The Spookiest Markets Offer the Biggest Returns

Halloween is not just for children this year: Investors could learn a thing or two from Count Dracula, the fictional (so they say) vampire made famous in countless books, films, and TV shows. While the idea of sucking blood out of the innocent brings to mind the actions of certain "too big to fail" banks, the Count has lessons for individual investors as well.

After all, who wouldn't want his or her portfolio to live an immortal life?

Eastern Europe priced to deliver
The Transylvanian's secret may be to add frontier markets to your portfolio. These countries are generally at the bottom of the barrel (the ones you'd never vacation at) and are feared by investors. The upside is that frontier markets are generally dirt cheap, have better growth opportunities, and usually don't move in lockstep with emerging and developed markets. This should please growth investors, value investors, and portfolio theory types (unlikely allies).

Right off the bat we see promising results. The SPDR S&P Emerging Europe (NYS: GUR) ETF has a P/E of 6.16 times this year's projected earnings. That's a whopping 16.2% earnings yield on your money. By contrast, the SPDR Dow Jones Industrial Average (NYS: DIA) , the "Diamonds," is trading at an 8% earnings yield (a P/E of 12.52). That means if earnings only grow at inflation, the Dow (INDEX: ^DJI) should more than double your purchasing power over 10 years.

That's great (and a good reason to be bullish on the U.S.), but nothing compared to getting more than four times your purchasing power in the Easter Europe equities. Such is the power of a 16.2% real return compounded over 10 years.

Of course that extra doubling doesn't come for free. Dracula's stomping ground is a heck of a lot riskier than the U.S., so the return may never materialize. Even worse is that the fund has more than half its money concentrated in Russian investments, a country already covered by the popular emerging market ETFs Vanguard Emerging Market (NYS: VWO) and iShares Emerging Markets (NYS: EEM) .

Bummer, let's see if we can do better.

Fool of Arabia
I doubt Dracula would ever step foot in the Middle East and Northern Africa. Coming from Transylvania, the weather would be quite a shock. Nevertheless the Middle East might offer the holy grail of uncorrelated and big returns.

The most liquid (easiest to trade) option is PowerShares MENA Frontier Countries (NAS: PMNA) . With big helpings of Kuwait, Qatar, and Egypt, there's enough fun for the whole family.

The chart tells the tale: $10,000 invested in PMNA upon inception in July 31, 2008, would be $4,720 today. $10,000 invested in the S&P almost broke even.

What happened is Middle Eastern stocks did not participate in the 2009 stock market rally. You can view this as either a good or bad thing: Good in that they didn't zig and zag with the rest of the world, or bad in that maybe the segment is a dud.

I'd look at valuation to decide. Right now PMNA has a P/E of 11.1. Pretty cheap, though not as cheap as Eastern Europe, and only slightly cheaper than the much safer Dow. I think the diversification could be worth it for a small portion of your portfolio.

Calling all ETF makers
Of course some of you are probably wondering why I haven't mentioned the biggest frontier market ETF thus far, the Guggenheim Frontier Markets (NYS: FRN) ETF.

My issue with the Guggenheim ETF is that it's concentrated in countries that are closer to being emerging markets than frontier ones, like Chile (at 37%) and Colombia (don't laugh). The result is that it pretty much tracks the movements of the emerging market ETFs you already own.

Ironically, Guggenheim's own marketing literature (link opens PDF) touts the benefits of a very different frontier market index, the MSCI Frontier Markets Index. The MSCI index gives zero weighting to Colombia and Chile, which make up half of FRN.

Instead, the MSCI Frontier Market Index is broadly diversified among small Asian nations like Bangladesh, along with Africa, Eastern Europe, and the Middle East all rolled into one.

Now that would be an ETF worth owning.

Until then, Fools could consider mixing and matching ETFs to get the balanced frontier market exposure they seek.

At the time thisarticle was published Fool contributor Chris Baines is a value investor. Follow him on Twitter, where he goes by @askchrisbaines. Chris' stock picks and pans have outperformed 89% of players on CAPS. He owns no shares of the companies mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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