Should this soaring stock market still get your vote?

India’s general election, the biggest poll the world has ever seen, began in mid-April, but the final results will not be declared until early June. By then, as many as 970 million people will have voted; it is a huge number and a mammoth logistical event that provides some clues about the drivers of India’s economic outperformance in recent years – and its stock market boom.

Indeed, the question today isn’t so much about India’s long-term prospects, which remain compelling. Rather, investors in Indian equities worry they may now be overpaying for exposure to the rise of India. Might other markets in Asia offer better value right now? “India is certainly very pricey,” warns Ben Yearsley, a director of Fairview Investing. “I’ve actually taken some profits recently and recycled into broader emerging markets.”

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The big picture in India is that if, as is widely expected, Indian prime minister Narendra Modi wins a third term of office, he will continue his programme of economic reforms. These span investment in infrastructure, incentives for foreign investment, support for urbanisation, and progress on decarbonisation.

It’s a combination that has delivered growth: India’s economy expanded 7.8% last year, the International Monetary Fund (IMF) says, and GDP growth is on target to hit 6.8% in 2024.

The stars are aligning for India. Its manufacturing sector, traditionally domestically focused, is now benefiting from Western companies’ determination to diversify away from reliance on China. Growing wealth has seen the size of the consumer class reach 475 million according to the Brookings Institute, providing ever more customers for consumer-facing businesses. The IT sector continues to deliver on the world stage. And a young population – the average Indian is aged just 30 – promises to drive this engine for decades to come.

This is no flash in the pan, says investment bank Goldman Sachs. It thinks India will consistently grow more quickly than China over the years to 2050 – and that by then it will have overtaken the US to become the world’s second-biggest economy.

No wonder that the Indian stock market has hit a series of record highs over the past 18 months, with its total capitalisation exceeding $4 trillion by the end of last year. The value of companies quoted on the National Stock Exchange of India grew 50% over the year to February; the exchange is now the world’s sixth largest.

Have valuations become too rich?

However, the worry is that such gains are a case of too much, too soon. Today, the Indian stock market trades on a forward price-earnings (P/E) ratio that is around 1.8 times higher than the ratio for emerging markets as a whole. In other words, Indian companies cost almost twice as much as their peers in other developing countries. Some analysts fear that is difficult to justify, even given India’s tremendous potential.

Raheel Altaf, manager of the Artemis SmartGARP Global Emerging Markets Fund, is one such worrier. As such, Indian equities currently account for only 10.1% of his portfolio, against an index weighting of 18.2%.

“We hold some great Indian companies, such as telecoms business Indus Towers, electricity company Power Grid, copper and iron ore producer NMDC and battery maker Amara Raja Energy & Mobility, but we are looking for growth at a reasonable price and you have to look quite hard for that in India,” Altaf warns. “We see better-priced opportunities elsewhere, such as China, where we think the gloom story has been oversold. We also like South Korea, Taiwan and Brazil.”

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Nathan Sweeney, chief investment officer of multi-asset at asset manager Marlborough, is similarly cautious. “As long-term investors, we like India, and there are still pockets of good value stocks; but we do see this market as overvalued right now,” he says.

Marlborough’s value-oriented bias in Asia and emerging markets means its funds are generally underweight India. Sweeney adds: “In Asia, we prefer the outlook in Taiwan, which we see as undervalued, and in emerging markets more broadly, we prefer Brazil, where we like the long-term macro story that’s developing.”

Still, such views are far from universal. “One of the key reasons why we remain positive despite higher valuations is Indian companies’ consistent earnings growth,” says Sam Banerjee, an analyst at Shore Capital. He adds: “Emerging markets often have a patchy record of translating GDP growth into earnings growth for corporates; Indian equities, by contrast, have delivered a higher return on equity.”

This has attracted robust inflows of money into the stock market from domestic investors, Banerjee points out, including both retail investors and institutions. “As long as domestic growth remains strong, this long-term trend can sustain significantly higher valuations,” he argues.

Mike Sell, the manager of the Alquity Indian Subcontinent fund, makes a similar argument. “India has a high P/E because of strong earnings growth over a number of years; its earnings per share (EPS) stands at 17%, giving it a P/E-to-growth ratio of 1.3 times’,” Sell says.

He adds: “On a PEG basis, India is cheaper than the likes of South Korea, Japan, Mexico and the UK; countries like Korea, Taiwan and Thailand may have a lower PEG, but they are cyclical, not structural stories, and India has multi-years of growth, rather than pockets of opportunity.”

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Clearly, however, a degree of selectiveness will be required, but as Vinay Agarwal, a director and India specialist at FSSA Investment Managers, points out, this is what fund managers get paid for.

He says: “We continue to find attractive investment opportunities in India on a bottom-up basis. In the last decade, valuations in India have consistently been higher than in other emerging markets, but in our view, there are a number of reasons that justify this.”

He points to regulatory protections for minority shareholders in India that are stronger than in other emerging markets, India’s larger universe of high-quality companies, and low levels of penetration in sectors such as financial services and consumer discretionary.

“Pockets of the Indian market are expensively valued, but this is also the case for most other emerging markets,” adds Agarwal.

Do other emerging market regions offer better prospects?

All of which leaves investors with a decision to make. Do they cut back on India exposure in favour of better-valued opportunities elsewhere, or stick with current positions (or even add to them), given the long-term opportunity?

There is no single right answer to this question. It will depend on the size and nature of your current exposures, both to India and broader emerging markets, your appetite for risk and your time horizons. Many investors focused on the medium- to longer-term narrative will feel very content with India-specific funds, or regional or emerging markets funds with significant holdings in the country. Others may prefer broader funds with reduced Indian exposure – perhaps value-oriented funds that will be trimming Indian holdings given the current valuation levels.

For those in the former category, Shore Capital’s Banerjee is a fan of the India Capital Growth Ord (LSE:IGC) Fund, which has a tilt towards consumer goods, banking and IT, all sectors of the Indian market that have not raced up with quite so much speed during recent years.

“IGC has an attractive structure,” Banerjee argues. “Besides being focused on the section of the market which has been the best performing in terms of long-term earnings growth, investors have the ability to redeem their stock at close to net asset value every two years. Thus, in the worst-case scenario, we expect the discount of IGC to narrow from around 10% to close to 3% in 18 months or so.”

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Alternatively, Fairview Investing’s Ben Yearsley singles out Ashoka India Equity Investment Trust (LSE:AIE). “It invests with a multi-cap strategy and could be characterised as seeking growth at a reasonable price,” he explains.

As for options for those who want a broader, value-led exposure to emerging markets, Yearsley has two suggestions. “I like Schroder Emerging Market Value and Fidelity Asia Pacific Opportunities,” he says. “The former uses cyclically adjusted PE ratios to assess where value is; Fidelity’s fund has about 9% in India but has a broader definition of looking for value.”

At ii, investment data analyst Alex Watts suggests ii-rated funds Pacific Assets (LSE:PAC) and JPMorgan Emerging Markets Ord (LSE:JMG), which hold 42% and 24% of their assets in the country respectively. For those who prefer a fund weighted towards other markets, he picks out Utilico Emerging Markets (LSE:UEM), also ii-rated which currently has only 8% in India.

Watts adds: “In addition, Stewart Investors Indian Subcontinent Sustainability fund is a good option for investors looking for India equity exposure with a sustainability focus. The fund invests in the highest-quality companies run by responsible management teams, and is managed by the same team responsible for Pacific Assets Trust.”