According to MSCI, some very obscure stock markets have been doing quite well of late. Kenyan shares were up 8.42% in dollar terms in the first half of this year. Qatari stocks gained more than 29%. And Lebanese shares have soared nearly 55%.

These kinds of numbers are in stark contrast with the rest of the world's depressed equity scene. The MSCI Emerging Market index was down 11.64% year to date at June 30 and the World Developed Markets had given up 10.25%. Even though the MSCI U.S. index has held up fairly well this year, it still significantly trailed these so-called "frontier exchanges," having lost 11.20%.

Characterized by eye-catching growth rates, dozens of small, evolving stock markets are fueling interest in the least explored corners of the global equity market. The interest has prompted the creation of a half dozen new ETFs that are awaiting listing. Three Market Vectors ETFs will offer passive exposure to Africa, the Gulf states and to the broad frontier market. WisdomTree is developing a fund that tracks the largest Middle Eastern dividend-paying stocks. PowerShares is offering a Middle East and North African play.

The Claymore/BNY Mellon Frontier ETF is the first one to be trading, offering rather filtered frontier exposure; more than half of its assets are actually invested in emerging markets.

This begs the question: What exactly are frontier markets? Michael Hartnett, Merrill Lynch's global emerging market equity strategist, says there are no strict demographic or economic metrics defining these places. "Rather," he explains, "these are developing economies with undercapitalized equity markets that are relatively new, thinly traded, with weaker regulatory frameworks, lower levels of transparency and low levels of foreign ownership."

Hartnett himself has helped better define these markets: Earlier this year, Merrill established a 17-country, 50-stock Frontier Market Index. The minimum requirements for inclusion in this "investable" index include companies with a market cap of $500 million or more; a three-month average daily turnover of at least $750,000; and foreign ownership that exceeds 15%. The largest half dozen markets making up the index are the United Arab     Emirates (which represents 23.1% of the fund), Kuwait (18.1%), Pakistan (13.6%), Cyprus (10.9%), Nigeria (9.4%) and Kazakhstan (8.3%).

The index is weighted by market cap, with banks representing the largest chunk of the portfolio (39.4%), followed by financial services (25.7%), oil and gas (13.6%), technology (5.2%) and industrial goods and services (4.9%).

Collectively, these indexes encompass markets with nearly 1 billion people, with a collective nominal GDP of $2.7 trillion and with an equity market valuation of $1.9 trillion. These numbers are significantly smaller than those of traditional emerging markets, which comprise nearly four times more people, with almost five times the aggregate GDP and close to seven times the market capitalization.

A back test of the index from January 2000 through December 2007 revealed that frontier markets were up 20% a year while emerging markets were up 12%, and the S&P 500 was up just 1%.

Still, most advisors would feel reticent about shifting client money into distant markets that most investors don't even know have stock exchanges. And given today's challenging environment where few securities and asset classes appear safe, investing in both the active and recently active war zones of Pakistan, Lebanon, Kuwait and Croatia may not seem to be the best way to attract and maintain clients.

More disconcerting is that sell-side brokerages, mutual funds and articles in the mainstream press are touting frontier markets as a surefire way to cash in on the next great growth stories. A big selling point, repeated ad nauseam, is these markets' low correlation with developed markets, at 0.30 to 0.40.

This suggests that investors might be able to profit in these markets when major exchanges are struggling. But as most have learned recently, the perception that emerging markets are largely disconnected from the developed world goes right out the door when a major crisis hits, with sell-offs tending to be more severe where prices have risen sharply.

For example, MSCI reported that as of mid June African markets were down more than 8%, while Central and Eastern European exchanges were off nearly 15%.

Just like their developed counterparts, frontier markets can collide with economic realities related to hyper-growth. Vietnamese shares, which doubled over three years through 2007, have lost nearly two-thirds of their value since January. Strong foreign investor sentiment that had propelled local shares has reversed amid evidence of soaring inflation, trade deficits and interest rates. Leveraged investing has been replaced by poor liquidity. And Standard & Poor's, which rates Vietnam's sovereign credit at BB+, has shifted its outlook from stable to negative.

T. Rowe Price makes a compelling case for Africa, citing its economic, legal and political reforms; its improving macroeconomic conditions; its falling debt; its attractive earnings outlook and valuations; and its limited analyst coverage. But in its prospectus' small print, the fund company warns that its Africa and Middle East Fund involves a high degree of risk, subject to abrupt and severe price declines, and should be regarded as speculative.

Which one is it? Are we looking at an astute, ahead-of-the-curve investment venture or are we going to the racetrack? The answer is probably a bit of both.

Venerable Templeton fund manager Mark Mobius thinks that frontier markets are characterized more by a lack of liquidity, wide price spreads and volatility rather than by inadequate reporting and regulation. He finds many firms run by well-educated managers who have cut their teeth in developed markets, and that the firms issue statements in accordance with the International Financial Reporting Standards.

"While some boards may not have enough oversight in place to ensure comprehensive accounting," says Mobius, "it is unlikely at this stage in their development that we'll uncover the kind of sophisticated accounting scandals we've seen in the States."

Jim Harmon, who in 2004 started the Caravel Fund-a $154 million hedge fund that focuses on frontier markets-believes that with proper due diligence, frontier investing is not especially more risky than most emerging and developed market plays. There is more volatility because of trading thinness, Harmon explains. But he thinks long-term investors can do quite well, if his fund's performance is any indication. It has racked up more than 40% in annualized returns over the past three calendar years.

In taking a bottom-up approach, Harmon explains that his portfolio managers get to know both the companies and their stock markets. "We go through the same steps as most developed managers do," he says, "meeting with management, reading financial histories and projections, talking with customers, suppliers and competitors." And he does this with analysts who often know the local languages and culture.

An underlying theme of Harmon's investments: An evolving middle class will drive frontier markets' demand for goods and services as disposable household income increases.

This has led him to investments ranging from Almacenes Exito, a Columbian retailer whose price has nearly tripled (in local currency terms) over the last four years, to Pakistani insurer Adamjee, whose stock has nearly quintupled over the last three years.

Templeton's Mobius agrees about Pakistan, seeing a huge, unpenetrated consumer market buoyed by U.S. aid. He likes Indus Motors, a joint venture with Toyota, whose stock has doubled over the past three years.

While he has been investing in exotic markets for 20 years and currently has a 5% exposure to frontier stocks, Ed Allinson, a co-portfolio manager of the $350 million Lord Abbett International Opportunities Fund, thinks the difficulties of succeeding in these evolving markets often outweigh the potential gains. He sees risks in finding local brokers to execute trades efficiently and in arranging reliable custody to channel assets into local markets and ensure proper security maintenance. Mobius and Harmon, however, don't believe this is a big problem.

Allinson is also concerned about investments exposed to government fiat. "Due diligence must continue throughout the life of an investment," he explains, "to ensure public officials haven't altered market trading rules, controls on currency or limits on foreign ownership."
He points to a Southeast Asian media company that collapsed when its station's license was pulled by the incumbent leaders after they defeated the opposition party. The station managers had backed the opposition unbeknownst to the company's foreign investors.

While the travails of Zimbabwe are well documented, Allinson says that it is easy to forget how vibrant the country was at the beginning of the 1990s. Toward the end of that decade, before the economy collapsed, the local conglomerate Delta Corporation (Zimbabwe's largest company) came to Allinson's office to attract investment after the shares' initial listing. But the fund manager balked, believing that "there were simply too many hurdles for the company to clear to justify the risk and depth of analysis necessary to invest." Today, the stock would have been worthless in dollar terms.

One way Allinson does play frontier markets is through proxy. It may be diluted exposure, but he says, "This approach offers a form of insurance that's worth gaining in exchange for some octane." One of his holdings is Orascom Telecom. Located in Egypt, which some investors consider an emerging market, the company has an exclusive license in the nascent North Korean market. Another holding is South African telecom MTN, a key service provider for much of Africa and the Middle East. Meanwhile, he also owns Danish brewer Carlsberg, which bought Cambodia's largest brewery, Angkor, providing the Danes access to a very fast-growing industry in Southeast Asia.

On occasion, Allinson also makes an educated speculation. Case in point: Kazakhstan energy explorer and developer Max Petroleum. He moved into this microcap in January via London's AIM market after shares tumbled nearly 75% because of problems stemming from the company's former management. The firm has no earnings and will be racking up expenses as it prepares to drill more than 50 wells. But what it does have, according to Allinson, is license to access potentially fertile ground. It also has a management team made up of ex-U.S. corporate energy executives, including a CEO that came from Texaco, who likely would not have signed on if it weren't a legitimate operation.

Julian Thompson, who manages the top-performing Threadneedle Emerging Markets Fund, with $748 million in assets, largely sidesteps frontier plays because he doesn't believe high economic growth rates necessarily translate into substantial market returns. He points to China during the decade between 1995 and 2005 when it was the fastest growing emerging market economy but registered the second-lowest returns.

But he has considered certain frontier plays. Recently, he looked into Halyk Bank in Kazakhstan. "This is a well-managed financial that should benefit near term from global demand for the country's energy resources and an evolving consumer class," Thompson observes. Still, he was turned off by the bank's expanding imbalance between deposits and loans.

Halyk's increasing reliance on foreign wholesale borrowing to finance expansion reveals an intrinsic risk facing fast-growing frontier economies in general. "Rapid inflow of foreign money fuels asset inflation," Thompson explains, "leaving balance sheets vulnerable to market correction." In such a scenario, local currency can come under pressure, and the bank's cost of capital can then exceed the value of the local assets it's financing.

Jim Harmon thinks allocating 5% into a well-diversified equity portfolio of frontier shares makes sense for high-net-worth investors. But for the rest of us, regardless of how dizzying the gains, frontier market exposure should be considered a nonessential, high-risk play. Those who want a piece of it should rely solely on seasoned international or global fund managers who have shown that they know how to navigate these hot, volatile markets.