Has Quality Lost Its Edge?

o. The medium-term case for holding quality remains sound, backed by healthy fundamentals, reasonable relative valuations, and quality’s diversifying properties, even if the current cyclical environment is not yet fully supportive. Investors should maintain exposure to the quality factor within equities, and those that saw their allocations fall due to recent underperformance should consider rebuilding. We expect patient investors will be rewarded for maintaining exposure—particularly those that implement actively and focus on businesses whose profitability is genuinely durable rather than relying on backward-looking index definitions of quality.

Historically, quality has outperformed broader equities in 71% of rolling five-year periods since 1980. But that hasn’t been the case lately. Quality has lagged sharply in the last two years, with the MSCI World Quality Index having lagged the MSCI World Index by nearly 10 percentage points, one of the worst two-year windows for quality in nearly two decades. The shortfall reflected strong performance from AI-linked technology names outside the quality index, including Broadcom, Micron, and Palantir, as well as quality’s underweight to financials. ¹ Within financials, banks benefited from higher-for-longer rates and more resilient credit conditions than investors expected after the 2023 banking turmoil. These dynamics were powerful, but look more like a temporary period of unfavorable market leadership than a lasting impairment of quality. The medium-term case for quality remains intact.

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