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Exotic markets few talk about, but probably should

While investors shunned emerging markets in 2013, riskier frontier markets racked up stellar gains - but can they stage a repeat performance this year given valuations are no longer as attractive?

John Lomax, head of global emerging market equity strategy at HSBC, says if and when emerging markets begin to perform better, frontier markets could be vulnerable to outflows. For the moment, however, the bank continues to favor frontier markets.

(Read more: Is Sri Lanka the new investment darling?)

"Frontier markets still have some intrinsic advantages, in terms of long-term growth prospects and some valuation parameters, such as dividend yield," Lomax wrote in a report on Tuesday.

"In relation to liquidity, the share of frontier market exposure in the average emerging market fund has increased noticeably over the past year," he added.

The MSCI Frontier Market Index rose 26.3 percent last year, compared with the MSCI Emerging Market Index's 2.6 percent decline.

Ho Chi Minh City
Rob Whitworth | The Image Bank | Getty Images
Ho Chi Minh City

While frontier markets are trading at higher price-to-earnings (PE) and price-to-book (PB) ratios compared with emerging markets, the former is expected to offer a higher dividend yield in 2014. Frontier equities are forecast to pay a dividend yield of 4.4 percent versus 3 percent for emerging equities, according to HSBC.

Exotic market picks

Among the world's least developed markets, HSBC has an exotic mix of markets that it is positive on this year, namely Argentina, Kazakhstan, Kenya, Nigeria, Oman, Qatar and Vietnam.

Kazakhstan, for example, is supported by a steady increase in domestic consumption and growing investment, the bank said, adding that the economy is closely tied to the global cycle and exhibits lower vulnerability to external shocks.

The positive case for Nigeria lies in its robust long-term growth prospects that are underpinned by the combination of natural resources, an impending demographic dividend and an underpenetrated consumer market.

(Read more: Investors to eye riskier markets in 2014: Control Risks)

Qatar, meanwhile, is a strong macro story with limited external risk, the bank said, pointing to the economy's rising budget surplus thanks to its oil- and gas-related revenue. In addition, the Qatar stock market may experience a liquidity boost in the lead up to May, when the MSCI will reclassify the country as an emerging market from frontier market.

Finally in Vietnam, a pickup in Western demand this year should boost demand for the country's goods such as apparel and electronics, HSBC said. Furthermore, a signing of the Trans-Pacific Partnership Agreement (TPP) - to create a large free trade zone covering 30 percent of global trade - would greatly benefit the Asian economy, it added.

—By CNBC's Ansuya Harjani. Follow her on Twitter: @Ansuya_H

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