Where in the world? Making sense of emerging markets.

If you have a taste for adventure and a tolerance for risk, some industry experts advise you to look overseas. Two years ago, the Eastern bloc countries were dancing in the streets to the tune of a new democracy, a free South Africa promised ground-floor opportunities and a post-NAFTA Mexico tantalized investors. If you had invested in any of these emerging markets back then, you might have realized total returns of up to 50%

Unfortunately, war, natural disasters and economic and political instability have dampened investor enthusiasm for these emerging markets. According to Lipper Analytical Services, emerging market funds posted a negative 9.57% total return last year. Still, some money managers say that if you have deep pockets and can stand the risks associated with investing in lands across the sea, emerging markets should be part of your portfolio.

"Despite the free fall of investment values in Mexico last year, 5% of everyone's portfolio should contain an emerging market holding," says Steven Sanders, principal of Sanders Investment Advisors in Philadelphia. Depending on your age, time horizon and risk tolerance, up to 15% of your portfolio should be in international securities, he advises. Of that total, he says, no more than one-third should be in the riskier emerging markets.

What or where are the emerging markets? It depends on who you ask. They've been called "third world" and "lesser developed countries." "Emerging markets" is the newest catch phrase. J.P. Morgan, the New York-based investment banking powerhouse, tracks eight countries on its Emerging Markets Bond Index: Argentina, Brazil, Bulgaria, Mexico, Nigeria, the Philippines, Poland and Venezuela. Other countries that are frequently thrown into the mix include India, Thailand, Russia and various African nations.

In general, the emerging market countries are just beginning to develop modern infrastructures, and are undergoing major political and/or economic overhauls. They're also starving for foreign investment. For example, China is considered by some to be an emerging market; Japan is not.

If you do decide to invest in the emerging markets, you should be prepared to stick with your choices for at least five to seven years, Sanders says. "The numbers show that sticking it out during the tough times is how people get the best returns on their money," he explains. According to a Lipper report, the emerging market sector turned in a 66.21% total return from 1989 through 1994.

"Investing in other countries is less liquid, more expensive and riskier than investing in domestic stocks," Sanders warns. But if you've got the stomach for it, there are three basic ways to invest in emerging markets.

Direct investment in foreign companies or sovereign bonds is the riskiest and most expensive investment you can make.

American Depositary Receipts--equity securities that trade on NASDAQ like domestic stocks--are another way to invest in emerging markets. With ADRs, you get paid in U.S. dollars, but the exchange rate value of your investment may fluctuate according to the condition of the native currency.

There are two advantages to holding ADRs over individual foreign instruments: control and expense. Since they are traded domestically, ADRs cost less to buy and less to sell.

ADRs represent ownership in foreign stocks that are held by a trustee, usually a bank. NASDAQ has a special bulletin board called PORTAL, which makes trades for more than 100 foreign companies.

A final way to invest is through mutual funds. One type, closed-end funds, offers a limited number of shares to new investors. When a predetermined dollar amount is collected (capital), the fund begins to trade on the exchanges.

Unlike open-end funds, closed-end funds never issue new shares nor do they call (or buy back) shares when investors want to liquidate (or sell).

Country funds, such as the Korea Fund and the Mexico Fund, focus on a specific country. There are also regional funds that invest in specific areas of the world, like the Pacific Rim.

Sanders says that the so-called theme funds, like GT Global Infrastructure Fund, may also be good bets. Theme funds spread the risk of loss around the world by investing in countries that are reinventing themselves, such as South Africa, Mexico and India.