Quality investing can produce superior outcomes for long term investors

Consistency is one of the most important attributes of fund performance. Many mutual fund schemes can deliver good performance i.e. beat market returns in certain market conditions but they may not be able to outperform in certain market conditions. For example, a high beta stock can deliver high returns in bull markets but see sharp fall in volatile markets. Quality investing aims for performance consistency across different market conditions / investment cycles. In this blog post, we will discuss what quality investing is, how quality investing performed in different market conditions and how it performs in the long term.

What is quality investing?

In simple terms, quality investing seeks to invest in the best companies. Some investment experts trace the origins of quality investing from fixed income, where high credit rating (high quality) denotes companies which are financially stronger than others. There is no clear definition of what constitutes a quality stocks. MSCI uses three parameters to identify quality stocks:-

• High return on equity (ROE)


• Stable year on year (YOY) earnings growth


• Low financial leverage (debt equity ratio)

Different fund managers may use different factors to identify quality stocks. Among the quantitative factors, the factors mentioned above and other factors (e.g. free cash flows, superior operating margins, valuations etc) are used by fund managers. Fund managers also use qualitative factors like market positioning, economic moats, business models, management quality etc to assess quality.

Quality investing outperforms in the long term

The chart below shows the annual returns of MSCI World Quality Index versus MSCI World Index over the last 10 years (as on 31^st December 2020). You can see that the Quality Index outperformed in most years. What may be of interest to many investors is the observation that, Quality almost always outperformed in volatile markets. The chart below provides strong evidence that globally quality investing outperforms in the long term.

Source: MSCI, Advisorkhoj Research (as on 31^st December 2020). Disclaimer: Past performance may or may not be sustained in the future

Has quality investing outperformed in India?

Quality investing is a globally proven concept. But there is a view among a section of investors that equity market in India is different from developed markets because we are largely a growth market. Let us see how quality investing has performed in India. The chart below shows the annual returns of MSCI India Quality Index versus MSCI India Index over the last 10 years (as on 31^st December 2020). You can see that even in India, the Quality Index outperformed in most years. The years circled in red saw relatively higher volatility than other years due to various factors viz. US sovereign rating downgrade (2011), taper tantrum (2013), Eurozone debt crisis and economic slowdown in China (2015) and COVID-19 pandemic (2020). You can see that Quality Investing outperformed in volatile market conditions. The performance of quality stocks during these periods showed that these companies are better positioned to withstand economic shocks. It is important to note here that, quality investing may not always give the best returns in short term, but it can outperform in the long term across several investment cycles.

Source: MSCI, Advisorkhoj Research (as on 31^st December 2020). Disclaimer: Past performance may or may not be sustained in the future

Long term investing approach helps in Quality investing

The chart below shows the growth of Rs 10,000 investment in S&P BSE Quality Index TRI, S&P BSE 500 TRI and Sensex TRI over the last 10 years (ending 31^st May 2021). There can be periods where the broader market outperforms e.g. rallies from market bottom etc, but over long investment horizon quality investing has the potential to outperform (see the chart below).

Source: MSCI, Advisorkhoj Research (as on 31^st May 2021). Disclaimer: Past performance may or may not be sustained in the future

Quality stocks tend to deliver consistent financial performance irrespective of investment cycles. Hence it is important to remain invested in these stocks over several investment cycles to benefit from the power of compounding across different conditions. As such, quality investing may be a good strategy to invest for your long term financial goals e.g. retirement planning, children’s higher education, children’s marriage, wealth creation etc. Investors should consult with their financial advisors to know about mutual fund schemes which follow the quality investing strategy.