some bumps along the way. For that reason, we suggest investors dollar-cost average their exposure and devote only a small portion of their overall portfolios to this routinely volatile asset class.
Below are two Asian-focused emerging-market offerings we're recommending.
Matthews Pacific Tiger MAPTX
This fund follows an all-cap growth strategy, and experienced hands have executed it extremely well. Managers Mark Headley and Paul Matthews have earned superior results for their shareholders, delivering above-average results during downturns. The fund currently has an 8% stake in Indian companies.
T. Rowe Price New Asia PRASX
In a category rife with overpriced offerings, this fund's expense ratio is dirt cheap at 1.09%. The fund is also one of the most flexible in the group, investing across developing Asian markets in pursuit of growth stocks. Sector bets tend to come with the territory here, though--Indian stocks soak up about 15% of the fund right now. That said, we have a lot of confidence in the experience and talent of the management team in charge.
