India is attractive, investors say, because it is insulated from China while also emerging as a strong parallel offshore manufacturing hub, and it has a healthy consumer base. The market has traditionally done well in an election year, and general elections are coming up in April.

But popular blue-chip stock valuations are sky-high, forcing these investors to pick and choose sectors such as autos and technology, while avoiding banks and blue-chip firms.

India is not alone in drawing investors who are disenchanted with China's markets and an economy limping after years of pandemic lockdowns.

But the nearly $16.5 billion foreigners have poured into Indian stocks this year, their biggest splurge since at least 2008, eclipses the $8 billion and $5 billion received by South Korea and Taiwan.

"I think the Indian market is attractive compared to its regional peers," said Sukumar Rajah, director of portfolio management at Franklin Templeton Emerging Markets Equity, pointing to the country's attractive demographics, market-oriented economy, and rising middle class.

LOCALS VS. FOREIGNERS

The blue-chip S&P BSE Sensex (.BSESN) and the Nifty 50 (.NSEI) index are both up 8% this year, outperforming the 3% rise in the MSCI emerging markets stock index (.MSCIEF) and a flat MSCI Asia-ex-Japan share index (.MIAPJ0000PUS).

But both indexes are close to the record levels, making it imperative for foreign investors, who usually prefer larger companies, to be discerning.

For Kunjal Gala, head of global emerging markets at Federated Hermes, technology stocks are a "contrarian bet" on the U.S. tech sector recovering, but he also likes automakers and non-banking financial firms.

UK-based Aubrey Capital Management Portfolio Manager Rob Brewis focuses on consumer-focused companies, with his fund counting Varun Beverages (VARB.NS) as its top holding. The Pepsi bottler is up 41% this year, after surging an astonishing 123% last year.

"We've always taken the view that you get what you pay for, and it's the best growth story. It looks like it's going to keep going for several more years to come," said Brewis, referring to richly valued Indian stocks.

Foreigners pulled $17 billion from India in 2022.

Their return this year however coincides with a pull back by domestic investors, who have been the driving force behind the market's 150% rise from the pandemic lows in March 2020.

Data shows data domestic institutional investors put over $13 billion into Indian capital markets this year, compared with roughly $36 billion last year.

Pramod Gubbi, Mumbai-based founder of Marcellus Investment Managers, points to the froth in small and mid-capitalised companies, the segment most domestic retail investors get into. The small-caps index (.NIFSMCP100) is up over 28% this year.

Local investors are now being tempted by traditional, safer savings options, as bank deposit rates have spiked since the end of 2022.

Yields on benchmark 10-year bonds are above 7%, while one-year bank deposits earn roughly 7%.

"Overall, equities start looking expensive versus other alternatives for domestic investors," said Sunil Tirumalai, an emerging markets and India strategist at UBS in Mumbai.

VALUATION GAP

Foreign investors have long been wary of India's rich valuations. The nearly $900 billion Sensex now trades at a price-to-earnings ratio of 22.6 times compared with 12.6 for the MSCI Asia-Pacific ex-Japan index.

Federated Hermes' Gala said his fund has trimmed its position since the start of the year to neutral in India.

"It's not that we are giving up on India. But... good quality companies, growth-oriented companies, the companies that we would ideally like to buy are not available at reasonable valuations."

Concerns over corporate governance are also deterring some investors, after U.S.-based short-seller Hindenburg Research accused the Adani Group in January of improper business dealings.

James Thom, senior investment director of Asian equities at abrdn, is overweight on India and has had a large position in the country for many years. He says China is cheap but not many investors are brave enough to bet on a rebound there.

"India stands apart as probably the most attractive macro story at the moment," Thom said.