What is quality investing and will it come back in favour?

In a world where markets can feel noisy and fast moving, quality investing is about stepping back and focusing on something simpler: owning good‑quality businesses that can steadily grow over time. Rather than trying to predict every twist in the economy, this approach looks for companies with solid foundations – strong balance sheets, reliable earnings and cash flows, and business models that can stand the test of time.

These are the types of companies that can continue to be profitable in different market conditions, even when things feel uncertain. So why has quality investing fallen out of favour in recent years? In this Q&A, we explore the shifts behind the trend with insight from Ross Brookes, Head of Collectives Research.

What is quality investing?

Quality investing focuses on buying companies with strong financial health – those that generate steady cash flow, have low levels of debt relative to their earnings, and consistently earn good returns on the money they invest. These companies often have competitive advantages that help them navigate different market environments.

This style gained particular popularity during the long period of ultra‑low interest rates up to about 2020. With bond yields low and economic growth subdued, investors tended to favour companies seen as dependable and relatively resilient.

So why has quality fallen out of favour?

The backdrop has shifted significantly since the pandemic. Rising inflation and higher interest rates helped areas of the market that had been unloved for years, often labelled “value” stocks. Investors moved towards more cyclical, economically sensitive sectors, many of which sit at the opposite end of the quality spectrum. 

What caused this rotation towards more cyclical or lower‑quality stocks?

Several forces acted together. Inflation climbed, interest rates rose, and government stimulus boosted parts of the economy that typically do well when activity picks up. These conditions generally favour companies that benefit directly from economic swings, making them look more appealing in the short term compared with steadier, high‑quality businesses.

Are there simple explanations for why some well‑known quality names have struggled?

It’s rarely down to just one factor. For example, many consumer‑focused companies have faced a combination of changing drinking habits, the rise of weight‑loss drugs, tariff concerns, and customers trading down because of the cost‑of‑living squeeze. These pressures vary from company to company and broad style labels don’t always capture the nuances of individual business challenges.

Why have US quality stocks struggled?

 

One major driver has been the strong shift towards speculative or higher‑growth companies, especially those linked to themes like AI. Investors have been willing to pay high prices for rapid growth potential, even when fundamentals are less established.

At the same time, high‑quality companies have tended to trade at higher valuations. When the market rotated into more cyclical or aggressive growth areas, these higher‑valued businesses were more vulnerable to seeing their valuations fall.

Is the story the same in the UK?

Yes. Many classic UK “consumer defensive” names have seen their share prices fall meaningfully. These brands are widely held in wealth management and fund portfolios, so the impact has been noticeable. Several are trading at valuations last seen in the early 2000s, which has weighed on quality‑income strategies.

Could undervalued quality stocks become more attractive again?

Historically, high‑quality companies have tended to hold up better during periods of economic stress rather than in the early stages of market rebounds. Recently, capital‑intensive sectors such as banks – which many quality managers don’t typically own – have benefited more from the environment.

So what matters when a style like quality struggles?

For us, the key is the consistency of a manager’s process. No investment style delivers strong returns all the time. Short‑term performance is often driven by style trends or shifts in market leadership. While we can’t control short‑term outcomes, we can assess whether a manager applies their approach with discipline, especially during difficult periods.

This matters because many investment decisions still rely on backward‑looking five‑year tables. Funds that have recently performed well are often the ones most heavily promoted. It’s rare to see a fund with weaker three‑ or five‑year returns highlighted – yet that’s where many quality strategies could currently sit.

Does past performance give any clues about what happens next?

 

Past performance isn’t a guide to the future. Many investors feel more comfortable buying funds that have recently done well, even if those returns don’t continue. That mindset can make it harder to consider strategies that have temporarily fallen out of favour.

There are parallels with value investing in 2020, when it was deeply out of fashion before later recovering.

What could turn things around for quality?

It’s impossible to predict. Catalysts often only look obvious in hindsight, and timing shifts between investment styles is effectively a form of market timing, which is not something our team aims to do. But we can observe that the typical valuation premium associated with the quality factor in many developed markets has compressed meaningfully.

For quality investors, part of the opportunity lies in focusing on the fundamentals: identifying companies with strong balance sheets, strong earnings, and dependable cash flows, all the hallmarks of a quality company. In this context, some strategies take a sector‑neutral approach, ensuring the focus remains on financial strength rather than industry exposure.

From a portfolio construction perspective, the significant de‑rating across parts of the market means a quality portfolio may now sit differently within a broader investment strategy. This doesn’t indicate what will happen next, but it’s one of the factors investors consider when making an investment decision.

As always, diversification matters. Quality‑focused managers typically look across sectors and regions, from technology to consumer goods to selective areas of real estate. No single style will be “right” or “wrong” at any given moment; what matters is building a portfolio designed to withstand a range of market conditions over the long term.