India Bubble?

By William Green

Finding a job in the investment world was always going to be easy for Navroz Udwadia, a second-year student at Harvard Business School and a former Rhodes scholar. But what made him stand out was not just his brain; it was that he had grown up in Bombay and had a passion for Indian equities. "Every hedge fund I interviewed with was fascinated by my Indian background," he says. Four of them offered him jobs. One, refusing to wait for him even to graduate, gave him $5 million to invest in Indian stocks in his spare time.

Entrusting millions to a grad student might seem foolhardy, but everyone these days seems to be groping for a way to get rich off India. Foreign institutional investors poured $8.9 billion into Indian equities in 2004 and $3 billion so far this year, up from $750 million in 2002. Awash in cash from overseas, Sensex--India's main stock index--has more than doubled in two years to hit a recent all-time high. As Udwadia puts it, "astute foreign investors" recognize that India's rise is "a unique opportunity."

He's right, of course. On a recent visit to Bombay, I soon found myself as intoxicated as everyone around me. It's hard not to be dazzled by what's happening: the economy is growing at 7%, per capita income is soaring 11% a year, and Indian corporations are more competitive than ever before. Yet this flood of hot--and often naive--foreign money into Indian stocks has me spooked. The Indian market has often proved a terrific place to lose money. If you had bet on the Sensex in, say, 1992, you would have been 30% poorer by 2003. But today there is an endless new supply of India-focused mutual and hedge funds, many with wonderfully alluring names like (my favorite) the Monsoon India Inflection Fund.

The most voguish are Indian mid-cap funds, which bet on riskier companies that may one day grow up to be blue chips. In November and December alone, the CNX mid-cap index jumped 28%. Returns like those make life worth living, but gravity has a way of bringing things back to earth. When I met him in Bombay, Nilesh Shah, head of equity strategy at Kotak Securities, seemed pleased but perplexed by the performance of his team's fledgling mid-cap fund, targeted at foreigners willing to pony up $100,000. Six months after its launch last August, he marveled, it had soared 59%.

Over tea at the elegant Taj Mahal Hotel, a fast-talking broker rhapsodized about a new Swiss-based hedge fund that he's hawking to foreigners. "The upside potential is huge. The downside risk is minimal," he assured me. Foreign investors are so receptive to India, that kind of giddily unrealistic pitch might just work. Indeed, a director at a Bombay brokerage house told me he has been startled by recent encounters with foreign investment firms. Their attitude, he says, is "'Let's just get invested quickly. It's going to boom for the next 20 years, so let's get a piece of the action.' They're not that focused on valuations."

As in any frothy market, the media are feeding the euphoria. TV viewers are treated to a regular CNBC program called Wizards of Dalal Street, showcasing the wisdom of local investment gurus. Another channel, NDTV Profit, offers a rival show called Big Fish (not to mention Sensex and the City). Indian business publications pile on with intoxicating headlines like THESE IPOS CAN MAKE YOU A SUPERSTAR INVESTOR.

Home-run examples do abound. Indiabulls, a financial-services firm that hopes to profit as wealthier Indians buy more stocks, has seen its shares quintuple since last fall, while Pantaloon Retail stock has risen 19-fold in two years as investors bet on the burgeoning spending power of the Indian shopper. Yet gains like those are a reflection less of unlimited promise than of limited supply, with momentum investors bidding up the few available stocks that offer a way to play those trends.

Does all that mean you shouldn't have a dime riding on India? Not at all. But don't wade into those waters with a blithe sense that the returns of the past two years are repeatable--or you'll end up battered and fried, along with all the other big fish.