Disquiet in quality: What happened and what now?

Quality has long been a cornerstone of equity investing. Quality companies — typically defined by high free cash flow, high return on equity, low leverage, and stable earnings — have tended to lead the market over full cycles. They usually hold up well during periods of volatility, and quality equities have delivered outperformance both in the US and globally over the long term. 

Yet quality has been lagging since 2021, with underperformance accelerating sharply in 2025 following the market lows of April 8. 

What went wrong for quality in 2025? 

While quality has faced challenges since 2021, several factors drove 2025’s marked underperformance:

• Prolonged uncertainty led investors to “hide” in quality, creating crowdedness
  The period between the 2020 pandemic and April 9 last year was characterized by recession fears and ongoing debate about whether the global economy was in the mid or late cycle. During this prolonged period of extreme uncertainty, quality’s reputation as a safe haven positioned it as a sensible place to ride things out. But this left many investors overweight quality stocks, as evidenced by the quality factor’s valuation hitting an all-time high entering 2025. This “weight of money” became meaningful when quality stocks underperformed.
• When the cycle turned, quality fell out of favor
  Rightly or wrongly, markets decided that April 8 marked a cyclical low in the global economic cycle. Since then, equity markets have rebounded, but this early-cycle environment has favored cyclically leveraged stocks, such as high-beta, low-quality, and, more recently, small caps. High-quality stocks tend to perform best in periods of market and economic uncertainty, not during the initial phase of market rebounds.
  
  As markets rallied on a wave of deregulation and monetary and fiscal support, investors rotated out of quality, triggering sharp underperformance. 
• Changing equity market dynamics accelerated these trends
  Economic stimulus packages announced in the US, Europe, and Japan and a rise in retail participation and speculative behavior further accelerated the rotation. This was an environment in which retail investors — often successfully — moved quickly to capitalize on opportunities. High-beta stocks started to behave like momentum stocks, retail investors increasingly drove the market narrative, and the period during which quality was rewarded came to a decisive end. Case in point: A preference for more volatile, less financially healthy companies drove the sharp outperformance of non-profitable tech stocks versus the S&P 500 in 2025. A similar phenomenon shaped markets in late 2020 and early 2021, marking the official birth of “meme stocks” — which subsequently underperformed as market conditions stabilized. 
• This culminated in a double whammy for relative performance
  Naturally, investors who are overweight high quality tend to be underweight low quality. A year in which high quality underperformed and low quality and high beta outperformed was especially bruising for relative performance.

What now? 

Put these points together and there’s a clear narrative behind quality’s underperformance. It fits a well-established pattern of how quality typically performs across market cycles. In market downturns, high quality tends to perform well — as it did when the pandemic first hit in 2020 — but it typically lags when markets rebound, which is exactly what happened when markets recovered in late 2020 and early 2021. There are indeed some similarities between 2025 and the early 2021 period; both followed periods of extreme uncertainty and both were shaped by retail participation. 

But where does this leave investors now? Before reevaluating the broader potential benefits of quality within portfolios, it’s important to be clear on what hasn’t changed: 

• Quality’s long-term record remains intact
  Quality has consistently outperformed over the long term in the US and globally. We believe this will continue. 
• There are still plenty of good reasons to hold quality companies
  There’s a strong case for believing that companies with strong balance sheets, high free cash flow and return on equity, and stable earnings are well positioned for the future, even if performance is disappointing in the short term. The quality factor outperforms precisely because quality companies generate consistent growth and returns through market and economic cycles. This creates a return profile where the upside capture should be higher than the downside capture. 
• Quality performs best during periods of uncertainty
  Quality’s strength is most visible during periods of market and economic uncertainty. While markets are currently engaged in a cyclical rebound, there’s no guarantee this will continue, especially in a less synchronized, more volatile world. Exposure to quality should provide an attractive combination of long-term offence and short-term defence. By contrast, low-quality and high-beta companies may be in favor now, but they often lack the strong fundamentals that help support resilience when the cycle turns. 

Taken together, the past few years have been challenging for quality, but not inexplicable. A crowded starting point, a market rebound, and shifting market dynamics created a backdrop in which quality was unlikely to lead. 

Yet none of this necessarily undermines the rationale for owning quality. The long‑term record remains intact, the defining characteristics of quality companies continue to matter, and history shows that periods of uncertainty are when quality’s strengths are most valuable.