There’s a reason why Brazil, Russia, India and China (the so-called BRIC nations) captivated investors in the 1990s and 2000s.

#-ad_banner-#Those four countries together host nearly 3 billion people. That created the opportunity for rapid growth in domestic consumption as hundreds of millions of people moved into the middle class.

Yet the BRICs have lost much of their luster in recent years. Only China has been able to maintain robust economic growth rates, and even that economy is beginning to wobble. Until Brazil, Russia and India in particular sort out their bottleneck and rule-of-law challenges, their economies will remain hampered.

In the face of such challenges, investors have been moving downstream to a group of countries, known as frontier markets. These markets typically have 30 million to 250 million people, and in many instances, have been pursuing investor-friendly policies that have helped to generate solid growth in both domestic consumption and exports. Indonesia, with nearly 250 million people, has been a clear success story: Its economy has grown from $95 billion in 1980 to $750 billion in 2010, according to the International Monetary Fund (IMF).

U.S. Investors latched onto Indonesian stocks in a big way when country-specific exchange-traded funds (ETFs) appeared on the scene. But in recent years, investors’ euphoria appears to have faded.

Is the Indonesia growth spurt over? Not hardly. Consider that purchasing power parity (a measure of household wealth) in Indonesia is still one-tenth of what it is in the U.S. That suggests ample more ground to cover as living standards rise.

In some respects, any country that has a population between 100 million and 250 million is ideally sized. They represent sizable domestic markets, and often serve as key trade hubs for their region. But in that category, you will find that some troubled countries — such as Nigeria, Pakistan and Bangladesh. Mexico and Japan, each with slightly more than 100 million people — are closer to developed than undeveloped at this point. 

Just below that 100 million threshold, you’ll find two countries. Each of which has had its share of struggles, but each of which is pursing increasingly sound economic policies that should fuel sizable domestic market growth. Indeed, both the Philippines and Vietnam are only now shedding long-standing reputations of shoddy governance and are doing an impressive job of luring multinational firms. 

To give you a sense of these two countries, which each have around 90 million to 100 million people, consider that not a single country in Europe is that large (Germany has 80 million people.). What’s notable about the Philippines and Vietnam is that their purchasing power parity, on a per capita basis, is reaching an inflection point, where many residents will soon be able to buy cars, appliances, vacations and other signposts of a middle class.

Purchasing Power Parity Per Capita ($US)
 

As a point of reference, these are the kinds of figures you saw in South Korea several decades ago. That figure now exceeds $30,000. To be sure, it will take the Philippines and Vietnam several decades to fully evolve, but they key to long-term investing is catching these economies before they have matured. 

Exchange-traded funds (ETFs) are still the easiest way to access these dynamic economies, and notably, they are a fair bit cheaper than they were a few years ago, when frontier investing was all the rage.

1. iShares MSCI Philippines ETF (NYSE: EPHE )

This fund, which carries a 0.61% expense ratio, is squarely focused on domestic consumption.  Real estate firms get a 23% weighting, while banks, utilities and consumer cyclicals each represent around 15%.   Unlike countries such as Indonesia or Chile, the Philippines is not blessed with vast natural resources, and therefore is not closely tied to the global commodity environment. As a result, this ETF has not suffered as badly as some other markets that have seen commodity price shocks. Shares of this ETF are off only 20% from their all-time high.

2. Market Vectors Vietnam ETF (NYSE: VNM )

I profiled this country (and fund) back in January, and though it is up only modestly since then, the economic reforms I discussed are now well underway.  Vietnam is currently in the midst of a naval dispute with China, which heightens the near-term risk, but over the long haul, a steady drift away from China’s orbit, and toward other Asian neighbors, will only help. Many of those neighbors, such as Cambodia and Thailand, have their own share challenges, but this entire bloc of countries is in the early stages of a developing middle class, which should fuel rising regional trade.

Risks to Consider: Neither of these emerging markets has attained the critical mass that can help avoid future peaks and valleys in their growth trajectories. That makes them suitable for long-term investors only.     

Action to Take –> Countries like Vietnam and the Philippines have a long runway of growth ahead of them, as the size of their middle classes starts to swell. They are following a well-trodden path that has seen Japan, South Korea and then Eastern Europe lay the foundation for sustainable growth on the heels of rising purchasing power parity.

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