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Should You Invest in Frontier Markets?

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Regular readers know I'm a big fan of diversification. It's been a long time since I've waved my flag as strongly as I have over the past few months.

I'm not optimistic about where the US stock market is headed over the next year or two. The Shiller PE is very, very high, which means that stocks are not likely cheap. The Federal Reserve has steadily been ending its bond-buying program and seem likely to raise interest rates next year.

The bull market has been going on for more than 5 years, which feels a little like José Iglesias hitting above .330 - you know it isn't going to last. The question doesn't seem to be "if", but "when" is the correction coming.

For this reason, I've been looking to squirrel a few nuts away from my United States-based pile. Over the last few years, I've been investing in more general foreign funds. I then found that I had a hole in my portfolio by not having enough emerging markets.

A few weeks ago, I even wrote about whether you should invest in a Russian ETF now as the stocks have taken a beating due to the conflict there. Many readers pointed out that it is a risk, but I jumped in with a whopping 1.5% of my portfolio. It's like getting your toe nail wet to test the waters... not even putting a whole toe in.

So it is with that in mind that I come across the idea of investing in frontier markets. These markets typically have the safe haven countries of Kuwait, Nigeria, Qatar, and many more. Did I just type safe haven? I meant extreme volatility, political instability, high inflation, and low liquidity, just about everything you don't want in an investment. On the surface this seems like the worst idea one could ever have.

Or is it? The iShares MSCI Frontier 100 ETF seems to be up 46% over the last two years. Individually, the countries probably aren't the safest investments, but each is a small percentage which makes it very diversified. Imagine this being 3% of your portfolio, which may be a lot for something like this. If Kazakhstan disappears and the investments go to zero that's 4.35% of 3% or around 0.13% of your portfolio. It's not exactly a death blow. However, these countries all have a lot of room to growth. In 30 years, I see globalization helping these countries become the size of some of the emerging markets today.

To borrow from my baseball analogy above it's almost like investing in 16-year old prospects. They may never play a game in the big league, but investing early means investing cheaply. The payoffs can be big. And to further the squirrel analogy these nuts are about as far away from the United States stash possible. And again, they are scattered around, so the loss of a single nut or two doesn't matter much.

I decided that I'm going to take the plunge. It turns out that the ETF trades commission-free in my Fidelity account. Not that the $8 savings on each side of the transaction is going to make or break the investment, but it's better than a poke in the eye. I figure that it's worth putting a little more than 1% in it.

Maybe every 5 years, I'll check back in with a progress report.

Last updated on August 21, 2014.

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