Mutual Funds Open Door to Frontier Markets

NEW YORK (TheStreet) -- After Dubai said a state-controlled company would have to reschedule debt, stocks around the world shuddered. In recent days, most stock markets have recovered, but the incident served to highlight the risks and opportunities in countries known as frontier markets.

Those are the smaller and less-developed countries in the emerging markets. While most emerging-markets mutual funds are dominated by major countries, such as Brazil and China, the MSCI Frontier Markets Index includes such economies as the United Arab Emirates, Sri Lanka and Ukraine.

A growing number of mutual funds have been focusing on frontier markets. What attracts investors is the chance to make early bets on economies that seem poised to grow. "The frontier markets look very similar to the way the major emerging markets appeared 10 years ago," says Donald Elefson, manager of Harding Loevner Frontier Emerging Markets(HLFMX).

A decade ago, it took guts to invest in an emerging-markets mutual fund. At the time, Russia was struggling to recover from a full-blown financial crisis, while Brazil labored to control roaring inflation. Since then, many emerging markets have put their financial houses in order and welcomed foreign investors. The resulting boom has made emerging markets one of the best-performing investment categories. During the past 10 years, diversified emerging-markets mutual funds have returned 10.9% annually, compared with a decline of 0.9% for the S&P 500 Index of the biggest U.S. companies, according to Morningstar.

Can frontier stocks repeat the success of major emerging markets? That's hard to know, but some signs are promising. At a time when forecasters are predicting sluggish growth for 2010 in the developed world, economists expect to see growth rates of more than 5% in many frontier countries, including Qatar, Nigeria and Vietnam.