The discipline of testing
We believe this is the discipline that underpins successful quality investing. Our quality criteria are a set of hypotheses and they continue for as long as we hold a company. We test each hypothesis against a company’s own results, against competitors and against its business environment, and change our view when the facts change.
This discipline is particularly important today. The fundamentals of the global economy are resilient, but uncertainty is high and the markets build narratives that reinforce themselves. There are prevailing hypotheses about the geopolitical situation, the increase in conflicts, the sustainability of public finances, the opportunities and risks of artificial intelligence and the impact on consumers. The temptation is to seek evidence that confirms them. Our task is to test them, because each may prove to be wrong.
As we argued in an investment insight earlier this year, the case for quality rests on a long record. Since 1994, the MSCI World Quality Index has outperformed the MSCI World by 3% p.a., so that an investor in quality would have accumulated two and a half times the wealth of an investor in the broader market.
However, that outperformance has never been linear, and we are now in one of its most challenging periods. The MSCI World Quality Index has underperformed the MSCI World by more than 11% since the second quarter of 2024 in USD, and over five years quality has underperformed for the first time in close to twenty years, as markets rotated into balance-sheet-driven financials, capital-intensive energy and resources, and policy-dependent utilities.
History is instructive. After the most severe comparable dislocations, in 1999, 2003, 2009, 2020 and 2022, quality delivered strong outperformance over the following 12 to 24 months as fundamentals reasserted themselves. The periods in which quality has underperformed have consistently been the greatest moments in which to invest for subsequent outperformance.
Read Full Article
