by The Pacific Advantage Alert Research Team

Between July 6, 2009 and November 30, 2009, Alex Green’s New Frontier Trader service made 82.57% on Buenos Aires’ Banco Macro.

It made 61.97% on China’s 51job between August 17, 2010 and November 10, 2011.

And between January 1, 2011 and June 6, 2011, it booked 17.48% on Buenos Aires’ MercadoLibre.

As evidenced by those examples, there’s money to be made in the less traditional areas of the investing world known as emerging markets.

Emerging markets are countries with economies that are still in the process of moving from a third world status into a first. And as such, they have great potential for growth… typically much more so than the usual places to invest, such as the United States and Europe.

Traditionally speaking, after all, the U.S. economy – a well-established nation with significant global influence – grows at a mere 2 or 3% per year. China, on the other hand, for all of its human rights violations, continuing communism and exceedingly poor underclass, claims anywhere from 8-10% per year.

That’s a significant difference by any measure.

When a country’s GDP grows, it usually does so because its citizens and their businesses are growing. People spend more, invest more, and demand more, encouraging the economy to expand in order to properly suit their needs.

For example, the Latin American emerging market of Brazil has always had potential in investors’ books. With its impressive land size, expanding population and abundant amount of commodities, it holds untold fortunes. The only problem was that it couldn’t seem to live up to everything outsiders were sure it could be.

For decades, its problems were numerous and obvious: a poor economy and poor citizens coping in the middle of a largely uncertain political terrain marked by corruption, dictatorship and warring factions.

In 1994, that all started to change though. The ruling government came together with businesses to act in the best interest of the country instead of itself, setting Brazil on an enriching path of prosperity and growth.

As emerging markets researcher, Tony Daltorio, explained for Investment U, by 2009, it had succeeded in “lowering inflation to a reasonable level, reducing net debt to an enviable 40% of GDP, paying off all [of its] IMF loans, aggressively boosting foreign reserves to $200 billion, and achieving a ‘cherished’ investment grade rating for its sovereign debt.”

Similarly, from 2001 to 2007, the country’s impoverished saw their income increase nearly 50%. By 2010, over 30 million people of Brazil’s 190 million had successfully risen out of poverty, moving into the ranks of the consumers where they could benefit and take advantage of:

• Airlines like Gol Linhas Aereas Inteligentes (NYSE: GOL) and Tam ADR (TAM)
• Telecommunication companies such as Tele Norte Leste (NYSE: TNE) and TIM Participacoes (NYSE: TSU)
• Banking services like Banco Itau (NYSE: ITUB) and Banco Bradesco (NYSE: BBD)

Naturally, the more business Brazil’s emerging middle class gives those businesses, the more profitable they become (or should become, if they’re doing it at all right) and the more attractive they become to investors.

… Hence the appeal of up and coming economies: They have more room to grow and therefore oftentimes more profits to offer.

The Downside of Investing in Emerging Markets

That all isn’t to say that there isn’t a downside to investing in emerging markets. Because there is. And it can be a big one.

Just like they have a bigger potential for sizable profits, they also carry a more substantial risk of significant losses.

Between changing governments trying to figure out what works and what doesn’t, businesses figuring out for the first time how to deal with larger clientele bases – or just clients at all! – and consumers experiencing the heady rush of getting to choose their likes and dislikes instead of having to settle for the barest minimum, the investment climate can all too easily become scary.

There is also often lingering corruption from the old order, unfamiliar customs and preferences, and dicey means of transportation for businesses to rely on. And not every country can rise above all of those obstacles or, even when they do, it can take years and even decades to do so.

There is no guarantee an emerging market or the businesses it houses will automatically do well.

For every Brazil out there, there’s at least one Russia, if not more. And for all of the positive whispering going on about the former Soviet Union right now, investors should consider just how many outside companies fled the country – or got kicked out! – after they tried their luck there.

Only a few years back, Russia was a significantly sized destination for intrepid investors to park their cash. Big businesses in Europe especially saw the potential of over 141 million citizens in a country that seemed to be shrugging off its communist past.

One of the more prominent businesses that misread the political climate was British Petrol (NYSE: BP). In 2003, then-CEO John Browne flew from England to Moscow to kick-start TNK-BP, a joint venture with the state controlled Rosneft to profit off of the country’s noteworthy amount of oil.

Russia had the resources and BP had the ability to get at them. It seemed like a win-win for everybody! That is except for Mikhail Khodorkovsky, essentially Rosneft’s boss until he fell foul of then-Russian President Vladimir Putin and got thrown into jail for it… conveniently allowing Putin to take over the company.

For the good of Mother Russia, of course.

With that kind of track record, it was no wonder then that just five years later, Bob Dudley, who was the boss of TNK-BP at the time, had to literally flee the country due to “sustained harassment” from the local government.

Admittedly, that didn’t stop the combined business from continuing to do well. As of 2010, TNK-BP even made up a full eighth of BP’s profits. But only a well-established big business with a main product as necessary as oil can thrive under those kinds of conditions.

And even so, BP got lucky. Individual investors putting their money into individual Russian stocks have significantly less chances of getting out intact.

Problem is, it’s not just Russia. The same holds for China with its still largely government controlled businesses, India with its continuing caste system that holds so much of the country back, South Korea with its problematic northerly neighbor constantly keeping it on its toes, and so many other investing hot spots.

Even the highly ballyhooed Brazil isn’t above criticism.

As Minyanville notes, “2011 was a rough year for emerging markets across the board as investors pulled cash out of these volatile economies and loaded up on bonds and ultra-safe US blue chip stocks instead.”

Argue all you want that the established economies in Europe and the U.S. didn’t exactly do well in 2011 either. But it won’t do much good.

If for no other reason than misplaced perception, emerging markets spook investors just as much if not more than they excite them.

When it comes down to it, investing in general can be dangerous. But investing in unknown elements in countries that still have a decent way down the road to a stable and profitable democracy can be even more so.

Diversify Your Portfolio with Some Emerging Market Goodies

With that caution aside, investing in emerging markets still isn’t a bad idea. In fact, it’s actually recommended to put a portion of your portfolio into those countries, just as long as you take special precautions.

One way to do that is to let somebody else like Alexander Green do the work for you. In his New Frontier Trader, Alex does the research into specific countries and companies for you and emails his conclusions. (To find out more about the New Frontier Trader, click here.)

Of course, there are still no guarantees. There usually aren’t any in life. But Alex has 20+ years experience as a research analyst, investment advisor, financial writer and portfolio manager, which can go a long way.

If you don’t want to shell out the money for his time, however, there are plenty of Exchange Traded Funds (ETFs) that focus solely on emerging markets.

These conservative plays act as single stocks but actually profit off of multiple companies at once. Investors can choose ETFs that invest in only China, Brazil, India, etc. Or they can further diversify by buying up ones that hold companies across Asia, Latin America or Africa.

This can cut down on potential profits – if one particular company does very well, investors don’t make the same kind of money somebody with direct shares would – but it also protects against possible losses in the same way.

Or, for those investors who can afford a little extra risk, plenty of great companies have been springing up around the world in the last few years. Many of them are even listed on U.S. exchanges, which usually is a pretty decent indicator that they’re less likely to crash and burn.

Though, with that said, it’s still just as important to properly research them with the same diligence necessary for any other company.

Emerging market stocks can easily become an important part of any portfolio. Just don’t make the mistake of thinking every single one of them is going up just because it’s in a country that sounds good.

At our Oxford Club Chairman’s Circle conference at The Ritz-Carlton in Naples last week, I noted a decided optimism about the outlook for the bond market. This enthusiasm is almost certainly misplaced.

We’re at the tail end of the biggest 30-year rally in bonds the nation has ever seen. Recall that three decades ago, Fed Chairman Paul Volcker pushed the prime rate all the way up to 21.5% to squelch inflation. Long-term Treasury yields reached 16%. But from that pinnacle, long-term yields have plummeted to around 3% today. Bond prices have soared accordingly.

It isn’t just unlikely that today’s bond buyers will see annual double-digit returns going forward, it’s mathematically impossible. And yet I sense that many fixed-income investors don’t understand this.

It’s not unusual to meet an investor who has plunked money in a bond fund because “its long-term track record is excellent.” They don’t seem to realize that it’s also irrelevant. Never has the old saw, “Past returns are no guarantee of future results,” been more apropos.

This doesn’t mean you should avoid bonds altogether, of course. But if you’re going to buy bonds, now more than ever you need to be smart about it. Here’s what you should do:

1. Ladder your maturities. You should buy two-year, five-year and 10-year bonds. If rates go up – as they will eventually – your bond prices will fall, temporarily. But you will get your principal back at maturity and be able to reinvest your principal at higher rates. And paltry as bond yields are today, they still beat the heck out of the 0.05% that the average money market fund is paying.
2. Keep a close eye on expenses. In the world of fixed-income investing, keeping a Scrooge-like eye on expenses is essential. Why? Because it’s difficult to work magic in the button-down world of fixed-income investing. Managers rarely earn their fees. And 12b-1 fees can eat away at your returns like termites in an antebellum house. My advice is to stick with individual bonds, Vanguard funds (whose expenses are one-sixth of the industry average) and low-cost ETFs.
3. Avoid leveraged bond funds. Ever wonder how bond yields can be so low and yet the yield on your closed- or open-end bond fund is higher, even after expenses? Open your eyes. Unless you’re holding junk bonds, your fund manager is using leverage, the fixed-income equivalent of buying stocks on margin. By borrowing cheap, he or she is leveraging the portfolio to add yield. This works just fine while bond prices are flat or rising. But when bond prices fall – as they will when interest rates rise – these shareholders will take a shellacking. Consider yourself forewarned.

Some fixed-income investors tell me they feel safe for now since Bernanke has pledged to keep interest rates low through 2014. Think again. The Fed has only announced its intention to keep rates low. (Future economic conditions could quickly change that.) The Fed is also keeping long-term bond yields artificially low by buying these instruments to goose the economy.

Inflation could tick up. The Fed could raise rates and/or quit buying long-term Treasuries. In the end, the Federal Reserve sets short-term interest rates, but not bond yields and prices.

Know this. Understand it. And act accordingly. Bond investors today should be in a defensive posture, capturing higher yields than what’s available in cash instruments, but prepared for that point in the future when bond yields will rise and prices will fall.

Good Investing,

Alexander Green

Over President’s Day weekend, I took my family to Massanutten Ski Resort in the beautiful Virginia Mountains. (It’s not Telluride, but when you have an eight-year-old son who yells “Woo-Hoo!” all the way down the slopes, it really doesn’t matter.)

We had admittedly low expectations for skiing when we arrived. It’s been an unusually warm winter and the snowfall has been virtually nil. Yet the night before we skied, the snow dumped fast and furious on top of the base of artificial snow.

The next day we woke up to a winter wonderland. Everything was covered with snow. The sun was shining. And it ended up being a perfect day. I couldn’t help thinking this was a lot like the stock market.

Here’s what I mean…

As well as being the Chairman of Investment U, I’m also the Chief Investment Strategist for The Oxford Club – a private fellowship for investors trying to achieve and maintain financial independence.

And our club has won numerous industry awards for editorial excellence. (The independent Hulbert Financial Digest ranks us among the top-performing investment letters in the nation for 10-year performance.) Yet much of our success actually comes from being well positioned to take advantage of completely unexpected circumstances.

Right now, for instance, the nearly two dozen recommendations in our Oxford Trading Portfolio are up an average of 43%, even though our average holding period is just 188 days.

Our portfolio is beating the market by a wide margin for two primary reasons:

• The first is that we have a proven system for identifying great companies at attractive prices.

• The second is that we don’t try to time the market. So when it suddenly puts on an impressive rally, as it has over the last three months (tacking on more than 1,500 points), we’re set to enjoy the benefits.

I don’t have a crystal ball. And neither does anyone else. Three months ago, we couldn’t have told you that the market was about to power higher. And two weeks ago, when I made my reservations for a mountain villa at Massanutten, I couldn’t have known that the skies would suddenly open up. But in both cases, it did.

Of course, stocks might not have rallied and the snow might not have fallen. But at least we took a chance. Successful investing is about hedging your bets, taking intelligent risks and being prepared for whatever happens.

Folks who wait for that mythical day when the investment landscape looks perfect will regret it. Just as those who wait for ideal conditions before planning a ski trip will find the fares are higher, the lift lines are longer or, if they wait too long, the snow is already gone.

Market bears will counter that the conditions may look right today, but that can change quickly. I don’t disagree. But we’ve thought about that, too.

We own plenty of investments outside the stock market, so our performance isn’t based on equities alone. We abide by strict position-sizing rules to limit our risk. And we run a trailing stop behind all of our stocks, assuring ourselves that our profits don’t slip through our fingers.

It’s not a perfect system, but it works, delivering high returns during the good times and protecting capital during the bad ones.

It sure beats sitting at home… wondering if it will snow.

Good Investing,

Alexander Green