Quality still works

Key takeaways: 

• Quality remains a relevant investment factor. Investors continue to favour profitable, cash-generative and financially resilient businesses, supporting the long-term case for Quality investing.
• Its character has changed, however, it has become increasingly technology-led. The rise of asset-light, highly profitable technology businesses means unconstrained Quality portfolios now have greater exposure to US mega-cap growth stocks and technology-led market leadership.
• ROA is now the dominant driver of broad Quality performance. This reflects the growing importance of profitable, asset-light business models. Simulated analysis shows that return on assets (ROA) delivers performance characteristics that closely resemble those of the broader Quality factor.
• Accruals emerge as the strongest stock-selection signal after neutralising sector, country and style exposures. Once broader market effects are removed, earnings quality becomes a more informative stock-selection signal than profitability alone.
• Quality is not automatically defensive. As exposure has become increasingly concentrated in profitable technology companies. A composite of different financial ratios to define Quality helps to remain relevant as the market changes and companies evolve.

Points of differentiation: 

• Re-examines one of the most widely used equity factors in the context of today's market structure, showing how Quality exposures have evolved and why implementation choices matter.
• Examines the changing relationship between profitability and earnings quality in an economy increasingly driven by intangible assets, technology platforms and AI investment.
• Demonstrates how different implementation approaches can lead to materially different outcomes across Standard Quality, Pure Quality and Defensive Quality strategies.
• Uses historical simulations and factor decomposition analysis to identify the underlying drivers of Quality performance and changing factor exposures.

What does our research mean for investors?

• Investors can look beyond a headline Quality allocation and understand the different characteristics captured by Quality implementations, including profitability, earnings quality, technology leadership and defensive attributes.  
• Quality remains a relevant investment factor, but today's portfolios may offer greater exposure to technology companies, growth stocks and profitability themes than many investors realise.
• Standard Quality, Pure Quality and Defensive Quality strategies can produce materially different return, risk and diversification profiles.
• Different implementation approaches are designed to achieve different objectives. Investors can align Quality strategy selection with their desired balance of return, risk and diversification objectives.