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GIVEN THE EXTREME RECENT PERFORMANCE GAP between growth stocks and value stocks, many asset owners are considering diversifying their holdings away from growth and into value. At first glance, this seems reasonable as large performance differences and valuation spreads between factors have historically tended to mean revert and narrow. The expectation appears to be that when growth trades off, value could rally.
But what may get lost in this “growth versus value” comparison is that there is another alternative for diversification: quality stocks. The quality factor has recently outperformed value while lagging growth.1 Notably, we believe quality stocks offer distinct characteristics and can thus add significant diversification potential to allocations that traditionally focus on blending growth and value. In particular, quality has historically provided stronger downside mitigation on average than either growth or value over the last 20 years, which included six major market drawdowns.2
In this paper, we explore why quality is particularly attractive right now and highlight how a quality allocation has the potential to offer diversification, to avoid unintended sector biases, and to help mitigate downside risks.
The time may be right for quality stocks
We often look to buy stocks after periods of underperformance, as we believe this increases the probability that we are buying them for less than their intrinsic values. In our view, that same principle can hold true for groups of stocks as well. Therefore, we think it is notable that growth’s recent outperformance over quality has been quite significant (Figure 1).
In addition, the low-volatility factor has similarities to, and much overlap with, many measures of quality. The poor performance of low-volatility stocks versus high-volatility stocks over the last few years has…
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1Data range from 31 October 2015 to 31 October 2020. Sources: MSCI World quality, value, and growth indices. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. For illustrative purposes only. | 2As of 31 October 2020. Data sourced from the MSCI World quality, value, and growth indices. Drawdowns include the technology bubble, global financial crisis, European debt crisis, 2016 and 2018 drawdowns, and the coronavirus pandemic.