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Frontier markets lure – and reward – hardy investors

Risks have been rewarded by diving into Bangladesh, Ukraine, and other small developing nations.

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According to data of EPFR Global, which tracks fund flows and allocations globally, net inflows from around the world into African regional equity funds hit $650 million in 2007, up from about $100 million the year before. Moreover, Middle East regional equity funds drew net inflows of $402 million last year, versus $130 million of outflows in 2006.

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And this year through Jan. 23, funds for Africa-only, Middle East and Africa, and Middle East-only attracted $617.9 million in assets from investors worldwide, according to Brad Durham, mana­ging director of EPFR Global in Cambridge, Mass. That was all the more notable, he says, since "investors' sentiment has significantly deteriorated toward global equities overall."

To be sure, money flows have inflated some frontier markets. For example, as of December 2007, Vietnam's market had an astounding price/earnings ratio of 93.5, while Bulgaria's market had a 54.3 p/e ratio; Slovenia's had a p/e of 41.7; and Romania's had a 35.9 p/e ratio, according to Standard & Poor's. (In general, the higher the p/e, the more expensive the stock is relative to its fair value.)

African markets have also become pricier. Data from show, for instance, that the p/e ratios of the Zambia, Malawi, and Kenya stock markets stood at 21.1; 15.5; and 20.7, respectively, as of November 2007. By contrast they had p/e ratios of 5.8, 4.2, and 8.7, respectively, at the end of 2002.

Nonetheless, to some close observers, frontier markets remain a good story, amid the growth in their economies and companies. To Terrence Gray, portfolio manager of the DWS Scudder Emerging Markets Fund, "Although you always have to be selective in the stocks you buy, we're finding some very good companies, especially in the Middle East and Africa." As three examples, he cites Emaar Properties in the United Arab Emirates, Guaranty Trust Bank in Nigeria, and Zambeef in Zambia.

Moreover, Christian Deseglise, global head of emerging markets at HSBC Global Asset Management, believes "it's difficult to find a better asset class" than frontier markets. He cites such factors as the markets' high performances; returns that don't move in step with those of developed, or even emerging, markets; and much lower volatility than that of emerging markets.