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Should You Invest in Frontier Markets?

|Includes: EEM, FRN, MES, Invesco MENA Frontier Countries Portfolio ETF (PMNA), VWO

Stocks in the world’s “Frontier” markets returned nearly 20% last year.  Growth in frontier markets is outpacing many emerging markets and trouncing the U.S.  Frontier countries in Asia could grow by 8.4% in 2011, compared to 2.2% expected in the U.S. and Europe.  Frontier markets are quickly becoming a separate asset class from emerging markets.  The Wall St. Journalrecently described them as “next year’s darlings in emerging-market investing.”  The economic growth is carrying over to stock markets.

Frontier markets are worth keeping an eye on for risk-tolerant investors who are able to stomach market shakiness in order to reap huge potential gains. They are less liquid and more volatile than emerging markets.  They are often politically unstable and extremely unpredictable.  But potential growth is high.

Markets like the Middle East, sub-Saharan Africa and parts of SE Asia have begun to grow sharply thanks to the commodities boom and business globalization – and could remain on an upward trend for the next 20 years.  Examples of frontier markets include Bulgaria, Croatia, Kazakhstan, Nigeria, Panama, Colombia, Sri Lanka, U.A.E. and Vietnam.

How can you invest in frontier markets?

Frontier stock markets are already outperforming more established emerging markets.  MSCI Barra’s MSCI Frontier Market Index (MXFM) was up more than 18% in 2010, compared with 16% for the broader MSCI Emerging Market Index (MXEF).

Risk can vary dramatically, so it pays to diversify via exchange-traded funds (ETFs).  Regional ETFs like PowerShares MENA Frontier Countries (PMNA), Guggenheim Frontier Markets (FRN) or the Market Vectors Gulf States (MES) are traded on U.S. exchanges. Two additional funds with exposure to frontier markets are the T. Rowe Price Africa & Middle East (TRAMX) and the Eaton Vance Tax-Managed Emerging Markets (EITEX).

Many emerging market ETFs have some exposure to frontier markets.  Two examples are the Vanguard Emerging Market Fund (VWO) – +18.9% in 2010 – and iShares MSCI Emerging Markets Index Fund (EEM) – up 16.5%.  A good source for researching frontier markets it the S&P/IFC Global Frontier Markets Index, which tracks 270 companies from frontier markets.

The Bottom Line

Frontier stocks should be part of any risk-tolerant investor.  However, it’s probably smart to limit your exposure to 10% of your portfolio.  I believe markets like Vietnam and the Middle East hold big potential for ETF investors.

Don’t be a stranger leave a comment below and let me know what you think or send them to my Twitter. Also remember to sign up for Stocks on Wall Street’s Monthly Newsletter.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.