Beyond the BRIC

Despite the recent tumble in foreign markets around the world, emerging markets have been on a tear over the past several years. Floods of foreign capital have helped to build and grow stock exchanges from relative anonymity into household names. The so-called BRIC markets -- Brazil, Russia, India, and China -- have enjoyed huge increases in economic activity and stock market interest. Early investors in these countries and their markets have enjoyed handsome rewards.

Now, however, it may be time for these up-and-coming economic powers to pass on the torch of stock market prosperity to even smaller countries. A new wave of economic growth, stemming from what many refer to as the frontier markets, is beginning to take center stage as countries like Vietnam, Indonesia, and Nigeria amass the potential to become the next great emerging market. Many financial analysts and investment management firms are now suggesting that looking at smaller countries may be more profitable than investing in the larger emerging markets.

The next frontier
However, tapping these markets as investment ideas isn't all that easy. If you're hoping to find a bunch of investment prospects by checking out listings on U.S. stock exchanges, you're likely to be disappointed.

The availability of securities from BRIC countries, such as China's Baidu (Nasdaq: BIDU  ) , India's Tata Motors (NYSE: TTM  ) , or Brazil's Petroleo Brasileiro (NYSE: PBR  ) , is becoming more prominent; many have American Depositary Receipts that trade in the United States. However, the majority of companies in newer emerging markets can be found only on exchanges within their own country.

A few frontier-market companies, such as Telkom Indonesia (NYSE: TLK  ) or Bancolombia (NYSE: CIB  ) , do exist, but it can be quite challenging to find ways to directly invest in these economies. When you dig down to the smaller frontier emerging markets, you almost have to rely on fund managers who specialize in those areas to gain access to promising investments.

Waiting for the bubble to burst
Investors may be shifting away from the BRIC nations, amid concerns about the sustainability of these markets' huge recent upward swings. With shares having doubled or tripled in just a few years, these stocks' price performance brings back memories of the Nasdaq in 1999 and early 2000. Hoping to avoid getting burned a second time, some financial institutions are cutting their exposure to potentially overheating markets such as China and India in favor of safer places for their money, as reflected by both China's 55% plunge and India's 35% drop since last October.

Others believe that the shift in interest from larger developing markets to smaller ones is itself a sign that the rally in international stock markets is entering its final stages. Bull markets often involve changing emphasis on particular sectors. As large and established investments increasingly become overpriced, speculators become more willing to look to lower-quality investments to sustain their big returns from earlier in the bull market. Eventually, there aren't any investments left that can justify their prices, and the overall market begins to decline.

Avoiding correlation
Some analysts believe that institutional investors particularly like these frontier emerging markets because their returns aren't as strongly correlated to returns in large industrialized countries. Although this was part of the reason the BRIC markets originally became popular, emerging markets are now much more likely to move in the same direction as stock markets in the developed countries. In contrast, frontier markets have about half the correlation of larger emerging markets.

As globalization becomes more pervasive, even among smaller economies throughout the world, the search for markets whose returns aren't correlated with the rest of the world will become increasingly difficult. In many ways, making investments to take advantage of low correlations is itself what causes those correlations to rise; increasing levels of investment capital make it easier for small economies to find their niche within the global economy and integrate themselves into foreign markets. When small countries begin to reap significant benefits from foreign trade, they become increasingly vulnerable to economic downturns in places far from home.

Overlooked opportunities
That said, one advantage for investors in frontier markets is that companies in these small countries don't have a large following among Wall Street analysts. That's especially important for small stock exchanges with relatively little liquidity, as a rapid influx of interest can quickly swamp the limited capacity of these markets. The pioneering financial institutions that are turning their interest to frontier markets are hoping to get in on the ground floor of an expansion similar to what you've seen in India and China.

That philosophy is similar to what drives the lead analysts of The Motley Fool's international-investing service, Global Gains. With a world of investment options out there, you shouldn't be afraid to search high and low for the best prospects for outstanding returns. Whether you're investing in Virginia or Vietnam, you can find good companies to help you reach your financial goals.

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This article was originally published on Feb. 22, 2007. It has been updated.

The Global Gains team recently returned from a trip to China and various frontier markets. Want to know what they found? Check out a free trial for 30 days with no risk, and discover how the service can open up a whole new world of investing opportunities. Tata Motors and Telkom Indonesia are Global Gains recommendations. Baidu is a Rule Breakers selection.

Fool contributor Kristin Graham updated this article, originally written by Dan Caplinger, and does not own shares in any of the companies mentioned. Both Kristin and Dan hope to follow their money across the ocean at some point. The Fool's disclosure policy is good around the world.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 13, 2008, at 4:09 AM, davenerven wrote:

    Why invest in Vietnam now when inflation is 21% and rising? Also, the dong was devalued recently.

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