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India stocks lag peers as investors lose patience

Locals play cricket in Kolkata, India.
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Locals play cricket in Kolkata, India.

After stampeding into Indian equities in 2014, investors are heading for the exit this year, with the country's stock market emerging as one of the worst performers in Asia during the first half.

The benchmark S&P BSE Sensex is up a mere 1 percent year-to-date, lagging far behind China's Shanghai Composite – the region's top performer - which is up 32 percent even after taking into account its recent 20-plus percent pullback.

"India's underperformance is very much due to the fact that initial expectations for reforms under Narendra Modi's government have not been met. Foreign investors, in particular, have looked at that and withdrawn from the market to a significant extent," Uwe Parpart, head of research at Reorient Financial Markets, told CNBC.

Indian's equity market rallied more than 30 percent last year in a wave of optimism after Prime Minister Modi and his ruling Bharatiya Janata Party (BJP) swept into power on a promise to revive the sluggish economy. While growth has picked up - largely on account of the government's new methodology for calculating gross domestic product (GDP) - investment levels remain low, corporate balance sheets weak and banks' non-performing loans are rising, according to analysts.

There were just a handful of markets in the region that performed worse than India. Australia's S&P/ASX 200 is up just 0.9 percent so far this year. While performance in equity markets in Taiwan, Singapore, Malaysia and Indonesia ranged from a 0.2 percent gain to 6 percent loss.

While he's not totally writing India off just yet, Parpart says there are more attractive investment opportunities elsewhere in the region.

"I would like to see a much clearer commitment to reforms, including stepping up privatization and decisively cutting subsidies. There were lots of opportunities to do that with lower energy prices, those have been missed," he said, when asked what it would take for him to reconsider Indian stocks.

His top pick in the region is Asia's second best performing market – Japan. The country's benchmark Nikkei 225 is up 16 percent this year.

Read MoreWhy Japanese stocks could keep crushing the S&P

"We've had a strong buy recommendation on Japan for some time and see no reason to change that," Parpart said.

His upbeat outlook on Japanese equities is driven by the country's supportive monetary policy and improving macroeconomic backdrop.

"The economy has been steadily improving. Consumption, after being hit by the VAT hike, has been picking up. Capital investment by businesses is proceeding at a larger scale than most expected – these are positive signs," he said.

Parpart's viewed was mirrored by several other strategists in the region.

"In terms of value for money, we think Japan is the best bet," said Simon Grose-Hodge, head of investment advisory for South Asia at LGT Bank. On top of the domestic economy gaining traction, the corporate sector reforms could be a significant catalyst for stocks, he said.

The government, under Prime Minister Shinzo Abe, has been working to drive a shift in corporate behavior. Earlier this month, a new corporate governance code was rolled to establish best practices for governance behavior. It encourages discontented investors to voice their grievances and requires companies to take calls for better returns more seriously.

North vs South Asia

Aside from China and Japan, the top performing markets in the region were also located in North Asia.

Hong Kong ranked third, with the Hang Seng Index racking up gains of 11 percent so far this year. South Korea's KOSPI followed closely in fourth place, up 8 percent.

"The performance differential between North and South Asia can be explained by cheaper valuation levels in the former," said Stephen Sheung, head of investment strategy at SHK Private.

"Three to six months before and after the Federal Reserve starts tightening, investors tend to be much more sensitive to valuations," he said.

Read MoreThese risks could derail China's bull run

As such, he expects the trend of North Asian outperformance to continue for the remainder of the year - and yes, that includes China. Looking past the current selloff in mainland stocks, Sheung expects that the market will gain traction once again in the third quarter.

"You can't ignore the annual political cycle in China," he said referring to the upcoming fifth plenary session of the 18th National Congress, expected to be held in October or November, where he expects Beijing will announce reforms pertaining to state-owned enterprises (SOEs).

This is set to inject fresh momentum into the SOE-dominated Shanghai Composite, he said.