The Next Great Emerging Markets

Imagine yourself as an investor more than a century ago -- before the industrialization of the United States. Would you have bet your money on the growth potential of our nation? Knowing the outcome a hundred years later, you wouldn't hesitate to answer.

We can't rewind to the past
Unfortunately for our generation, those days are long gone on domestic soil. The opportunity for high-flying GDP growth and rapid infrastructure development is well in the past.

GDP growth in the United States has averaged just 3.3% annually for the past 25 years. It will struggle to reach even 1% this year, despite continuous technological advancement in the United States. And because many guru investors, including Warren Buffett, argue that GDP growth is a key ingredient to long-term market returns, the future doesn't look so bright for domestic-only investors.

But even if you weren't around for the roaring '20s, you didn't completely miss your chance for the exponential growth that infrastructure development can offer. While the U.S. can no longer capitalize on heavy infrastructure expansion for growth, beyond our borders lies a world full of nations -- exploding with growth -- that can.

A new investment frontier
China and India won't be running out of steam soon, but these countries are already emerging, and they're off to a great start. To capture the even more exciting early years of initial growth, you need to find economies that possess characteristics that point toward becoming the next emerging market.

While not as prominent as the BRIC foursome of Brazil, Russia, India, and China, investor buzz is starting to collect around tiny economies such as Vietnam, Indonesia, and Bulgaria. Dubbed the "Frontier Markets" by the Barra Index, these economies are just beginning their development stages; they hold less than 1% of the money invested in stock markets worldwide.

But that will all change soon. Goldman Sachs anticipates that Indonesia and Vietnam will be two of the 15 largest economies. And looking at the accomplishments of past emerging markets, the prospects are enticing. According to a recent Newsweek article, the current major emerging markets, including China and India, also held fewer than 1% of worldwide stock market money back in 1987. Today, that share has increased to 12%.

Sign me up
Unfortunately, gaining access to these markets isn't always that easy. While a handful of notable American depositary receipts (ADRs), such as Chile's Lan Airlines S.A., offer investors direct exposure to these frontier economies, there aren't many companies available for direct investment. But that doesn't mean your only option is to fall back on an ETF or closed-end fund.

The key is to search for strong global players that can capitalize on the growth in these countries by investing portions of their business there. This will provide exposure while minimizing some of the risk inherent in investing in frontier markets.

For example, in 2006, Honeywell (NYSE: HON  ) secured a $17.5 million contract to supply control systems for Vietnam's first oil refinery, expected to begin production in 2009. Yum! Brands (NYSE: YUM  ) is expected to have 20 Pizza Hut and 100 KFC locations in Vietnam by 2010. This summer, Starbucks' (Nasdaq: SBUX  ) CEO Howard Schultz indicated that he might be turning to Vietnam for a new sources of coffee beans.

In addition, by the end of 2008, the coffee chain will open its first cafe in Bulgaria. A few weeks ago, IBM (NYSE: IBM  ) announced an agreement with the Bulgarian State Agency for Information Technology and Communications (SAITC) to install an IBM Blue Gene/P Supercomputer, one of the fastest in the world, in Sofia.

Sri Lanka has seen GDP growth averaging 5% annually over the past 10 years. It's not surprising, then, that foreign direct investment there has been increasing, reaching $425 million in the first six months of 2008. Some 90 companies have entered the country, including AT&T (NYSE: T  ) , American Express (NYSE: AXP  ) , and United Parcel Service (NYSE: UPS  ) .

And it isn't just enormous companies that are optimistic. Fund managers are tapping into these countries for foreign portfolio exposure. According to Cliff Quisenberry, manager of the Eaton Vance Tax Managed Emerging Markets Fund, countries in the bottom 4% of the world capitalization universe returned roughly 18.1% annualized over the past decade, versus a 5.6% average return for developed markets.

Don't miss your chance this time
A recent U.N. conference had good reason to rank Vietnam as the sixth most desirable place to invest. Simply put, frontier markets offer untapped potential to informed investors.

That's why our Motley Fool Global Gains team recently returned from some of these markets (Indonesia, Vietnam, and Singapore, as well as China). Gain access to their best findings as well as a free trip report with a free 30-day trial.

This article was originally published on May 24, 2008. It has been updated.

Kristin Graham , a contributing analyst for Global Gains, owns shares of Starbucks. Starbucks and American Express are Inside Value selections and the Fool owns shares of both. Starbucks has also been recommended by Stock Advisor. United Parcel Services has been recommended by Income Investor. The Fool has a disclosure policy.


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