Updated from 1:31 p.m. with additional comments from fund managers.
NEW YORK (TheStreet) -- Indian markets have rallied to record highs on the election of Narendra Modi and his government pledging economic reform, but fund managers warn of pitfalls when investing in the world's second-most-populous nation.
Recent returns have been promising. The S&P BSE Sensex has gained 18.91% over the past year while the iShares India 50 ETF notched 26.72% and the WisdomTree India Earnings Fund (EPI) returned 13.33%.
Like China, India is an emerging economy where a growing middle class presents opportunity for savvy investors. Yet many professionals shy away from direct exposure to its stock market, where access is difficult for foreigners. Rising inflation has also affected purchasing power in a country where more than 800 million people survive on less than $2 per day, while manufacturing growth is contracting and stress in India's banking sector continues.
"For now the market seems to believe that, as Mr. Modi sweeps to power, he can generate millions of new jobs, plug India's infrastructure gap and attract the kinds of foreign money he has lured to Gujarat (but) the economic reality is not going to change tomorrow or the day after," said Kunal Kumar, vice president and India economist at Societe Generale.
"But I believe that we can see material impact of the new government on the economy within a year and a half," he said in an interview.
Kumar said many foreign investors had poured their money into India in anticipation of a new government. "The recent rally is a bit stretched and the market ought to take a pause from here onward," he said.