The benefits of diversification and exposure to international and emerging markets are well known to most investors. None-the-less, investors continue to be under-exposed to emerging markets.

In my view, this is principally due to the psychological barriers associated with investing in asset classes in which investors lack comfort. The attractiveness of investing in EM is based on the expectations of outsized returns.

What most investors fail to recognize is that economic growth and stock market appreciation are only loosely correlated in the short term. Moreover, EM equities (as well as their bourses) are impacted by many variables that go far beyond current and expected GDP Growth.

On a forward looking basis, I believe inflation, and more importantly governments and central banks attempts to contain inflation, will impact emerging economies and emerging markets to a greater degree than these actions will impact developed markets and economies.

Investors seeking to increase exposure to the EMs, without exposing themselves to the local market volatility, political and regulatory risks, and potential tariffs being assessed on foreign capital investments by some nations (just look at what is occurring in Cyprus, or happened in Brazil in 2010), may want to consider a three-tiered approach to investing in the EM:

1) Direct Beta exposure (i.e., utilizing country specific ETFs, or investing in local markets)
2) Commodity investments
3) Investing in U.S. multi-nationals with substantial EM exposure

To counter investors’ natural reluctance to investing in volatile, less understood markets, I favor over-weighting U.S. multi-nationals to help achieve the desired EM exposure. In my experience, investors are most likely to adhere to this allocation and strategy over the long-term, providing them with exposure to EM, without the volatility associated with direct EM investments.

Note: in order for this strategy to have a greater chance of success, it is important that the selected multi-nationals EM exposure and revenues stem from high margin business that is accretive to earnings (as opposed to low margin/high volume).

Separately, given the historical evidence that markets perform relatively poorly during periods of monetary tightening coupled with high inflation (over 4%); this strategy may prove to be superior to direct EM investing over the coming two or three years, as emerging markets are more likely to tighten monetary policy in response to elevated inflation levels.

As is always the case, there are several drawbacks to this strategy. Most obviously, it is more difficult to achieve a precise country-specific exposure utilizing this approach. More significantly, the growing strength of the emerging economies will cause varying policy responses, which could significantly impact U.S. dollar-denominated revenues and profits.

For example, Brazil is growing increasingly concerned with the strength of the real, which has appreciated roughly 40% versus the U.S. dollar since January 2009. As a result, Brazil has adopted a policy to keep local interest rates high to offset a very lax fiscal stance.

By way of comparison, China is tightly controlling its currency, and only allowing minimal appreciation against the dollar, preferring to address currency and inflationary concerns with higher bank reserve requirements and increased tariffs on imports. All of this could lead to some form of trade war between the developed and emerging economies, most likely through increased protectionist measures. This would be damaging to U.S. multi-nationals.

Even so, on balance, I believe that utilizing a balanced approach to investing in EMs is likely to be the best way to obtain and maintain the desired exposure. One word of caution–given expectations of increased labor costs in emerging economies, we would refrain from new investments in companies that require significant manual labor in the production cycle.

Speaking of emerging markets, I was pleased to see the closing of a VC fund focusing on Israeli tech start-ups. Based here in the United States in San Francisco and Philadelphia, JANVEST, will invest up to $500,000 in several companies focused on the Internet, software, telecommunications and security/defense sectors.

This struck me as good news since, undeservedly, it looks like the bloom came off the rose on Israeli tech companies, with VC dollars off some 20% in 2012, according to Eze Vidra, head of Google’s Campus, and de facto, one of the Israeli tech sectors biggest cheerleaders via his VC Café blog.

My observation is that living in a nation under constant siege–tragic as that is–nonetheless produces a breed of entrepreneur that is uniquely suited to compete and win in today’s technology markets. That JANVEST is focusing on early stage companies, and is based in the U.S. is a big plus, because it provides a pipeline for individual and institutional investors here.