With the first signs of the coming global crisis rattling global markets investors are starting to swoop for opportunities that fit the new financial paradigm.

Recently we entered the eleventh straight year of a bull market, only to see a double digit slide happening just days later. Everything appeared to be relatively calm with all the main indices of the developed world touching record-highs, with interest rates and inflation low and stable. The labour market was also expanding and wages were rising. In other words, the future seemed to be very bright.

But suddenly the landscape is changing with the coronavirus outbreak making the markets sick with worry. However, many investors saw change coming and were already prepared for such an event. For those investors, the time has come to stress-proof their portfolios to suit the emerging paradigm shift in the world of investment. A period where the old familiar rules get torn up and new ones are formed. 

Were we overdue a market correction? Possibly, but it’s always difficult to predict when they will hit. Remember back in 2006 when stocks were relentlessly climbing up and up? Who would’ve thought within a year the Subprime Mortgage Crisis would hit, followed by the first Great Recession of the new century. 

The New Paradigm Shift Can Help You Weather Financial Storms

The key economic paradigm of most developed economies in the decade since the Great Recession can be characterised with two phrases: low rates and quantitative easing (QE). 

To keep the economic system afloat, central banks decided to:

  • Keep interest rates low to make borrowing much cheaper to stimulate demand
  • Buy up financial assets to increase liquidity in the economy to encourage spending (i.e. quantitative easing)

However, after 10 years of this strategy, we are beginning to see visible side effects:

  • Low rates have significantly decreased central banks’ ability to respond to another economic shock (e.g. with Bank of England’s base rate at 0.75%, it is hard to imagine it being lowered further)
  • Low rates have encouraged excessive borrowing, which pushes up asset prices (as more money is chasing after a limited supply)
  • QE has significantly expanded the money supply to the economy, which further exacerbates asset price inflation and exerts upward pressure on consumer prices

Consequently, most assets have had more than a decade to absorb and digest the effects of low rates and QE and their valuations today are at a peak. Given that rates can hardly go much lower and QE has already saturated the market, peak asset pricing offers little upside and significant downside going forward.

Furthermore, asset price inflation, combined with automation, globalisation and tax cuts (all of which benefit corporate earnings), have significantly increased wealth inequality. This is damaging social stability and exerting political pressure on governments to alter course. Plus, the protectionist trade policies pursued by President Trump are an inherent (albeit incorrect and suboptimal) response to an electorate dissatisfied with the status quo. Going forward, we will see more and more governments with nothing more than knee-jerk responses to an increasingly disillusioned population.

All of these factors are damaging the current economic paradigm and forcing it to transform. As a result, investors who fail to get to grip with the new market fundamentals might see their portfolios run into serious trouble. Plainly speaking, now is not the time for dithering but to master a new way of investing and doing business.

The Curse of the Old Paradigm in a Brave New World

Traditionally investors favour a rather limited range of asset classes, namely: stocks, bonds and properties. Some more adventurous individuals might enter the realm of precious metals, but they are in the minority. Most investors would simply buy an index fund or ETF for their pensions and forget about it.

This approach is very dangerous, especially now.

Firstly, after a decade of low rates and QE, asset valuations are at their highest, which means investing now offers a much lower margin of safety than ten years ago. This increases the probability of permanent capital loss. 

Secondly, the shift from active management to passive has significantly expanded index-based ETFs. Many of these funds, despite the claimed diversity, run a very concentrated portfolio as a result of the capitalisation-weighted method. For example in the iShares MSCI Switzerland ETF, the top 10 holdings occupy 67% of the portfolio. This is hardly a sound risk mitigation strategy. 

Thirdly, most of these assets suffer from liquidity issues one way or another. Properties and precious metals are inherently less liquid than stocks and bonds because their trading volume is much lower. Stocks and bonds are more liquid in the sense that they trade in high volume on open exchanges. However, the proliferation of ETFs has resulted in trillions of dollars being indexed against them, a number that vastly exceeds their daily trading volume and value. This means that in the likes of the Great Recession where these capitals are getting liquidated (an event made far more likely than in 2008 through indexation and algorithmic trading), the market will simply seize up, preventing investors from exiting.

It is evident that we need an alternative approach to investing in the new era.

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Learn How to Quickly Identify Hidden Gems and Other Treasures

In the fast-paced digital world, information is both abundant and instantaneous. This means that businesses that rely solely on first-mover advantage simply will not thrive, as competition can rapidly become fierce. Instead, we need to look for the hidden gems: businesses that sail beneath the radar and yet deliver superior returns to investors.

These businesses may come in all sizes, types and sectors. However, they all share three key traits:

  1. Easy and stable business models
  2. Consistent profitability and healthy financials
  3. Fair valuation

1. The Idiot-Proof Business Model

Warren Buffett once said of his investment approach that, “I try to invest in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will.” His playful remarks contain an important kernel of truth: businesses that have solid margins with reliable supply and demand are much easier to manage and far less likely to fail, especially in times of market turbulence.

This principle permeates across the macro and micro levels.

At a macro-level, investors start looking at countries that are more politically stable, fiscally conservative and sensible in monetary and regulatory terms. These are the key factors that explain why Swiss and Japanese currencies (and investments in those currencies) are perceived as “safe havens”, and why during times of economic turbulence investors flock to Switzerland for example.

Perhaps its also something to do with the fact that the alpine nation is naturally more accustomed to  navigating safely through the big peaks and deep valleys in dynamic, fast-moving landscapes, where conditions can sometimes rapidly deteriorate. However, despite the world-leading transport infrastructure that can whisk you from city to city in a flash, it still pays in Switzerland to keep fit, nimble and healthy. Like the economy. Switzerland traditionally enjoys strong GDP with low unemployment to boot. Fiscally it has a small budget deficit and an independent monetary policy set in Zurich. All reasons why so many savvy investors think it a perfect location for bankable assets. Local blue-chips like Roche and Nestle would likely agree.

At a micro-level, companies in stable sectors are far easier to manage than their more volatile peers. After all, it is far easier to make plans and forecasts when you know how the next month, quarter and year is likely to pan out. Taking the Swiss tourist market as an example, there has been positive and stable growth for the past 25 years. Remarkably, it was completely unaffected by two huge global recessions during this period. Whether in terms of finance, real estate or the tourism industry, Switzerland has always been a rock of stability during times of economic shock.

2. Rock-Solid Returns With a Rosy Financial Outlook

If a stable and defendable model is the key foundation for success, then consistent profitability is the secret ingredient.

Companies that are consistently profitable tend to be able to deliver positive cash flow, which is vital to future growth as well as the ability to withstand shocks. This is more likely if the company is stable at both the macro and micro levels mentioned above. The ability to produce positive cash flow consistently creates value and enormous benefit to shareholders.

Hundreds of successful mid-sized companies, some which have been around for hundreds of years, enjoy sustainable and high returns, thanks to the sizable domestic demand and reliable economies of scale. But despite such impeccable credentials, these types of enterprises are not always targeted by big capital, as they are neither startups that promise skyrocketing growth nor companies that can accommodate hundreds of millions of dollars investments. But they are highly efficient and profitable niche brands which can be expected to perform come rain or shine, year in, year out. Just think of Rolex.

3. Fairly and Squarely Valued for the Long Home Run

There is a saying amongst investment professionals that “timing is everything”. What this implies is that the highest asset values are usually extracted with early-bird acquisitions which can enable investors to get the most premium rates of return. In fact, veteran value investors like Benjamin Graham are vocal advocates of the concept of margin of safety. That entails acquiring assets at below their fair value and holding onto them for the long-term, also minimising the risk of catastrophic capital loss.

Unfortunately, in recent years the market has been anything but fairly valued. After a decade-long bull market, the S&P500 price-to-earnings ratio had been comfortably sitting at 24, way above the long-term average of 15. It means today that finding fairly valued assets is becoming increasingly important, but also ever more challenging.

This is primarily caused by a single factor: market crowding.

The key allure of the public market is its liquidity. Securities that are publicly traded are easy to buy and sell (which is the whole point of exchange) and therefore it improves the efficiency of capital allocation. However such efficiency can never be absolute and frequently investors are driven by their emotions and perceptions rather than objective realities. 

For example, the recent surge in popularity of ETFs and index funds led to capital being channelled into some of the largest companies (by market capitalisation) in the world, even without a serious reappraisal of their long-term viability. Until recently the market was crowded with overblown valuations, not because of any outstanding financial performance, but because excess capital is competing for an artificially limited number of stocks. The situation is further exacerbated by low rates and QE, which vastly expanded the capital pool to make such investments, resulting in grossly inflated valuations.

Be ready, but stay patient. Hidden gems are not easy to discover but you’ll instantly know when you see one.

Businesses like Le Bijou are privately owned and therefore not listed, so shares are rarely traded (hence illiquid). They often have a very small investor base (a dozen) compared to their public counterparts (thousands). They often slip under the radar because investment banking analysts don’t get to report on them every day. They are different but in reassuring ways. For example, there are none of the bureaucratic hurdles and cumbersome fixed costs of public companies. (e.g. IPO fees, Big 4 auditing fees). And naturally, they are not under pressure to disclose market-sensitive data or forecast the future to Bloomberg reporters 24/7.

In other words, they are stealthy.

This is an enormous advantage in today’s viewing-glass world because these assets have way fewer investors chasing after them. They are hardly influenced by quantitative easing, which means their valuation is more likely to be fair and reasonable. Investing in such businesses provides for a significant margin of safety for flighty investors looking for safe sanctuaries to incubate wealth as well as benefit from healthy capital gains. 

Furthermore, these hidden gem companies tend to be run by managers with a significant stake in the business (often owner-managers) and their personal fortune is tied to the fate of the business. This means their incentive is truly aligned with other investors, rather than public CEOs who often worry about meeting earning targets, only to unlock a chunky bonus. 

Here are some new paradigm investments glittering under the radar:

1. Cadre

Projected Yield: 5-9%, up to 19% IRR

Asset description: Direct ownership in commercial real estate

Site: cadre.com

Country: United States

Cadre is a platform that makes commercial real estate accessible to ordinary investors with as little as $50,000.

Commercial real estate boasts certain advantages that can make it a highly desirable asset to own: it has a low correlation with the stock and residential real estate market, which makes it a great option to diversify the portfolio. Investing in the commercial estate was a privilege of institutions and super-rich until Cadre’s Ryan Williams raised 133M to disrupt it.

Unlike REITs, direct ownership is less susceptible to market moves and global volatility. Direct ownership also means lower liquidity, which Cadre elegantly solves by providing an internal platform where investors can trade their shares.

Another quintessential feature of “hidden gems” is their integration with so-called Opportunity Zones - Swiss neighbourhoods with the greatest potential for growth and where the government offers attractive tax cuts of up to 15%.

The third of Cadre’s advantages tells you why the firm is now valued at $800 million. The magic sauce is in the powerful data science that allows precision tracking of over 1 million assets and the utilisation of all this big data helps accurately predict capital movement and dividend gains for real estate. Cadre is truly shaking up an industry that has already given rise to more than 30% of the world's billionaires.

What are the hallmarks of this hidden gem?

  • Off-market, dividend-yielding commercial assets less susceptible to market hysteria.
  • A novelty factor - the company is still not on the radar of big institutional investors.
  • Robust dataset tools for nimble acquisitions of bargain properties.
  • Opportunity zones featuring beneficial tax shelter status.

What about the pros and cons?

One of the risks could be for investors whose circumstances have changed and who want to liquidate in a hurry. This would normally be a costly drawback but in this case, the risk is somewhat mitigated by the internal Cadre marketplace where investors can fairly trade without taking the kind of haircut likely in the open market.

2. Le Bijou

Projected Yield: 2 - 7% (B shares), over 7% (A shares), 3% - 6% (bonds, various issues)

Asset type: Private equity, real estate

Site: invest.lebijou.com

Country: Switzerland

You might think that developed markets in mature democracies like Switzerland are a little too stagnant for their own good. But then you probably haven’t met the founders of Le Bijou. The Swiss hoteliers' game-changing business model has ruffled the feathers of the continent’s 5-star hotel industry and recently prompted a gushing Apple Co-Founder Steve Wozniak to call his stay at Le Bijou, “the best hotel experience of my life”.

This avant-garde hotel-apartment business caters to a new type of well-heeled, artisan traveller, who wants genuine privacy and a level of control and comfort only normally possible by renting apartments, along with the special conveniences of 5-star hotels. So things like on-demand door-to-door deliveries and special catering.

Le Bijou’s customer base consists of a new breed of clientele that Airbnb, the one-time disruptor, is unable to cater for. A classic example of unbundling if ever there was one. The Swiss hoteliers also provide a range of spacious venues for corporate functions, special media events, personal celebrations and luxury brand launches. Together they provide a diverse flow of steady revenue streams that guarantee chunks of cash every single day.

Although the company is consistently profitable and large enough to run dozens of buildings in the largest Swiss cities, it is still too small to be on the radar of the big funds. Therefore it is very reasonably valued for an enterprise that regularly returns tidy sums to its investors.

With Le Bijou there’s also plenty more than first meets the eye. The owners are ambitious and envisage the business as a leading icon from a new-generation of blue-chip Swiss corporations to emerge in the coming decade.

There’s already an exclusive in-house investor community with professional workshops and Le Bijou member-only networking parties that often feature the leaders of world-famous firms like Porsche. The regular roster of community events is part of the philosophy of Le Bijou that hospitable, creative relations are an important ingredient for reliable and rewarding business.

What are the hallmarks of this hidden gem?

  • Solid dividends and a mature, easy to operate business model.
  • Capitalises on the booming Swiss tourism market which boasts 30 years of continuous annual growth.
  • Has an original and memorable brand that is easily distinguishable from competitors.
  • A technology advantage - Uber-like service systems for example. Or AI-backed smart technologies that help deliver signature services efficiently and elegantly.
  • Liquidity on tap through an internal marketplace with hundreds of like-minded participants.
  • Totes the availability of sophisticated investment kits to fit all sorts of private investors, especially since banks only offer up to 50% finance, on, for example, commercial property developments.

Possible risks and cons:

Airbnb rentals accounting for 8% of a company’s revenue may soon be banned in some Swiss cities. Company officials insist this won’t impact Le Bijou's bottom line, as the bulk of revenue comes from returning customers, from other booking agents like Expedia and Booking.com, as well as other income streams, like from hosting brand events. Some of the other disadvantages are the company doesn’t accept capital from outside of Switzerland and A-shares are rarely available - the company seems to prefer investments from a close group of original investors.

3. Horizon Equity

Projected Yield: 7 - 10%, the investment opportunity is available through brokers

Asset description: Private fund issued by a reverse mortgage provider

Site: horizonequity.ca

Country: Canada

Horizon Equity is a firm that offers “reverse mortgages”. A reverse mortgage loan is a fully-secured, non-recourse loan that enables homeowners, typically over 60 years old, to use the equity value of their home to release cash, a line of credit, a series of monthly advances or a combination of the three methods. In other words, it allows pensioners to start releasing liquidity from their homes without having to sell up.

The company raises funds to purchase reverse-mortgage portfolios and offers insurance to protect lenders against the risk that the value of the homes drops and becomes insufficient to the maturity on the loan.

What are the hallmarks of this hidden gem?

  • Non-traditional niche with strong novelty factor and the lion’s share of a growing segment that is noticeable for a lack of strong competitors.
  • Not a publicly-traded company, so private investors are not in competition with millions of others.
  • Banks can finance only a part of the fund, and thus the firm is pushed to raise capital from private investors and firms for a premium.

Possible cons and risks:

The risk we see comes from a possible unexpected increase in life expectancy that might drain the company’s profits.

4. Montreaux Capital Management

Projected Yield: 10%, unsecured fixed-income agreement

Asset type: Direct ownership in care homes

Site: montreuxcm.com

Country: United Kingdom

Ageing is one of the world’s most reliable business trends, something Montreaux CM was quick to spot. With the population of UK pensioners increasing from 17% in 2000, to 20% in 2020, and with another 25% increase by 2030, the demand for care homes is literally going through the roof. 

Montreaux CM offers opportunities to invest in elderly care homes. An investor can invest in something as little as a one room-unit, for a fixed-income contract with the management company. Around 80% of potential residents of care homes envisioned by Montreaux CM will be funded by the government.

A peculiar detail about the care home industry is that it has barriers to entry based on local economies of scale. In other words, once you open a care home in a neighbourhood, it is almost impossible to imagine another one opening across the street, as it will have tremendous troubles seducing patients to relocate.

What are the hallmarks of this hidden gem?

  • A “local monopoly” potential.
  • The government secured spending for 80% of the potential residents.
  • Predictable demand - the UK population is inevitably ageing.
  • Banks can finance only a part of the fund, and thus the firm is pushed to raise capital from private investors and firms for a premium.

Possible risks and cons:

The most significant risk we see is an investor largely dependent on his fixed-income agreement with the management company, and if the latter goes bankrupt, it might be difficult to replace.

Nestle Down Under the Silver-Lined Clouds

Investors need to recognise the paradigm shift that is rippling across the global market right now. After a decade of economic recovery (the slowest on the record) where experimental policies like quantitative easing and ultra-low rates have become the norm, we are now in an age where traditional assets are becoming overvalued and lacking fundamental economic support. The smart play will, therefore, be to shift capital away from these securities and instead divert to smaller, less liquid and yet extremely profitable hidden gems.