Although the Indian stock market has been racing ahead for the past few years, the country is still in the early stages of its transformation into a developed economy, says Jayesh Gandhi, portfolio manager at Mumbai-based Birla Sun Life Asset Management Co. Ltd. and one of two Birla managers choosing investments for the $277-million Excel India Fund.

Birla is a joint venture of Sun Life Financial Inc. of Toronto and India’s Aditya Birla Group.

India’s average annual productivity per person is hovering at slightly less than US$1,000. Based on the experience of emerging markets such as China, once that figure crosses above the US$1,000 mark, the pace of economic growth will probably increase exponentially, Gandhi says.

“It’s a virtuous cycle,” he says. “Once people start making more money, they start spending more money. And the effects multiply as wealth trickles down.”

Gandhi also manages Excel India Trust, which has an identical portfolio to the original mutual fund. The trust will begin trading on the Toronto Stock Exchange this month. Both funds are sponsored by Excel Funds Management Inc. of Mississauga, Ont.

Launched in 1998, Excel India Fund caught the early wave of investment opportunities generated by the emergence of India on the world stage, as well as the volatility that comes with a rapidly changing economy. As of May 31, the fund has shown an average annual compound return of 18.7%, with the most recent three years showing a particularly spicy 32.1% average annual return, beating the median of 24.8% for emerging-markets funds.

But it has been a roller coaster. Excel India Fund’s best 12-month period since inception was the year ended Dec. 31, 1999, when the fund roared head by 202%. Its worst 12-month period, on the other hand, was the period ended March 31, 2001, when the tech stock bubble was imploding globally, and the fund’s value plunged by 60%.

Gandhi, who has lived and worked in India and the U.S., sees a positive direction for his native country. One of India’s most intriguing differentiators is the youthfulness of its population, he says.

A YOUNG POPULATION

More than 50% of India’s population of almost 1.1 billion people is under the age of 25. Currently, about 550 million people are under 25, with about 350 million less than 15 years old, which means the country’s population will remain young for decades.

“India has a young population, with a lot of people now moving into their employment years,” Gandhi says. “As income is generated, spending power increases, which creates more jobs and allows more people to afford more things. The growing availability of credit through loans and mortgages will further stimulate buying power.”

Also, massive government spending on infrastructure is creating more jobs and, thus, contributing to the expansion of the middle class. Gandhi estimates that India is about 10 years behind China in terms of infrastructure development, but in 2005 the Indian government announced plans to spend $230 billion on infrastructure by 2010.

“Infrastructure growth has been stronger in China during the past 15 years and is only just taking off in India,” Gandhi says. “However, India is five years ahead of China in terms of efficiency of its stock markets and financial system, corporate governance and the distribution of accurate corporate information. There is a strong entrepreneurial culture within corporations, and many have the ambition to go beyond India’s borders and become world leaders in their industries.”

Gandhi’s strategy is to invest in “scalable businesses” that have strong management capabilities, viable business plans and the necessary resources to expand profitably as India’s economy matures.

About 75% of his portfolio is in large-cap stocks, which, he says, are the most liquid, with the balance in mid-caps. These companies must show the ability to make the transition from a culture dominated by the entrepreneur or visionary who started the company to one in which the company is run by a professional management team.

Gandhi likes to diversify across industries and sectors, with 35 to 50 holdings in the portfolio. His largest holdings, including cellphone manufacturer Bharti Airtel Ltd. and power and industrial machinery producer Bharat Heavy Electricals Ltd., each account for 6%-7% of the fund’s assets. He also has holdings in ICICI Bank, India’s largest private-sector bank; Infosys Technologies Ltd., a major software company with worldwide reach; and Tata Motors Ltd., India’s largest commercial vehicle manufacturer.

@page_break@“We’re bottom-up investors who seek growth at a reasonable price, but the price is based on huge growth in India,” he says.

India’s gross domestic product is growing at 8%-9% a year, which is two to three times faster than that of developed countries. As a result, corporate earnings are also growing quickly, averaging 30% a year since 2002, based on the Bombay Stock Exchange Sensex 30 index. Gandhi thinks GDP growth of 8%-9% and earnings growth of 15%-20% are both sustainable for at least the next five years. Some managers consider the Indian stock market expensive, but Gandhi says its current price/earnings ratio of around 18 times estimated earnings for fiscal 2008 is not unreasonable, considering the growth outlook.

“We look at the long-term sustainability of business momentum, and value a company based on a projection for future growth,” says Gandhi. “If a company is trading at less than fair value, it’s a buy; if more, it’s a sell.”

That’s not to say there aren’t risks in the Indian stock market. Because Chinese stocks are considered by some to be in “bubble” territory, a dramatic decline in the China market could spill over into India. India also faces the risk of inflation, and further interest rate hikes could be implemented as the government attempts to cool prices down. There has already been a couple of interest rate hikes this year, bringing inflation down to 4.8% from 6.5%. As well, India could also feel the effects of a U.S. or a global slowdown.

Although Gandhi was born in India, his perspective has been influenced by the time he spent studying and working in the U.S.

He graduated from Mumbai University in 1989 with a degree in finance, followed by his chartered accountant designation. He began his career as a research analyst with Morgan Stanley in Mumbai, then moved to an India-based asset manager that was part of the J.V. Gokal & Co. group. In 2001, after becoming a portfolio manager and training in Britain, Gandhi decided he wanted global experience and attended the Garvin School of International Management in Tucson, Ariz.

His second day in the U.S. was the day of the 9/11 disaster. After studying for a year in Arizona, he spent a couple of years working for an asset-management firm in Salt Lake City, Utah, before returning to Mumbai in 2004 and joining Birla. IE