Searching for the Next Hot Emerging Markets

Tickers in this article: EEM FM FRN VWO WAFMX
NEW YORK ( TheStreet) -- During the past decade, emerging markets stock funds soared, returning 15.7% annually, according to Morningstar. It was a notable performance in an era when most stocks delivered uninspiring results. Can emerging markets repeat their strong showing in the next 10 years? Probably not. The problem is that the stocks have become too rich to deliver outsized results.

A decade ago, stocks in Asia and Latin America sold at modest prices. Few investors were enthusiastic about emerging markets because they had suffered from a series of financial collapses in the 1990s. As the emerging economies recovered, the stocks rallied, rising sharply from depressed levels.

These days emerging markets have become market darlings, boasting healthy balance sheets and ebullient stock markets. In the past year, investors have poured into emerging markets ETFs, putting $11.4 billion into iShares MSCI Emerging Markets (EEM) and $7.2 billion in Vanguard FTSE Emerging Markets (VWO) , according to IndexUniverse.com.

But there is an area of global markets that has received little attention: the countries known as frontier markets. While the emerging markets ETFs focus on established countries, such as Brazil and India, the frontier markets ETFs include shakier economies. Guggenheim Frontier Markets ETF (FRN) has assets in Kuwait, Pakistan and Kenya.

Like emerging markets stocks, the frontier exchanges were crushed during the financial crisis. But since then, the established emerging markets have rebounded, and the frontier stocks have struggled. As a result, frontier stocks are now relatively cheap, says Christian Deseglise, Managing director of HSBC Global Asset Management. He says that frontier markets trade for 10.2 times earnings, compared to 11.5 for emerging markets.


Deseglise argues that frontier markets will outperform in future years. He recommends stocks in such countries as Qatar and Nigeria. "In the next five years, the earnings growth will be much faster in the frontier markets than in the established emerging markets," he says.

The IMF predicts that in the next two years many frontier countries will report growth rates of more than 4%. Countries that should exceed 6% include Qatar, Bangladesh, and Vietnam. The growth is accelerating as frontier economies experience the kind of massive modernization that swept countries such as China and Mexico a few years ago. While hundreds of millions of people in the established emerging markets now enjoy middle-class comforts, consumers in frontier markets have only recently gained access to cell phones and bank credit.

Frontier stock markets could achieve strong growth for years, says Raman Subramanian, executive director of index research for MSCI. Subramanian says that in 1988, the emerging markets accounted for only 0.8% of the total global stock market value. But by 2011, the figure had climbed to 12.3%.