Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

Here’s a warning to investors. There’s a new term you’re going to hear a lot about in the coming weeks: "Frontier Markets."

Regard the term – and the investment strategy behind it – with substantial caution.

Here’s why.

When it comes to Wall Street, the worse the markets around the world behave, the more you’re going to hear about potential "alternatives."

Travel back about 10 years and it was the so-called "emerging markets," including Hong Kong, Singapore, Taiwan and Malaysia. Then came the "BRICs" – Brazil, Russia, India and China.

Now the "alternative markets" du jour are the frontier markets.

These are places like Namibia, Bangladesh, Pakistan, Romania, Vietnam, Morocco, Cyprus and Nigeria, for example. These markets aren’t exactly paragons of geopolitical stability anymore than they’re economic security.

Even so, the Big Boys read that to mean Wall Street’s insiders are starting to talk them up as having BRIC like potential.

And with good reason. The Standard & Poor’s Frontier Markets Index reflects an annualized return of 37% over the last five years, which is better than the Morgan Stanley Capital International Global Emerging Markets Index (MSCI GEM) and a whole lot better than the Standard & Poor’s 500 Index, especially lately.

Sound appetizing?

Think again. You’ve heard this song before.

Despite the fact that Standard and Poor’s, Morgan Stanley (MS) and, most recently, Merrill Lynch & Co. Inc. (MER) all have created frontier indices of their own, investing in them is largely limited to institutional investors. Save for one tiny (and expensive) frontier fund from T. Rowe Price Group Inc. (TROW), there is no easy way in for individuals. But that won’t stop the Wall Streeters from telling you all about it – especially as U.S. market conditions continue to worsen.

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Why? Because it’s in their interest to keep you interested. They generate fees – lots of fees – by holding onto your assets, meaning they have a lot of "skin" in the game here.
                    
Callous?

You bet. But it’s true, nonetheless.

By the time somebody creates an exchange traded fund (ETF) and makes it available to individual investors who want to get their feet wet in the frontier markets, the institutions that are enjoying everything the talking heads will tout in their glowing reports will unload those holdings and rebalance their portfolios using the flood of money from individual investors to do so.

This will once again potentially leave the little guys like you and me on the hook in unstable, untested and uncorrelated markets. There’s a relative lack of regulation and corruption rampant in these markets. So are the risks related to political instability, currency devaluation and a near complete lack of research data on the companies, or the markets.

If you ask me, this sounds a lot more like a recipe for indigestion than a strategy for market-beating investment returns.

So what’s an individual investor to do? Here are three simple rules that will keep you on the investment-profit pathway:

• Don’t Chase Performance: You will hear a lot about these markets in the near future and the numbers you’ll hear will make it very tempting to make a play. But don’t do it.

• Play Stability: Stick with the established global companies that are actively doing business in these markets, rather than investing "in country" yourself. Not only are top-tier global managers more capable of cutting deals in – and wringing profits out of – the emerging markets, but they provide a built in safety-brake and diversification play that can actually lower your risk while potentially increasing your returns at the same time. Companies focusing on infrastructure, energy and agriculture are good solid choices, for instance.

• Keep it Sane: If you can’t resist buying in, we don’t blame you. But at least make sure that your exposure to the "frontier markets" is kept within reason. That way you won’t get burned too badly when these volatile markets retrench – as they will. That’s when we’ll be buying in, because by that time we’ll be able to base our decision on stability, and not speculation.

In conclusion, it’s important to remember that even though going global is an absolute necessity in today’s markets, it’s not a license to be reckless – no matter what Wall Street claims about past performance.

It’s the future that matters.

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By Keith Fitz-Gerald
Contributing Editor

Whenever I’m faced with a market like this one – rocky and volatile, with hidden wildcards just waiting to trip us up – I can’t help but think about my late grandmother, successful amateur investor Virginia Gruner, and the warning she would issue in just these situations: “Hold onto your bippies!”

As I sit here and stare at my trading screens this afternoon (Monday) – watching as central banks around the world inject billions into the global economy in an effort to blunt the effects of the spiraling credit crisis – I can just hear my grandmother issue her ever-so-familiar warning.

The Greatest Investor I’ve Ever Known

You see, my grandmother was a super-successful amateur investor.  She’d spent most of her adult life managing her household, the wife of a highly successful insurance-industry executive (my grandfather). When her husband died, my grandmother found that her family’s own finances were in disarray. So with characteristic commitment, and with a resolve I always admired, she set out to become a successful investor. She became one of the smartest individual investors most of us will ever see – and, actually, one of the best investors of any kind I have ever known.

My grandmother then set out to pass that “gift” along – to me. Starting when I was a teenager, she made sure that I always had the entire Value Line investment research series, and annual subscriptions to such leading publications as Business Week and Forbes. She wasn’t forcing this on me, mind you, but rather was sharing it with me – and in a way that made me want to learn all that I could, and be as successful at this wonderfully engaging pursuit as my grandmother.

Yesterday’s late-afternoon trading patterns suggest that her bit of wisdom may somehow be fitting to keep in mind over the next few days. I’m now hearing from traders based both here in the United States and around Europe that the $275 billion injected into the world economies by the global central banks may not be enough.

And, yet, Asia’s traders seem placated.
 
So, what gives?

I honestly don’t know. But here’s what my experience tells me should be happening – as well as what’s actually happening.

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The Global Realities

Somehow, the Euros and Americans don’t trust the system. They think that Monday’s rally is nothing more than a continuation of the short covering and limited bottom fishing that began Friday on the heels of nearly $275 billion in central bank liquidity injections

They’ve got a bad case of: “I’ll believe it when I see it.” And investors seemingly want the ECB and Fed to drop rates as a sign of good faith that things are truly behind us. Yesterday, in fact, I saw no fewer than 20 different news stories, research reports, and market essays from various people suggesting that a “Fed rate cut is in the bag” – which makes me suspect all the more that it isn’t.

Asian traders, on the other hand, seem to think that the massive amounts of money shot into the system was enough to fix the problem.

It’s the way that the Asian markets are trading that leads me to draw this conclusion – that, of course, plus the 20-plus years I’ve spent in and around the Asian markets.

The Japanese and Chinese in particular have a different cultural framework than we rely on here in the West. As a result, the Japanese have a sort of implicit trust in the government as a benevolent entity while the Chinese view it as a strict leader to be obeyed…maneuvered, but obeyed nonetheless. There are, of course, finer points to each but those are more academic than anything else.

In more practical terms, based on how the two camps (the West vs. Asia) appear to be divided in their trading philosophy right now, what we as individual investors are left with is a dichotomy: Roughly half the world’s financial system wants more “liquidity,” while the other half seems content with what it’s got.

Really Time to Go Global

So, who’s right and what does it mean for us?

That remains to be seen. I’m personally of the opinion that we have a long way to go before the extent of the damage is truly recognized. There will undoubtedly be some big names on the chopping block in the weeks to come as more light is shed on this messy credit situation. Some of these revelations will have been anticipated. But others will be huge surprises, and could well roil the markets.

Either way, this suggests to me that individual investors have yet another reason to focus at least part of their financial strategies on global investing (Wharton Professor Jeremy Siegel recently said that an international allotment of under 40% was a “disservice,” as well as a recipe for substantial underperformance).

That said, it’s clearly not enough any more to diversify by country because most of the countries, as so many people found out last week, are inextricably linked at the central banking level.

Therefore, it is vitally important to take a different approach that both lessens your risk and heightens your potential returns. Part of that approach includes lining up your money with the virtually unstoppable trends of our time. The other part suggests “an offensive defense” may be more appropriate now more than ever.

Last week’s financial shenanigans have clearly changed the rules of the game – yet again.

As I reason this all through, I can’t help but consider what my grandmother would say about this situation. The best revenge, of course, is to take advantage of all possible profit opportunities. But we all know that these next few weeks could be highly volatile, which either connotes danger or opportunity – depending upon your viewpoint.

So brace yourself for still more volatility (“hold onto your bippies!”). Then capitalize on whatever opportunities the financial markets throw at you. Look especially closely at global investment opportunities, but don’t be afraid to be opportunistic domestically, either. Be bold, but not reckless.

And have at it!

Good Investing to us all.

 Keith Fitz-Gerald

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