But what about investing in the next layer of BRICs-which might include stocks from Bangladesh, Romania, Ivory Coast and Cambodia? These frontier markets might develop into tomorrow's emerging economies. Or sink into oblivion.
"There are definitely opportunities for appreciation in these areas, but there is also a major downside with the political uncertainty," says Andrew Feldman, a financial planner in Chicago. "Some of my clients are exposed to the frontier markets, as a subset of emerging markets, but these funds are extremely volatile and not appropriate for smaller accounts."
FINDING THE FRONTIER
Proponents of frontier markets believe they're attractive for many of the same reasons used to support allocations to emerging markets. Economic growth might be far higher, for many years, than the growth rates in the United States and developed foreign markets. Within frontier markets, an expanding middle class may bolster a desire for an improved lifestyle, thus generating profits for local businesses. Many frontier markets are rich in natural resources and likely to profit as demand increases.
Planners who believe frontier markets may be the next hot asset class face some obstacles in getting exposure. For one, explaining frontier markets is not so easy.
Obviously, a frontier market is one not in the "developed" or "emerging" categories. Many countries fit that description, but some are poor choices for investors. Potential picks should include a lineup of publicly traded companies, liquidity reporting requirements, property rights, rule of law and other features investors expect to find in a country serious about attracting international investment.
"They tend to be more rural and low-tech, yet market-oriented, with high human capital. Frontier markets are forecast to have twice the economic growth rate of emerging markets in the next three to five years," says Christian Hviid, chief market strategist at Genworth Financial Asset Management in Encino, Calif.
Moreover, investors are not paying much for that growth because of the risks. "Access to information about those markets is improving, but it is still a challenge," Hviid adds. "The worldwide market cap of frontier markets is less than their worldwide purchasing power, so their stock markets should outperform in the coming years."
Frontier markets may be ill-suited to investors if their time horizons are on the short side, however. "The growth occurring in the frontier markets will bring an opportunity for outsize investment returns for patient, long-term investors," says Mark Luschini, chief investment strategist at Janney Montgomery Scott in Philadelphia. "However, the process will not be linear, so investors should expect setbacks along the way."
RECOGNIZING RISKS
Such setbacks have been apparent in 2011. The Middle East and North Africa play a huge role in frontier markets investing, and that region has literally come under fire in recent months. Stock markets in two frontier markets-Egypt and Bahrain-have faced shutdowns.
Under normal conditions, Luschini says his firm would suggest splitting an international allocation evenly between developed and emerging markets, and they might allocate one-quarter of the emerging markets weighting to frontier markets. Thus, about one-eighth of a client's international equity exposure could be in frontier markets.
His firm has reduced its emerging-markets recommendation to 25% or less of international exposure. He adds that, for now, they are reluctant to recommend any weighting in frontier markets, given the turmoil and uncertainty in the Middle East and North Africa.
"We are very cautious in the near term because of food inflation, which is causing equity market disruptions, and because of the political instability in some areas," he says. "One day's events can bring a rush of buyers to these markets followed by a riot, bombing or other shock that can cause declines of 5% to 10% in a single day."
That is uninviting from an investment perspective, he adds. "We think it is prudent to let the situation in the Middle East reach some resolution before committing capital unless the speculation of such an investment is understood and accepted."
Some advisors see a possible bright side. Feldman agrees the current crises can have a negative effect, but if there are favorable outcomes in some markets, the region's stability and growth might improve. "These are high-risk, high-reward allocations," he says.
Brent Brodeski, managing director of Savant Capital Management in Rockford, Ill., adds that the upheaval underscores a crucial theme-diversification. "If you hold many different frontier markets, several might get pummeled by political uncertainty while others do well. Thus, it is of paramount importance not to put too much in any given frontier country. While diversification is always important, it is even more so in frontier markets."
