Indian Stocks Bounce Back

India may be the next big thing after all.

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Fund companies last year raced to launch India-only funds, betting the Asian country's compelling growth story would lure regular investors. But the longer-term potential of "the next China" couldn't overcome more immediate fears of market volatility and a global economic slowdown, and shares of Indian firms plummeted 40%.

So far this year, India has gone back the other way. Led by solid economic growth, including an ever-bustling information technology sector, the country's benchmark Sensex index gained 10% through June 22. That compares to a 6% rise for the S&P 500-stock market index.

American fund managers have slowly crept back in to the world's second most-populous country. After yanking nearly $790 million from Indian stocks in 2011, U.S. fund managers invested $1.1 billion in shares this year, according to EPFR Global, a research and data firm.

The allure, India fans say, is that while its economy is growing at a slower-than-expected rate of 5.3%, that is still double the growth in the U.S. and other developed countries -- a trend that could boost corporate profits and eventually stock prices.

And unlike some other emerging markets, India boasts an increasingly educated and employed middle class, which investing pros say bodes well for consumer spending and Indian shares.

"The next 10 years could be the decade of India," says Brian Jacobsen, chief portfolio strategist for Wells Fargo Funds Management, who has India as his top pick among the emerging-market nations.

The renewed interest in India dovetails with some investors' desire to make more concentrated bets -- particularly when it comes to emerging markets. Indeed, the number of mutual-fund offerings that invest solely in India has doubled over the past year and a half to 30, including new offerings from BlackRock, Inc., Dreyfus Corp. and Goldman Sachs Group.

Critics point out that this approach is risky, noting that investors who allocate too heavily to a single country, especially a volatile market like India, could suffer steep losses.

Other emerging-market experts question whether Indian stocks can keep up their strong showing this year. Higher food costs are putting a damper on consumer spending, while political corruption in the country has delayed much-needed infrastructure projects.

"We're less optimistic than we have been," says Marc Tommasi, head of global investment strategies for Manning & Napier. He is considering scaling back the India exposure in the $570 million Manning & Napier International Series fund after legislation that would have encouraged political whistleblowers recently collapsed.

India bulls say such fears are overblown.

"The only way to tackle the short-term volatility and take advantage of earnings growth is to hold Indian stocks for the long term," says Sunil Asnani, co-manager of the $575 million Matthews India fund.

In Charlottesville, Va., financial adviser David Marotta say he prefers to get exposure to India for his clients through a diversified emerging-markets fund like the $49 billion Vanguard MSCI Emerging Markets fund, which has a 7% allocation in India.

Among all equity funds that invest in India, the average allocation to the country was 3.9%, up slightly from 3.7% at the beginning of the year, according to fund researcher Lipper.

Other managers have been more selective. Peter Newell, senior portfolio adviser at Vontobel Asset Management, which sub-advises the $3.9 billion Virtus Emerging Markets Opportunities fund, says last year's market drop has left many Indian stocks undervalued. He has been snapping up more shares of consumer-staples companies like Nestle India, Hindustan Unilever (500696.BY) Ltd. and ITC Ltd., a tobacco company.

"It's a very limited play on India, but it's a high conviction play," he says, noting his fund has 24% in India, up from 19% last year.