Source: Demographic World Urban Areas Population Projections, Demographia

This table dramatizes two powerful forces that will drive global GDP growth through 2013: population and urbanization. In 10 of the 20 largest cities in the world, all in emerging or frontier markets, urban populations will grow by more than 30 percent over a 15-year span – an even higher rate than national population growth. This reflects urbanization, the movement of people from rural areas to cities. Urbanization is, in fact, a key policy initiative through which emerging and frontier markets will sustain GDP growth over the next decade and more. For example, The New York Times recently reported that "China has announced that it plans to move 250 million rural residents into newly constructed towns and cities over the next dozen years."

Related story: When building a portfolio, are BRICS still a buy?

When farmers who have consumed very little move to cities, they quickly begin to consume much more. In addition to jobs, housing and food, they need vast urban infrastructures that include electric power grids, water utilities, transportation networks, schools, police protection and retail stores. Urbanization also creates social and economic problems, and some people uprooted from rural homelands fall by the wayside, unemployed and living in urban squalor. But for emerging and frontier nations as a whole, urbanization is a proven driver of GDP and corporate profits, especially when it is supercharged with the rocket fuel of consumer credit. While overleveraged consumers have become an economic drag in the U.S. and Europe, consumer credit is only now developing in emerging and frontier markets. Over the next decade, urbanization and consumer credit will combine to turn these economies away from a dependency on exports and toward meeting the expanding needs of their own domestic consumers.

Which emerging and frontier markets will offer the most attractive growth profiles over the next decade? Although China and India, the two largest emerging markets by population, will continue to produce annual GDP growth rates averaging around 5 percent, they may not be the most attractive places to invest. Selectivity will be the key to successful long-term participation in these markets, and investors will be wise to use active managers who understand local market dynamics.

In emerging and frontier markets, urbanization and domestic consumer demand can only advance as far as the supply lines of food, water, energy and minerals. You can see this by looking at Egypt, a country with 84 million people, where interconnected scarcities of all four have contributed to political and social instability. Over the past decade, China has focused on acquiring and developing sources of energy and minerals, so it now can swap those commodities for critically needed food and water resources. China also appears to have a long-term goal of creating a strong currency, which will allow it to purchase from abroad whatever commodities it needs to sustain upward mobility.

Long-term investment themes

Here are a few more themes to consider for long-term investment planning:

• Avoid Japan and MSCI EAFE – Japan suffers from a shrinking and aging population, limited natural resources, increasingly expensive energy and food supplies, and a current monetary policy aimed at increasing exports and short-term stock market values, at the expense of the domestic standard of living. Many U.S. investors have gained exposure to Japan's stock market through the MSCI EAFE Index, which currently has about 22 percent of its weight in Japan.
• Look south – Selected frontier markets in Africa, including Nigeria and Kenya, are rich in natural resources and they are projected to have some of the world's highest rates of GDP growth over the next decade. Latin America also is poised for growth, led by four resource-rich countries where democratic and economic reforms are taking root – Brazil, Mexico, Columbia and Chile. Their combined populations exceed that of the U.S.
• Diversify bond and currency exposure – Over the next few years, bond markets of the U.S. and Europe may not perform much better than cash, and they will produce more uncertainty and volatility. To diversify global currency exposures, investors should consider asset allocations to emerging market local currency bonds, hard currency funds and precious metals.
• Equity sectors – The best performing equity sectors over the next decade may be those tied to the food, water, energy and minerals theme – in the Basic Materials and Energy sectors. Although this will be the decade in which the world finally begins to address global warming and break dependencies on fossil fuels, oil and natural gas will see strong demand over the next few years. For the next decade, they will continue to generate most of the energy required for global transportation, farming, mining and construction.

The technology sector also will do well, but with different drivers. Over the last two decades, technology has revolutionized global communications and entertainment. In the decade ahead, successful tech companies will focus on delivering clean water, increasing agriculture and aquaculture yields, preventing epidemics, providing affordable shelter, creating fuel-efficient transportation, and expanding renewable energy production and distribution.

The pie graph below draws these ideas together into one possible investment framework for the next decade.

An investment framework for 2023 

Observations for financial advisors

Whether or not you find this framework useful, it helps to make three points:

1. In the past, it would have been difficult for many U.S. investors to achieve their objectives without weightings in U.S. and European securities. An expanding array of global asset classes has made other long-term frameworks available to most investors.
2. Clients who are least likely to have the option of choosing a new framework invest through participant-directed retirement plans, such as 401(k)s. If you want to address 401(k) participants' needs, show plan sponsors how to implement a new framework by expanding investment choices.
3. Many investors will want to have their asset allocations periodically reviewed and adjusted. For example, if and when the U.S. and European dramas are resolved, investors may be less inclined to kneejerk and more willing to increase allocations to these regions. Advisors who help clients develop and implement a long-term framework will be in the best position to review portfolios and make timely adjustments.

In some asset classes, such as commodities, clients may wish to enjoy the broad diversification and economies of index funds. In other classes, such as emerging and frontier market equities, they should use active fund managers to choose the most attractive markets, asset classes or companies.

Funds aligned with the long-term framework

Here are six fund ideas aligned with the long-term investment framework described above.

• Merk Hard Currency Fund (MERKX) – This actively managed mutual fund seeks to profit from a rise in hard currencies vs. the dollar. In addition to strong currencies, it owns gold and may short the weakest currencies, such as the yen recently. Currency exposures are strategically adjusted by the manager, Axel Merk. The expense ratio is 1.30 percent.
• Nile Pan Africa Fund (NAFAX) – This actively managed fund is the best choice for participating in selective equities that are part of Africa's dynamic growth story. Portfolio manager Larry Seruma is an African native, and the fund was ranked by Morningstar as the No. 1 fund among 542 in the Diversified Emerging Market category in 2012 (+39.77 percent for the year). The expense ratio is 2.50 percent.
• Calvert Global Water Fund (CFWAX) – This actively managed fund invests in U.S. water treatment and engineering services, which will be among our most valuable exports to emerging and frontier markets in the years ahead. It is a four-star Morningstar fund with a nearly five-year track record, and in 2012 it returned 27.13 percent. The expense ratio is 1.85 percent.
• Fidelity Latin America Fund (FLATX) – Although Latin American equities have been weak in 2013, the long-term track record of this fund is good – 9.22 percent since inception in 1993. Recently, the largest weights were in Brazil (46 percent), Mexico (24 percent), Chile (15 percent) and Columbia (8 percent). The expense ratio is 1.02 percent.
• Van Eck Global Hard Assets Fund (GHAAX) – Van Eck fields one of the strongest teams for global research and active management of hard assets. This fund diversifies globally among the largest hard assets producer equities, with the heaviest weights in oil and gas, energy equipment and services, and metals and mining. The fund has returned 10.70 percent since inception in 2003. The expense ratio is 1.38 percent.
• Powershares DB Commodity Index Tracking (DBC) – This ETF is one of the best vehicles for broad diversification among commodity futures. With exposure to agriculture, industrial metals and precious metals, it is not as energy-heavy as some other commodity index funds. Its Optimum Yield method helps to reduce the contango cost drag of indexed futures. The expense ratio is 0.87 percent.

Summary 

The interconnected dramas now playing in the U.S. and Europe began 15 years ago, and it may take several more years before investors see a return to normalcy in these markets, whatever "normalcy" ultimately means. 

In the meantime, the powerful trends of population growth, urbanization, consumerism, and resource utilization will drive economic growth in emerging and frontier markets. As a result, carefully selected emerging market stocks, bonds and currencies may prove more resilient (and less volatile) going forward than those of the U.S. and Europe. Advisors who take the time to understand emerging and frontier markets will enjoy a competitive edge.

Most of your clients don't want to keep doing the kneejerk for the next decade. You are the professional who can show them a new set of long-term investing steps.