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A majority of India's stock fund managers see at least a 5 percent rise in the benchmark BSE index in the next three months and may invest mainly in shares in engineering and financial sectors, a Reuters poll show.

Three-fourth of the respondents in Reuters Asset Allocation Poll conducted from March 17-25 said the index, down 21 percent this year, will have positive return in the next three months. A fourth said it will rise more than 10 percent.

"Expectation of better result and valuations being closer to the long-term PE band of 15 makes Indian market one of the most attractive markets in the emerging world," R. Rajagopal, chief investment officer of DBS Cholamandalam Asset Management, said.

The fourth quarter results will show earnings expectation of the firms and bring clarity to the markets, he added.

The benchmark BSE index traded at one year forward price to earnings (PE) ratio of above 21 in early January but a sharp fall since then has softened the valuations, with the PE ratio falling to nearly 15 last week.

This has made fund managers look to deploy cash back into the stock market. The funds held an average 7.32 percent of their assets in cash at February-end, a five month high. But investment would be selective and mainly in relatively liquid large-caps.

Over 87 percent of the respondents said they would mainly shop for large-cap stocks. More than a third said they would cut exposure to mid- and small-cap shares in the next three months.

"In volatile times, people prefer large caps because the risk involved is lower," Rajagopal said.

The BSE Mid Cap and BSE Small Cap indices were down 36 percent and 44 percent respectively till March 26 in 2008, compared with a 21 percent fall in the main stock index, wiping out 29 percent of diversified stock funds' net values.

Diversified equity funds invested an average 42.5 percent of the assets in small and mid-cap firms at Feb-end, ICRA data show.

METALS LOSE SHEEN

The fund managers will continue investing in engineering and financial services stocks -- their top-two preferred sectors -- and may lower exposure to metal stocks.

Diversified equity funds invested 9.2 percent of their assets in the metal sector -- highest in at least a year -- but half of the poll respondents said they would start cutting allocation in the next three months.

The BSE Metal index is down 31 percent this year.