Mumbai/Bangalore: India’s construction and engineering companies are set to produce the best returns for investors for a third year running as the country pours more cash into building roads, airports and power plants, but their popularity has left some stocks with lofty valuations.

The stock market stars of three to eight years back — technology and software companies like Infosys — will stay out in the cold as they are heavily exposed to a potential recession in the US.

Analysts and fund managers said the recent stock market slide, which has left the benchmark BSE 30-share index down around 10% this month alone, has helped skim some of the froth from infrastructure stocks.

They say India’s builders, power equipment makers and engineers are relatively protected from any US downturn.

“If 1995-2005 belonged to information technology, then 2005-2015 belongs to infrastructure,” said Ved Prakash Chaturvedi, MD of Tata MF.

Infrastructure funds were the best performers for two years in a row, with four of the top 10 funds notching gains of 90% in 2007 following a more than 55% jump by six of the top 10 in 2006.

“It will be a predominant theme in 2008 also and should outperform the broader market,” said R Rajagopal, chief investment officer at DBS Cholamandalam Asset Management.

The government has said India needs to invest $500 billion over the next five years to build infrastructure to help sustain an economy that is expanding at about 9% annually.

Fund managers believe the spending offers opportunities for the next few years, though many stocks in the sector are pricey and trade at nearly a third more than the price multiples of their peers in Asia.

Firms such as Larsen and Toubro, and power equipment maker Bharat Heavy Electricals are expensive, but they do have an upbeat outlook.

“L&T remains one of the fundamentally best proxies to infrastructure story,” Citigroup analyst Venkatesh Balasubramaniam wrote in a report.

At Friday’s close, L&T shares, which nearly tripled in 2007, had fallen about 6% this month to Rs3,890 and trade at 54 times forward earnings, while Bharat Heavy trades at 33 times after dropping 16% to Rs2,095.55.

Tata Consultancy Services, Infosys and Wipro have fallen from grace in the fund portfolios on worries about the health of the economy in the US. Investments by diversified equity funds in software stocks dropped to $1.7 billion in 2007 from $2.8 billion in 2006, and the trend is expected to continue this year.

Infosys was the worst performer in the BSE index in 2007, falling 21%, while the sector index dropped 14%. A 12% rise in the rupee’s value against the dollar weighed on software services exporters.

They say demand for outsourcing is robust and firms are rapidly expanding to Europe, Asia-Pacific and Latin America to lower their dependence on the US market, but fund managers are worried about shrinking margins.

Source : Dna